Reckitt Benckiser (RB.)
We are adding RB, formerly known as Reckitt Benckiser, to the Best Ideas list because we think its wide moat and above-average pricing power are underappreciated. RB's fourth-quarter results show that the company is not immune from the ongoing structural changes in consumer staples retail; however, with a portfolio that is increasingly skewed to businesses with pricing power, we think RB has a better chance than most in its peer group of reigniting organic growth.
The near term may remain ugly due to the return of commodity inflation, the recovering British pound, and pricing pressures in the weaker parts of the portfolio, but if the firm can return to a long-term organic revenue growth rate of closer to 5% while sustaining its margins, we believe there will be significant upside to the stock.
BT Group (BT.A)
While narrow-moat BT Group has had some issues in the past two years that caused its stock to decline, we believe the sell-off is overdone. BT is the incumbent telecom operator in the United Kingdom. In 2016, it acquired EE, the largest wireless telecom operator in the country.
The company now has the largest fixed-line telephone, broadband, and wireless telephone subscriber bases in the country. The company has been slow to market its converged services, but we believe now that it has reached an agreement with telecom regulator Ofcom regarding Openreach, its U.K. business that owns its fixed-line network and wholesales access to it to other operators, we expect a more aggressive marketing push into converged services during calendar 2018.
The market appears to believe the problems BT has seen will continue and potentially get worse, whereas we believe business can improve over the next few years. In the meantime, the stock yields 5.4% and the company has increased its dividend for each of the past seven years. Additionally, as it is a U.K.-domiciled company, there is no foreign tax withholding on the dividend.
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 fair value estimate.
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 3.5%.
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 is driven mainly by geopolitical uncertainties that may have discounted the expectation of enduring moderate economic growth.
Furthermore, 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 U.S. GDP and monthly economic figures provided some assurance that the economy will keep growing modestly. The European Union’s third-quarter economic numbers also have been reassuring. The annualised growth rate for the United Kingdom remained steady.
The firm possesses 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.
Shire (SHP)
We view Shire’s diversified rare-disease portfolio and neuroscience franchise as warranting a narrow moat rating, and while the pipeline is thinner than most large-cap biotechs, we think the portfolio is quite defensible, particularly the rapidly growing immunology franchise.
Given the stability of the firm’s core businesses, we’re not concerned about Shire’s financial health. We believe synergies between Shire and recently acquired Baxalta on the top line have not been fully appreciated. The immunology franchise appears to be gaining share internationally and seizing on trends for increased subcutaneous use in the US.
