Emma Wall: Hello and welcome to Morningstar. I'm Emma Wall and here with me today to give his three stock picks is James Clunie, manager of the Jupiter Absolute Return fund.
Hello, James.
James Clunie: Good Morning.
Wall: So what's the first theme we are going to talk about today?
Clunie: The first theme is I am long on big oil stocks around the world, so companies like Statoil (STL), Eni (ENI) and Total (FP) and the reason I like them is that they represent fairly decent value, are somewhat out of fashion and have reasonable quality and reasonable balance sheets. But in the main, the change story is that they have grown their capital expenditures over many years, made a series of bad project choices as well as good ones and learned their lesson.
What we should see going forward is better capital discipline, reduced CapEx and in about two or three years' time, we'll begin to see improved returns on assets, improved returns on investment. At that point, I suspect the market will say these firms are actually quite decent rather than the low quality firms we currently think they are and there should be a re-rating. While you wait for that re-rating, you get a fairly good dividend yield hence a decent total return over the medium term.
Wall: I think the two big themes that perhaps made people nervous about oil investment, about energy investment is number one the Middle East and the sort of ongoing turmoil, sadly that we see in that region. Secondly, is the big energy boom is going on in U.S. and how those shale gas discoveries and oil discoveries actually have, I suppose, the opposite effect on the Middle Eastern stuff, a downed pressure on energy, so how do those impact the stocks?
Clunie: Sure, the thing I like about the reduced CapEx argument is that it's something that management can do regardless of what the economy does or what the geopolitics is like or regardless of what their oil price does, it's actually a management action that they can actually take a form of discipline.
Wall: Inner efficiency as it were.
Clunie: Yeah, in a sense, rather than choose all the projects out there, is to say, look, we have a reduced budget, we'll chose what we think are the very best projects and we'll defer or remove the projects that are less attractive for the margin. So, the things that you mentioned I think are important and will swing around the actual results they get. But what they do, they can do regardless of what goes on and I think it will mean improved returns that become visible in a few years' time and our understanding of the quality of these firms should change.
Wall: What's the second position then you wanted to talk about?
Clunie: The second position is a short position and it's in the high-quality firm, but what I think is a bad stock and it's Diageo (DGE), which is a great firm, with a great long-term track record, a wonderful global reach of its products. But quite simply, it is highly rated, we all believe it's a good quality stock with a great growth prospects and actually it's suffering from a deteriorating outlook.
Revenues are disappointed, earnings have been downgraded. So, what we've essentially got is a highly priced stock with negative news flow. Great firm, bad stock.
Wall: Is part of that negative news flow to do with things like the SABMiller (SAB) merger? The conversation that's going on in the moment, are there just simply better brewers out there?
Clunie: Well, I think part of the reason is foreign exchange. Part of it is the fact that, lot of the growth of firms like Diageo were in emerging markets and mentally we as analyst had extrapolated that growth forward forever. We're now learning it's cyclical and so there is a shock there that's negative. Then also, some of the acquisitions that we've seen recently seem to be fairly rich valuations. It is not obvious whether they were creating value for the shareholders and Diageo themselves.
Wall: What about your third position then?
Clunie: So, third position is also a short position. Sorry, to be too negative. But it is a Portuguese retailer with lots of activities in Poland, Jeronimo Martins (EMT) and it's a very similar story. A highly rated stock that's been growing for many years, where now we're seeing earnings downgrades and the thematic sort of negative catalyst there is that a price deflation or removal of sort of price inflation in some of the markets like Poland are beginning to have an impact on that business. Supermarkets don't like price deflation, they seem to like price inflation, so you've got an overpriced stock with downgrades and some negative sort of economic sort of headwind and together that looks like a straightforward short sell.
Wall: If the European economic – even the Eastern European economic situation improves, would perhaps that be a key for you to sort of pull back on that?
Clunie: That would be positive news and that indeed would be now the removal of one of the negatives, so that would be an important fact, but I think looking at the inflation rates says is, another important factor and the moment what we seem to have is a reasonably dull European economy, but the inflation series are not going the right way for supermarkets, so I'd be watching both of those to either stop the short or to actually continue on building it.
Wall: James, Thank you very much.
Clunie: Thank you.
Wall: This is Emma Wall for Morningstar, thank you for watching.
