There are two questions that come up time and again in meetings with clients, says Invesco Perpetual’s Mark Barnett: what do you think about Brexit and why are you buying oil companies?
The latter question “tells me how contrarian a call this is”, the manager of the Bronze-rated Invesco Perpetual Income fund admits. It can even be argued it’s at odds with Barnett’s own wider view of markets.
At an event in London last week, Barnett explained how domestic sectors have been unfairly de-rated in the aftermath of last June’s Brexit vote. He illustrated that UK-centric Next (NXT) and Capita (CPI), two companies he likes, have seen their valuations pushed down.
Similarly, sentiment towards real estate, a sector he is positive on, is near rock-bottom. As a result, stocks in this area are taking advantage of an arbitrage opportunity by selling assets at premiums to book value and retiring equity at a 25% discount to book value. He likes London-focused Derwent (DLN) and Shaftesbury (SHB).
He says “the market is trying to say that Brexit is an accident waiting to happen”, while international investors “have all but given up on the UK”. However, “while I’ll accept that the UK economy has slowed this year, actually the economy’s performed better than expected”.
But, despite preferring domestic companies, “some of the international sectors are looking interesting as well”. The oil sector in particular is “undergoing significant self-help”.
The oil price has seen a heavy de-rating in recent years. Brent crude was trading above $100 as recently as mid-2014, before reaching a nadir of $28 in early 2016. As a result, oil majors’ share prices slipped to multi-year lows.
While these firms' share prices have pretty much recovered now, they are still lowly valued, according to Barnett. “That’s anomalous in the context of how markets are valuing businesses”, with investors paying up for dollar earners at the expense of domestically focused ones.
However, oil companies have quietly been improving their efficiency. The likes of BP (BP.) and Royal Dutch Shell (RDSB) have been driving down their break-even points in response to an oil price that is likely to remain within a range of $40-60. They are now more profitable than when the oil price was over $100.
The oil sector is a fertile hunting ground for income-focused investors and Shell and BP are two of the highest yielding stocks in the FTSE 100 at 5-6%-plus. They are numbers Barnett believes are “significantly too high”. “It wouldn’t surprise me if they start to trade below 5-6% over the next few months.”
BP, the largest holding in IP Income, is so confident in its prospects it announced last month that it would resume a share buyback programme aimed at cancelling its dilutive scrip dividend.
Pharmaceutical Stocks also Look Good
Pharmaceuticals are another international area Barnett is bullish about. He benefits here from the ability to select non-UK-listed stocks and holds Swiss pharma Roche (RO) as well as many US firms. In the UK, he has big positions in AstraZeneca (AZN) and BTG (BTG).
Demographic trends in both developed and emerging markets – ageing populations – are “well established” and “prospects for pipelines are better than we have seen for some time”, he says. In the developing world, “consumers are demanding better standards of healthcare and western drugs and the companies that can benefit from that are the companies that I own”.
