Looking for investment opportunities to add to your value-driven portfolio? Morningstar’s equity analysts cover more than 1,500 companies worldwide and once a month identify the firms they believe are trading at below their fair value, looking across sectors, industries, and geographies. The list includes a broad mix of quality and risk characteristics to meet varying investor needs – some stocks may take some time to rise in value, and it may be a bumpy ride.
This month, just three UK companies make the list.
WPP (WPP)
WPP, the world’s largest ad holding company, is on our Best Ideas list, as we think the stock’s recent decline has created an attractive entry point for this narrow-moat name. The shares are trading at a discount to our £16.40 fair value estimate. At current levels, WPP's dividend yields 4%.
While we have been cautious regarding WPP and its peers, the selling is overdone, in our view. We think that what appears to be a slowdown in ad spending, based on the firm’s third-quarter results and lower guidance, is driven mainly by geopolitical uncertainties that may have discounted the expectation of enduring moderate economic growth.
Further, we believe that during the possible slowdown, WPP can maintain its operating margin at its current 14%-15% level and reward its shareholders via dividends and share buybacks. The latest US GDP and monthly economic figures provided some assurance that the economy will keep growing modestly despite the negative impact of hurricanes Harvey and Irma in the third quarter. The European Union’s third-quarter economic numbers also have been reassuring. The annualised growth rate for the United Kingdom remained steady.
While we view the latest indications as positive for the year, management has remained conservative and after releasing its third-quarter sales update lowered its 2017 organic growth guidance to flat from 0%-1%. We think WPP can maintain the 14%-15% operating margin range as it continues to streamline its agencies’ account management and increase efficiency in overall operations. Our narrow moat rating is based on valuable intangible assets around WPP’s brand equity and the strong reputations of its various advertising agencies around the world.
We also think the firm's continuing investments in consumer data accumulation and analysis give WPP a sustainable competitive advantage. Finally, to a lesser extent, we think WPP benefits from customer switching costs associated with further integration of its resources with its clients’ marketing departments.
Imperial Brands (IMB)
Imperial is the unloved stock in a sector that is very much in favour. The market is valuing tobacco stocks based on their exposure to heated tobacco, the emerging category that is achieving impressive growth in Japan and select markets around the world. We are bullish on heated tobacco, and we think a valuation premium for those leading and developing the category is appropriate.
However, we think the market is overestimating the value of the first-mover advantage, and if heated tobacco gains traction in other markets, particularly the U.S. and Europe, we expect Imperial to leverage its wide moat and follow Philip Morris, British American, and Japan Tobacco into the space with its own technology. Imperial's current multiple discount of 9 times P/E is much larger than the historical discount, and we think this is unjustified.
G4S (GFS)
Global security leader G4S has fallen more than 25% from its 2017 peak on the back of concerns about its India and Middle East business and resultant cuts to full-year revenue growth guidance. However, this division generates just 11% of group revenue and 15% of earnings before tax, and we believe many of the issues highlighted by investors in this business are short term in nature and do not pose a significant structural risk.
Longer term, we believe the ongoing restructuring program can further simplify the business and remove costs, and structural improvements, as the largest players in the industry shift toward higher-value activities, should go some way to improving revenue growth and operating margins for G4S. We see material upside to our 312p fair value estimate.
