Emma Wall: Hello, and welcome to Morningstar. I am Emma Wall and here with me today to give his three stock picks is Richard Buxton, Manager of the Old Mutual UK Alpha Fund.
Hello, Richard.
Richard Buxton: Hi.
Wall: So what's the first stock today?
Buxton: Well, it is one I've held for a couple of years now, but I still think there's a lot to go for and that's the insurance company, Aviva (AV.). It's been a self-help new management improved turnaround situation, which slightly caught the market by surprise by the end of last year announcing a merger with Friends Life, which is just about to complete.
Now, that I think is actually a classic case of two plus two equals a lot more than four. I think the businesses are going to fit together extremely well. It's going to provide additional cost savings and synergies and I think there's a lot more to go for in the share.
Wall: Shareholders of Aviva a couple of years ago had a bit of a shocker when it cut its dividend quite unexpectedly. Have things significantly improved since then?
Buxton: Absolutely. I mean, that was a necessary thing to do; they've sold businesses, they've raised capital. Let's forget it's a completely new management team since then. And again this combination with Friends Life will re-accelerate the prospects of dividend growth from the rebase level. So that actually you look at couple of years out, we could see dividends back at the level it was before the cut.
Wall: What's the second stock today?
Buxton: Well, controversially I'm going to go for mining company. Now, the commodity super-cycle is over, dead and buried. But, Glencore (GLEN) firstly, has the huge marketing, trading side where since it's been floated – I've now got much more comfortable with the consistency of the delivery of a level of profitability from that. It's got an interesting mix of assets and is very focused on returns to shareholders.
It is buying back shares even as we speak. And I think that an area that is extremely out of favor with – for managers will know China is growing much more slowly, et cetera. This is a contrarian idea that our three-year view could actually make you quite a lot of money.
Wall: Commodity prices have gone only one way down over the last couple of years, pure commodity fund has done very poorly, oil prices obviously halved, copper has done very badly…?
Buxton: Iron ore is down $47, I mean, yeah. But again we know all this and we know that China is growing much, much more slowly. They want a different type of growth over the next 10 years, much less dependent on infrastructure investment. But as they from here I think all of this is reflected in the share price.
And actually the scope for them to continue to use their trading network profitably, to be able to actually deliver quite strong returns to shareholders both buybacks and dividend makes this an interesting opportunity.
Wall: And what's the third and final stock?
Buxton: Well, I was going to mention Tesco, which is a first stock I've been buying this year. That has actually rallied 20% since I started buying it. So, I mean, in the medium term I think that is a good stock to go back into.
But again, I'm going to go for something a little more risky and a bit off beat. Drax (DRX) is a power station, Yorkshire based. It's transitioning from being a dirty grid coal-fired one to a green biomass fueled one. It was very weak last year, partly because ultimately electricity prices are linked to gas prizes and oil prices. And clearly with the weakness in the oil price, that didn't help. The mildest winter in U.K. for years didn't help. There was uncertainty about the government subsidy regime and levels of subsidy that are going to be given.
So the shares are right down at a low point. But the fact is that power stations are closing across the U.K. and we do not have sufficient capacity looking a few years out to actually keep the lights on. So this is a very strategic assets, it generates about 7% of the U.K.'s electricity in a market that is tightening. So, I think, again taking a longer view, pricing will firm up. We probably won't have a repeat of the mild winter. And as pricing firms up and you've got clarity on the degree of incentive that's being given for the biomass this is an asset whose value is only going to grow.
Wall: Renewables have dropped off the radar a little bit just because it seems that we were told fossil fuels are finite and then all these discoveries keep being made in America and potential fracking here in the U.K., how much does supply and demand of these traditional fossil fuels impact a newer form of energy?
Buxton: Hugely. I'll say because ultimately it's the fossil fuel prices that drive still the markets both electricity, gas et cetera and renewables was having to bid price against that. And as I say it's levels of subsidy to encourage companies to make the investments or as I say, not, which is leading to other coal-fired stations that are closing down.
So, no, I've never believed that we're coming to the end of the usage of fossil fuels. If you look at the long-term projections, they will continue to rise. It's just that the renewables and non-fossil fuels will form a greater proportion of the cake. But here is a very interesting company that is making the shift.
Well, I think as I say that tightening in the electricity supply market in the U.K. means that it's good to be increasingly valuable.
Wall: Richard, thank you very much.
Buxton: Not at all.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
