Emma Wall: Hello and welcome to Morningstar. I'm Emma Wall and I'm joined today by Simon Brazier, Manager of the Investec U.K. Alpha Fund. To give his three stock picks.
Hi Simon.
Simon Brazier: Hi Emma.
Wall: So what's the first company you'd like to highlight today?
Brazier: The first company is one of my very long term holdings which is Booker (BOK). Our main theme of our portfolio is in a low growth world, is trying to find companies that can reinvest their cash flow for growth. And Booker to me is a classic example of this. I mean here's a company in the food retailing/food distribution area.
Everyone talks about Tesco, what a disaster it's been and how there is pressure on the food retailers. But this is a company that’s continued to grow in that environment. Because actually they have built out a fantastic online distribution platform that can deliver frozen, chilled and fresh food across the U.K. but not serving the consumer, but serving private independent retail stores, cinemas, prisons, hospitals et cetera.
A classic example was last year he bought the Budgens and Londis stores across the U.K. they were loss making. But Booker are able to deliver to those stores profitably and we're going to see very good returns on the investment. He actually spent £40 million buying that business. and with recent sells of some of the freeholds that he bought he's already nearly got his GBP40 million back. That’s Charles Wilson the Chief Exec. So a very good story, good growth potential with that business. But most importantly he's able to use his cash flow to find opportunities like the Budgens and Londis stores to reinvest for growth.
Wall: It sounds like a golden child. You've held it for a very long time. What risks are involved in that stock, is it very linked to the domestic economy.
Brazier: Yes it is. I mean the reality is that if we would – some of the threats maybe that he – that Booker is making the independent retailer quite profitable. The supply chain for Booker is such that they are buying more Pepsi Cola than any of the other big supermarkets. So they are able to make their customers who are the convenient stores quite profitable.
So if we were to see the big supermarkets getting their game back together that maybe a threat. But the reality is it's such an incredibly well run business now and with some of that competitors more stressed financially, some of them have quite a lot debt. I think it's a company that could continue to grow in what is a low margin. Relatively low growth business, but actually if you are taking market share it can be profitable from a cash point of view.
Wall: What's the second stock today?
Brazier: Well, again in a low growth world where we are not relying on the top line growth of companies. I actually want to find companies that have got some self-help where there is recovery opportunity. And Balfour Beatty (BBY) is a company that I invested in the middle of last year. Leo Quinn who is the new chief exec he was at De La Rue and QinetiQ before has come in. And Balfour Beatty is never going to be highest quality business. It's a contracting business it has very, very low margins. But one dynamic of Balfour Beatty that has been weak, has been its cash, its cash generation.
And they are doing two things. They are improving the contracts they write. So they can improve their cash from that and also improving that cash within their business, their working capital, how they run their business and we're starting to see that cash generation come through in the business already. And yes profitability may take a bit longer but for me if Leo Quinn can continue to deliver cash flow and grow cash flow, we only need to see the margins in their contracting business back to 2%, 3% and the shares could have significant upside.
Wall: What's the third and final stock.
Brazier: The final area that may seem slightly strange in all the uncertainty around Brexit. But actually we see the U.K. economy as being a bit of a star in the global economic system. In the developed world we have 2% plus GDP growth, consumer confidence is relatively strong and low interest rates, low unemployment et cetera. And this gives rise to the fact that some of the domestic stocks we look at could do quite well. And one which is Lloyd's Bank (LLOY). I'm not stale bull on Lloyds. I have only bought Lloyds recently in the last year. I particularly added my weightings after the election.
And the three key factors for me, are first the political and regulatory environment around the banking system is better. The governments, the FCA, the PRA who have just signed off their dividend are much more supportive. Secondly the regulatory but from a capital perspective is better. Lloyds now has a 13% core tier one ratio. It is that where it needs to be, which means therefore as it grows its business which will be much slower than it was historically, but it can generate capital, it can generate cash.
And that cash flow does not need go back into the balance sheet. There was always this tension before Vince Cable saying I want the banks to lend and George Osborne said I want them to get your book in order. Today Vince Cable should be happy because actually they are able to lend and George Osborne should be happy because their balance sheet is in good position and hence they can generate cash, which would come back to me as a shareholder. And the special dividend we've just seen is I think a good sign that I can continue from here.
Wall: Simon thank you very much.
Brazier: Thanks Emma.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
