Lloyds Banking Group PLC (LLOY)
Lloyds nearly destroyed itself in 2008 with its ill-considered acquisition of HBOS, and the U.K. government ended up with 43.5% of the combined group. Now, after years of bailouts and setbacks, the bank has come a long way in righting itself, and the government has begun selling down its stake. We're encouraged that the U.K. recovery is gaining speed, and we expect to see double-digit return on equity in 2015, along with a 2016 forward dividend yield of at least 4%, as a result.
Glencore ranks among the most diversified of the global megaminers. Glencore plays in everything from aluminum to zinc, but copper and coal are its most important products. But because China is the key demand driver for nearly everything Glencore digs out of the ground, diversification benefits are limited. Weaker Chinese GDP growth and the end of the investment-led economic model portend tepid demand and lower prices for most of Glencore’s industrial commodities. Glencore's oil and agriculture businesses are less China-centric but smaller in size.
Even when oil prices were $100 a barrel, Shell's portfolio was strewn with problems. Huge bets on shale destroyed huge amounts of capital, and the company's upstream resource base has few growth options with strong economics; the low-cost Brazilian oil it is acquiring from BG is the one major exception). The company's chronically poorly performing downstream also has been a consistent drag on returns on capital. Even though significant restructuring actions have begun under new CEO Ben van Beurden, the recent collapse in oil prices adds considerable pressure that we think the company will struggle mightily to overcome.
The oil majors face a key challenge: Replacing reserves is becoming increasingly difficult for a company of BP's size. There is a lot of oil left in the world, but finding large amounts of new low-cost reserves remains a daunting task, in no small part because many governments now don't allow Western companies access to their resources. Outside of Russia, BP today produces the equivalent of more than 800 million barrels of oil and gas; this represents the level of resources it needs to add on an annual basis to prevent reserves from declining. But there simply are not this many barrels of conventional oil and gas reserves annually accessible to BP.
As one of the largest pharmaceutical companies, GlaxoSmithKline has used its vast resources to create the next generation of health-care treatments. The company's innovative new product lineup and expansive list of patent-protected drugs create a wide economic moat, in our opinion. The magnitude of the company's reach is evidenced by a product portfolio that spans several therapeutic classes, as well as vaccines and consumer goods. The diverse platform insulates the company from problems with any single product.
Flowgroup (FLOW)
Flowgroup PLC and its subsidiaries are engaged in developing and commercializing alternative and efficient energy products and supply home energy.
HSBC’s narrow moat is built on its nearly unparalleled global network, whose geography covers 90% of global trade and capital flows, with approximately 40% of its revenue coming from firms operating in two or more markets and other institutional clients. We think this gives HSBC the reach and scale necessary to serve international corporate clients in a way few other firms can rival. This reach has increasingly been a double-edged sword in recent years. The ongoing slowdown in Asia and Latin America is likely to cause revenues to dip and loan losses to rise.
We believe Aviva's turnaround efforts will continue to limit the firm's near-term growth, but so far the firm has showed steady improvement in cash flow generation and capital surplus. Under the leadership of Mark Wilson, Aviva is set for a new direction aimed at reviving insurance sales, reducing financial leverage, and disposing of underperforming businesses. To achieve these goals, the firm exited the U.S. market, where profits took a dive because of spread compression. The firm also reduced dividends to shareholders to retain more cash for rainy days. All of these efforts seem to have had a positive impact on the company's financials, with capital surplus more than doubling and cash remittances continuing to improve.
We believe 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.
Barclays spent much of 2015 at a crossroads but its path may soon be much clearer. New Chairman John McFarlane is clearly determined to improve profitability, though it's been unclear how he intends to do so. Investors may soon have the answer when new CEO James "Jes" Staley takes over after former CEO Antony Jenkins' dismissal in July.
