Holly Cook: Hello, and welcome to the Morningstar series, "3 Stock Picks." To share his stock picks with us I'm joined by John Baker. He is Co-Manager of the JPMorgan UK Dynamic Fund.
John, thanks for joining me.
John Baker: Good morning, Holly.
Cook: So, let's jump straight in. What's the first stock pick that you're excited about at the moment?
Baker: Well, one of the stocks that we particularly like at the moment is Aldermore (ALD). Now, Aldermore is a challenger bank, the banks that the government wants to encourage to increase competition amongst the traditional banking system. Aldermore is interesting also because it does what we call manual bespoke underwriting.
So, for instance, if you're an applicant for a mortgage but you've perhaps got multiple income streams or perhaps you've changed jobs recently, you might not pass the automated checking that the large high-street banks do. So, Aldermore focuses on those people. It also engages in buy-to-let lending. The buy-to-let market is extremely strong. I think over the year till September it's grown by 36%, so significant growth opportunity for Aldermore there and of course, as they lend more, it improves their overall cost base, so driving a very strong profit trajectory.
Cook: And if we look on the sort of potential risks side, is it perhaps as a challenger bank engaging in slightly more riskier activity in terms of buy-to-let or is that not a concern for you?
Baker: It's not a concern for us. We believe that their underwriting standards even though they are manual and bespoke are in actual fact very rigorous and they take a holistic view also of the person who is borrowing for them, making sure that the average monthly payment is actually within the ability to pay.
Cook: Okay. Let's move on. What's number two on your list?
Baker: Number two is Next (NXT). It doesn't need much of an introduction, a high-street retailer. Next has been growing very rapidly for many, many years now and there has been actually no slowdown in that rate of growth. The growth from their store portfolio is strong, also online and of course, they've had a directory business for quite some time now. Directory is also growing internationally.
They are rolling that business out and in the last year it delivered 26% growth. Next also has an extremely strong balance sheet and it's able to return cash to shareholders.
Cook: So, this is all standing kind of rather stable. What would be a potential alarm bell for you?
Baker: For any retailer one of the most important things to do is to manage their stock such as they are not forced to write down stock in sales. That's very detrimental to profitability. So, we constantly watch in what we call the gross margin to make sure that there is no deterioration there. That's the key focus.
Cook: And last but not least I'm sure, what's the third stock pick?
Baker: I'm going to talk about Taylor Wimpey ( now. This is a U.K. housebuilder. I like to talk about the U.K. housing market quite distinctly sum it up in just one sentence which is that supply is running at just 50% of the level of demand. So, of course, this creates an environment in which housebuilders are able to put prices up and also increase volumes as well.
Profitability has been improving for another reason as well which is that the cost of buying land for housebuilders has come down significantly since 2007 and that's because there is so much less competition from small local housebuilders who neither have access to credit like the big guys do nor do they have the efficiencies to develop the environmental standards that are now required and also put in the infrastructure that government now demands as well.
Cook: Of course, we are all too familiar with the ups and downs of the housing price market. Is it pricing that is a concern for you or would it be another factor that you would keep in mind?
Baker: Pricing is quite clearly a factor. That is probably the single most important influence because we need to consider that consumers are going to be able to borrow sufficient capital to buy the house and also to make sure that affordability stays within normal bands. So, we're constantly watching house price inflation to make sure that people are not being priced out of the market.
Cook: John, thanks very much for sharing your stock picks with us today.
Baker: Thank you, Holly.
Cook: For Morningstar, I'm Holly Cook. Thanks for watching.
