Emma Wall: Hello and welcome to Morningstar. I'm Emma Wall and joining me today to give his three stock picks is Freddie Lait, Manager of the Latitude Horizon Fund.
Hi Freddie.
Freddie Lait: Hello.
Wall: So, what’s the first stock you'd like to highlight today?
Lait: So, all three stocks that I want to talk about are, very, very cheap stocks in the current market, which is characterised by overvaluation, and all three have a digital angle which I think gives them a great reason to own them for the next year or two, I might own them for the next five years.
The first stock is Bank of America (BAC), one of the leading banks in America. It’s a universal bank so it has trading, markets business, investment banking and a retail business across America. It's trading on 10 times earnings, 1.5 times book value which historically have been more like 14 times earnings and 2 times book value. So, I believe its trading 30% to 40% cheap, in any event. Plus, there's a couple of key reasons to look at it.
One is that growth in America is coming through very strongly. Loan growth is set to be 5% to 10% a year for the next few years and critically the growth over the last decade, since the crisis has been an incredibly high quality, high quality mortgages, high quality corporate loans. So, I believe the balance sheet is far stronger.
The business is far better capitalised, and it should experience some great growth. There is going to be some even better operating leverage drive through to the bottom line because of digitalisation. And the three key areas for them are payments technology, trading systems and customer satisfaction and service. If they can interact with you through their mobile banking app, it costs them a-tenth as what it costs them to deal with you in branch or elsewhere.
So, I see reason to believe that they could cut 10% to 15% out of their cost base driving earnings a further 30% higher. So, I think you could make 75% or maybe even 100% out of this stock over next three to five years. And you are getting 6% to 7% capital returns through buybacks and dividends already.
Wall: Pretty good and what's the second stock today?
Lait: So, the second stock is probably little bit more contentious, it's Royal Mail (RMG). Which we in the U.K. obviously know, but in case you have global listeners. It is the universal service operator for delivery in the UK, but critically it's also got a very, very successful international business called GLS.
Now the overall business trades on 10 times earnings again, very, very cheap. But GLS is a-third of its operating profit growing at 10% a year with very high margin, incredibly well regarded. And if you exclude that from the 10 times actually the core business in the U.K. trades on around seven times earnings, which I believe is incredibly cheap for business with its market position.
Now they have come out of a position of very heavy unionisation, very heavy pension deficit and they have a lot to do with their balance sheet to fix it. But they have done most of the things they need to do. Their productivity has been improving dramatically and their gross hours worked has gone down 15%, while driving increased revenues and margins which I think is a phenomenal achievement over the last five years. They have one of the top five brands in the U.K. they continue to monetise that.
And critically this digital angle if they can get tracking on to your parcels and letters which they are getting that market share up far higher. It's 50% to 75% cheaper to do the delivery for them, not to mention the obvious thing about the fact that digital is driving us all to shop online more and that’s driving parcel volume as well as advertising in post. And then once again the customer interface they can benefit from, if they send you a text and get you there on the hour et cetera, et cetera and the deliveries aren’t missed. It’s a phenomenal pickup in potential margin for this business. It pays a 6% dividend and I think there's lots of reasons to be hopeful for next five years that they can double their margins.
Wall: What about the third and final stock?
Lait: So, the third and final stock is European stock, its Orange (ORA). Which is the old France telecom. It is fixed and wireless in France. It's trading little bit more expensive, it's on 13 times earnings, but for a very, very recurring earnings base. I still believe that’s very cheap. It has 5% dividend and a phenomenal position in a cycle where post the dotcom bubble in 2000 its undergone this massive transformation where the regulators have been aggressively attacking the market. And have now take their foot off the throttle a little bit. So, I think the regulatory cycle is turning slightly in their favor. And again, the key thing for them is this cost saving which I believe is a 30% cost saving potential market share.
From moving from manual services to digital. For example, they recently relaunched their app, using IBM's AI software, Watson which is obviously very advanced digital software. And its cut their costs by 20% in half a year which is a phenomenal achievement and again its about as a-tenth as expensive to service someone through an app as it is through personal interaction. Their revenues are also driving through digital as they cross sell and manage to target banking customers from their telco base. And I just think that’s a phenomenal thing for their cash flow and I think probably a 30% increment for their cashflow over the next five years.
Wall: Freddie thank you very much.
Lait: Thank you.
Wall: This is Emma Wall from Morningstar. Thank you for watching.
