Emma Wall: Hello, and welcome to Morningstar. I'm Emma Wall and I'm joined today to give his three stock picks by Richard Buxton, manager of the Old Mutual UK Alpha Fund.
Hello, Richard.
Richard Buxton: Good Morning.
Wall: So, what's the first stock today?
Buxton: HSBC (HSBA). Now, this is a very sort of stogy, boring, large-cap stock. But firstly, it's a dollar stock and with sterling weakening you're getting automatic upgrades to profit forecasts from HSBC. Secondly, it's a financial and as we begin to see that perhaps the bond bull market has come to an end after 30 years, gilt yields are just slightly starting to move upwards, a positive move upwards in interest rates, particularly in the U.S. will be hugely beneficial to the profitability of someone like HSBC.
Wall: Now, HSBC is a financial and it is a U.K.-domiciled financial. There is a lot of uncertainty around financials as you well know yourself post Brexit. How much do you have to take that into consideration when choosing to invest in HSBC?
Buxton: Very much, but I think the shares until very recently because of the currency movement. Financials have been very unloved. They are under-owned and I think they are pretty cheap. We met their Finance Director recently. We're extremely confident that the very attractive dividend yield is going to be maintained.
There's a number of analysts who still suspect it will be cut. So, you've got a very reassuring degree of support from the yield coming through from the stock and because they are very exposed clearly to faster-growing markets like Asia, I think you can take a lot of comfort from owning that stock.
Wall: What's the second stock today?
Buxton: Tesco (TSCO). Now, five years ago I sold Tesco – five, six years ago after many years of ownership and we know there was a sort of slow motion car crash for a number of years. But I bought back into it last year. I think that Dave Lewis, the new Chief Executive, ex-Unilever, has acknowledged that it's going to be a five-year process turning this business around, but recent results have clearly shown that it's beginning to work.
All the actions that he is taking they are beginning to attract customers back and they are spending a bit more money and they are still far and away the largest player in what is a very crowded U.K. market. So, although we fully accept it's still an incredible competitive industry and discounters are here and they are not going away, I do think that slowly incrementally he will be able to turn that business around and that will be rewarding for shareholders.
Wall: Now, Tesco was a Dividend darling; however, it's cut its dividend following the expenses scandal – not expenses, accounting rather – do you see Tesco being in a position to reinstate that dividend anytime soon?
Buxton: Not anytime soon. If they did do something, it would be remarkably too good because they still have quite a lot of debt on the balance sheet and they'd rather be honest to spend the money buying in some of the leases on stores that they sold in previous years, buy them back and own them and avoid some of the very onerous rental increases and so on.
So, no dividend from them anytime soon, but if you've got your HSBC, you'll have a nice yield there. But I think it's still good two three years to go before they can really get back to a level of profitability where you will start to see a resumption of dividend.
Wall: What's the third and final stock?
Buxton: Merlin Entertainment (MERL). Now, this is a worldwide business but listed in London that owns theme parks and attractions which is a fabulous long-term structural growth industry. They partner with LEGOLAND to build the LEGOLAND parks around the world. It's not a cheap share because the market does recognize the quality of the long-term franchise, but they have suffered a little bit year because bizarre to recall now, but the pound was actually stronger against the euro, so they suffered from more Britons holidaying abroad, fewer visitors to the U.K. and London is quite an important center for them.
But clearly, next year the reverse will apply. There may will be many Brits who end up concluding their holiday in the U.K., so go to the U.K. attractions and conversely, there will be many more visitors coming to London from overseas. So, that's the kind of short-term fillip for the next 12 months to what is a very good long-term story.
Wall: And how concentrated in the U.K. is it, because of course there is still a slight threat of recession post Brexit and with stocks that are too domestically-focused that is something to be concerned about, isn't it?
Buxton: It is. I think the U.K. economy will gradually decelerate and it is going to be quite sluggish. But as I say, with a company like Merlin, it's so driven by overseas visitors to London in particular that whilst its other attractions in the U.K. are important, it's far more offset by people coming to the London Eye and so on and so forth. So, I think they are pretty well hedged against consumer weakness in the U.K.
Wall: Richard, thank you very much.
Buxton: Not at all.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
