UK Equities: Opportunity in Adversity

For example, the environment has improved for electrical retailer Dixons (DXNS). Financial pressures resulting in the exit of a major competitor, Comet, should bring market share gains and a better balance of power between retailers and manufacturers in an industry that is currently benefiting from significant new product development, despite price deflation. Added to management’s restructuring initiatives, we believe investors are too fixated on the macroeconomic environment and are underestimating Dixons’ potential future profitability.

We are also positive on Howden Joinery (HWDN), the kitchen cabinet designer and installer. Despite a difficult market, we expect the company’s focus on trade buyers to ensure growth, as demand shifts from do-it-yourself to done-for-you. Howden is also improving operational efficiency and adding new depots while gaining market share from competitors such as Magnet, where credit rationing is causing difficulties and forcing capacity reduction.

A lack of credit is an issue for many industries. In the US, limited financing is constraining new hotel supply growth, despite strong corporate demand and revenue per available room returning to 2007 levels. Therefore, UK-listed Intercontinental Hotels Group (IHG) (Chart 1), owner of Holiday Inn and Crowne Plaza, is able to capitalise on high occupancy rates by charging more for its rooms. The company can also use its relatively advantageous position to develop new brands that will help broaden penetration in the US and Asia.

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Ashtead (AHT), a plant hire company with significant business in the US, is another firm we expect to continue to perform well, as capital-constrained customers increasingly hire rather than buy machinery. With their smaller competitors also struggling for financing to replace and upgrade their fleet inventory, we expect Ashtead to gain market share. Significant earnings upgrades demonstrate that carefully selected companies can thrive in a difficult economic environment.

End-Market Recovery

With so much focus on the domestic economy, it is easy to assume all industries are experiencing depressed conditions and also to forget that many UK companies have significant overseas growth avenues. One end market where we see signs of recovery is US housing.

Construction materials supplier Wolseley (WOS)(Chart 1) has significant American exposure and is in a strong position to exploit this positive change. Our interest extends beyond a cyclical US housing market recovery; the company is also a beneficiary of the UK Green Deal and boiler scrappage schemes intended to improve household carbon emissions. In addition, we believe investors are currently underestimating management’s self-help strategy, which could be a potentially significant source of additional profitability. This initiative is designed to improve operational performance through more efficient procurement, pricing reforms in the US, where 60% of branches have yet to implement the preferred pricing structure, and better use of its customer database to target sales efforts.

Lupus Capital (LUP) is another holding with exposure to this recovering market through its energy efficient doors and windows, as well as its locks and electronic security controls business. 

Elsewhere, economic growth in Eastern Europe and Mexico is providing companies such as International Personal Finance (IPF) the opportunity to realise the significant potential in its consumer credit business. In addition, the company is focused on operational improvements, particularly training of employees and reducing staff turnover, in order to accelerate loan growth. We believe this will supplement the already strong market potential by creating a sound basis from which to grow more sustainably over the longer term.

Our Strategy within UK Equities

UK equities suffer from broader downbeat perceptions of the UK economy as a whole. However, while several industries are suffering, we continue to identify strong investment opportunities. These include, for example, significant, underestimated industry or stock-specific changes in end markets showing signs of recovery.

One area where we are increasingly positive is banking. The sector is approaching the end of its capital rebuilding phase and many peripheral businesses have been sold. Companies such as Lloyds Banking Group (LLOY) and Barclays (BARC) have enjoyed earnings upgrades from improved net interest margins, while the sector’s low valuation relative to international peers could lead to a further re-rating as risk perceptions subside.

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All information, opinions and estimates in this document are those of Standard Life Investments, and constitute our best judgement as of the date indicated and may be superseded by subsequent market events or other reasons. This material is for informational purposes only and does not constitute an offer to sell, or solicitation of an offer to purchase any security, nor does it constitute investment advice or an endorsement with respect to any investment vehicle. Any offer of securities may be made only by means of a formal confidential private offering memorandum. This material serves to provide general information and is not meant to be legal or tax advice for any particular investor, which can only be provided by qualified tax and legal counsel. This material is confidential and is not to be reproduced in whole or in part without the prior written consent of Standard Life Investments.