3 Undervalued UK Stocks

THE VALUE INVESTOR: These three UK stocks are trading at less than their fair value according to Morningstar equity analysts - they all have a four star rating

Morningstar Equity Analysts 2 June, 2015 | 5:02PM
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De La Rue (DLAR)

Based in the United Kingdom, De La Rue offers services that centre on designing, printing, and handling currency and security documents. The company is a leading player in its industry and has relationships with 150 countries. De La Rue employs about 4,000 people in 24 countries.

The nature of De La Rue's business means year-to-year performance can be quite lumpy. Some industry issues will be a serious headwind in the near term, but we think the company can achieve modest growth and strong profitability over time. Until the world is completely cashless, which we believe is unlikely anytime soon, De La Rue will remain in business.

In fact, the company estimates that the volume of banknotes worldwide has been increasing at a 4% rate over time, allowing for modest growth. But that growth can be lumpy and is tied to a fairly unpredictable cycle of new currency designs.

Tesco (TSCO)

Tesco operates a network of more than 6,500 retail stores in the United Kingdom, Europe, and Asia. A majority of Tesco's revenue comes from the sale of food products, although the firm also sells gasoline and a variety of general merchandise products in multiple channels. Tesco generates more than 65% of its revenue in the UK. The remainder is generated from Asia, Europe and Tesco's bank.

We think Tesco's scale allows the firm to operate more efficiently than many competitors, and its convenient locations and loyalty program should continue to drive traffic. However, we don't have enough confidence in Tesco's ability to sustain excess returns over the long term to assign the firm an economic moat.

Switching costs are non-existent in grocery retail, and competing on price while sustaining excess returns is a tough proposition. Defensive retailers with a moat tend to have clear cost advantages, and because Tesco's competitors have sufficient scale to remain competitive on price while touting points of differentiation many of which could be replicated over a decade, we don't think Tesco has a material leg up on its peers.

Centrica (CNA)

Centrica PLC is a vertically integrated utility based in the UK with operations that produce and supply natural gas and electricity. Its British Gas business unit is the largest residential supplier of natural gas and HVAC services in Britain. Centrica owns the Rough natural gas storage facility, representing 70% of the UK's total storage capacity. Its North American Direct Energy unit, although growing rapidly, is smaller than British Gas, but has a similar business model.

We suspect the recent sharp decline in energy prices has resulted in Centrica rethinking its strategy to hedge its retail natural gas sales with its own assets. Its British Gas subsidiary is the largest natural gas retailer in the UK, with more than a 35% market share. Centrica has also increased its US presence.

In 2013, its Direct Energy unit acquired Hess' energy marketing business for $1.2 billion, making the company the largest commercial and industrial natural gas supplier in the US Centrica's strategy is to hedge approximately 50% of its natural gas sales with its own assets.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
Centrica PLC118.00 GBX0.60Rating
De La Rue PLC95.80 GBX-2.84
Tesco PLC348.00 GBX1.69Rating

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Morningstar Equity Analysts  Morningstar stock and fund analysts cover 2,000 mutual funds, 2,100 equities, and 300 exchange-traded funds.

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