Overblown fears about a Brexit ‘no deal’ has created the opportunity to pick up attractively priced stocks that could benefit greatly from a rally in the UK’s high street, says Alan Custis, head of UK equity at Lazard.
‘We have already had several shots across the bow; for example, when people started talking about the Brexit divorce bill and started putting a number on that we started to see an uptick in some of the better UK names,’ he said.
‘We always have to be aware if there was a change that is viewed positively by investors we could have a snap back rally. So in the last few weeks we have started to pick up a couple of UK names, such as SuperGroup, which is UK themed but the investment thesis is not around the UK in particular.
‘Post the referendum we, like many others, thought we would see significant weakness in the UK, whether that was manifested in consumer spending or corporate decision making, which turned out to be wrong. The economy held up a lot better in the second half of the year,’ he said.
Continuing to anticipate weakness coming into 2017, the Citywire A-rated manager reduced his holdings in a number of companies exposed to the expected slowdown.
His Omega fund sold names like Provident Financial, although this was ahead of its meltdown in the summer, as well as Greene King and Howden Joinery Group.
However, Custis re-examined this position when surprise ‘progress’ in the negotiations brought about a small rally in the FTSE.
Should Brexit talks lead to a meaningful deal that markets support, SuperGroup will benefit through its 60 UK stores, while being blanketed from the effects of a bad deal through its international expansion plans and significant online sales, argued Custis.
How to win on the high street
It is not just SuperGroup that could benefit, according to Custis. Other high street retailers also look set for a good year.
One company the fund manager is looking at coming into Q1 2018 is Dixons Carphone. The telecommunications retailer fell out of favour over fears that it could not make the structural changes needed to sell products online and because of a rerating after the collapse of Carphone Warehouse, was seen as a ‘harbinger of things to come’.
‘Dixons, the PC World white good section, is currently doing plus six in like for like sales against Amazon and Ebay,’ said Custis.
‘This is because when people purchase high value items, such as a washing machine, they still prefer going into the shop, getting advice in person and having a store which they can return the item to should it be faulty.
‘This shows that when you are the de facto high street operator there is still quite a big business if you are priced competitively. Retailers that have a future in physical stores that are attractively valued such as this could be an area that next year we look at more constructively.’
Another such sector is supermarkets, where Custis argues the price war is finally over.
‘Tesco’s price proposition is now closer than ever to discount retailers Aldi and Lidl on the “essential 300 items”. So why would you go to Aldi or Lidl instead of Tesco?
‘It has also been given the okay from the regulator for the Booker deal which should clear in the first quarter of 2018. At the moment they are making margins of 2.5% and guarding 3.5% to 4% – and that’s not including any synergies from the Booker deal which means, in theory, you could see a near doubling of profits from where it is today.’
For these reasons Tesco, which is a top 10 holding in the fund, continues to look cheap, according to Custis.
Going into 2018, UK banks could be another high street staple that provide good returns, he added.
‘We are now more constructive on banks,’ he said. ‘We believe that we have now reached a regulatory high water mark and it feels like there is potential for a more stable landscape.
‘It is horses for courses, Lloyds for example is not expected to grow its earnings and will pay the majority of its earnings in the form of dividends. If that suits your investment time horizon and status then that’s fine. The book value will not grow.
‘While Royal Bank of Scotland, the cheapest of the high street banks, has to unwind its government ownership and still has a conduct ruling overhanging from the US.
‘But the underlying business is improving and low valuation reflects the fact that these issues haven’t been fully resolved.
‘That leaves Barclays, which is very cheap,’ said Custis. ‘However, it has its own issues, such as whether the bank’s CEO Jes Stately will resign following an investigation into his alleged attempt to unmask a whistle blower in 2016.’
The Lazard Omega fund returned 13.55% and 27.7% over one and three years, compared to a sector average return of 14% and 26.7% respectively.