It’s no secret that the UK has been an out-of-favour market for many investors, particularly global ones, since the country’s referendum on leaving the European Union. It’s also no secret that, within that, domestic names have done much worse than those overseas earners.
Indeed, between June 24, 2016 and December 31, 2018, the blue-chip FTSE 100 index, which is largely made up of the latter, had returned 17%. In contrast, the more domestically focused FTSE 250 is up just 4.5%.
However, we recently revealed that investors into exchange traded funds have started to rethink their allocations to UK stocks, and it’s that beaten up mid-cap area they have begun with. Inflows into ETFs tracking the FTSE 250 reached €872 million in the first quarter of 2019.
And the signs are positive. In the year to April 10, the FTSE 250 is up 12.4% compared with the FTSE 100’s 11.8%. True, it’s only a slight outperformance, but it’s a start.
And fund managers are becoming more positive on mid-cap UK. In fact, while the index is more domestic in its make up, there are plenty of ways to gain exposure to places like the US, Europe and even Africa from its constituents.
Morningstar.co.uk asked a trio of fund managers which FTSE 250 names they preferred.
Britvic (BVIC)
Britvic owns beverage brands including Robinsons fruit squash, R Whites lemonade and J2O, as well as having exclusive agreements to make, bottle and distribute products made by Pepsico including Pepsi, Gatorade and 7UP.
Outside of the UK, it owns similar brands in Ireland, fruit juice and syrup brands in France and liquid concentrates and ready-to-drink nectar products in Brazil.
David Smith, manager of the Henderson High Income Trust (HHI), says the firm has been investing heavily in recent years both for growth and also to improve their operational efficiencies and supply chains. This is something he likes to see in investee companies.
“You’ve seen three years where capex levels have been very high,” says Smith. “As you see that capex fall off, you should see profits growth from the fruits of their investments coming through, whether it’s through growth or operational efficiencies.”
That should translate through to better free cash flow generation over the next two years or so, and Smith thinks we’ll see much better dividend growth than the market is currently anticipating.
Since reaching a three-year low of 533p in November 2016, shares have resumed their slow but steady upwards trajectory and are up two-thirds since the start of 2017, trading on a price/earnings ratio of around 20 times with a near-3% yield.
TI Fluid Systems (TIFS)
TI Fluid, which provides fuel and brake lights for cars, floated on the London Stock Exchange in October 2017 but has struggled since, with the share price having declined by more than a third in late January.
Despite that, Smith believes it is a good quality business with a market-leading position in a niche industry.
Currently, a pay-out ratio of around 30% is pretty low, but free cash flow is strong at around 9-10%. But Smith says he thinks the pay-out ratio should improve going forward. “That’s certainly the indication we get from the management team,” he asserts.
Shares have recovered a third since their January low, but, at 208p currently, still remain 18% below their offer price.
PZ Cussons (PZC)
Consumer staples stocks tend to be all-weather investments and generally largely stay in favour with much of the equity investment community. Their steady growth profile and gently rising dividends, backed by revenue from strong brands offering consumers essential products, mean they can be the bedrock of many an equity portfolio.
As a result, they can stay on high ratings for extended periods of time, including now. Even in the UK, the likes of Diageo and Unilever are in demand.
But there are still pockets of value, one of which, according to Philip Matthews, fund manager at Wise Funds, is PZ Cussons. The firm owns brands including Carex handwash, Imperial Leather bathing products and Morning Fresh washing up liquid.
As well as a presence in its home market of the UK, it has locations around the world including Australia, Europe, Asia and Africa. The former, in particular its Nigerian business, is the reason it’s currently trading at a very significant discount to other consumer staples stocks, says Matthews.
The Nigerian economy has been under pressure for five years or more now due to the slum in the oil price and an unstable political environment. That’s hit PZ Cussons and its business in the country has gone from making profits in the range of £40 million in past years to zero today.
Despite that, it has a dominant market share and some strong and valuable franchises there.
Outside of Nigeria, management is also open to restructuring its portfolio and offloading some of its high-quality assets. As a result, Matthews likes the optionality the stock gives you.
“You’ve got a free option on Nigeria coming back [to profitability] and them selling off some of the assets at multiples in excess of where they trade at the moment,” he says. It’s a stock his TB Wise Multi-Asset Income Portfolio has recently added.
Pets at Home (PETS)
Retailers across the globe have struggled over recent years, as online shopping continues to disrupt traditional high-street and shopping centre-focused business models. Indeed, just this week, we saw the collapse of yet another historic department store as Debenhams was placed into administration.
Pets at Home listed in London five years ago at 245p. Having peaked at 300p just 15 months later, it ran into problems and looked like being the next retailer to succumb to the structural troubles.
A mid-2017 profits warning didn’t help and by the beginning of 2018, it was the third most-shorted stock in the UK. Just four months ago, it further disappointed when announcing an 80% fall in pre-tax profits.
But Sue Noffke, manager of the Morningstar Bronze-rated Schroder Income Growth Trust (SCF), bought into the stock 15 months ago, around the start of 2018, at around 170p. The call didn’t immediately work, with the share price bottoming out at 110p.
However, recent news has been more positive. Solid Christmas trading saw shares spike in January and the stock is up 41% year-to-date. Noffke says its run of eight consecutive quarters of like-for-like sales growth is “quite impressive for a UK retailer”.
Further, it’s not even a pure retailer, she adds. Vets4Pets is the largest small animal veterinary services group in the UK and The Groom Room offers dog grooming services.
