Holly Black: Welcome to the Morningstar Series "Three Stock Picks". I'm Holly Black, with me in the studio today is Laura Foll, she's Co-Manager of Lowland Investment Company (LWI). Welcome to the studio.
Laura Foll: Thanks.
Black: So are there any sectors or areas that you are particularly finding great opportunities at the moment?
Foll: There's one area I am quite excited about which I think will be a bit of a controversial one which is motor insurance. And the shares have generally been quite weak and the reason for that is that – is the claims are going up and that’s because of car theft is increasing quite a lot.
If you got one of these cars that you don't need a proper key for one of these keyless fob things that makes it more easy to steal your car essentially. And therefore car thefts are going up, claim costs are going up and that’s bad for the motor insurer, because they’ve got higher claim costs.
So why I am saying this is an interesting area is that the types of motor insurer that we have within the portfolio the likes of Direct Line are managing these claim costs really well. So they are managing to make good margins even in a year where claim costs are very difficult.
So I think that shows the underlying resilience of the portfolio and at the same time with something like Direct Line (DLG) you are getting an almost 10% dividend yield, that I think is sustainable. So motor insurance is an area that I think is really quite interesting at the moment. But you need to be selective and pick the good companies within the sector.
Black: You think that with so many innovations the motor theft would be going down.
Foll: You would think, that wouldn’t you? But actually it's the exact opposite. And the problem is cars are getting more complicated as well. So now there is a lot more electronics than your average cars. If you have even a very simple crash that means a lot of electronics need to be replaced. Whereas it used to be much more mechanical so you could just, if you hit your bumper its fine you just get rid of the dent, no problem. Whereas now there is a lot of sensors and things that need to be replaced. So the costs are going up, not just because of thefts also because of all these more electronics in cars as well.
Black: So have you got a second stock pick for us?
Foll: Got a different one for you which is a company called Shoe Zone (SHOE), you might know it's on most UK high streets, but it wouldn’t be on the best road in the high street, it would be on the next road over.
And what Shoe Zone basically is, it's very cheap shoes and often things like children school shoes or wellies that kind of thing which aren’t really a discretionary purchase. You need to buy your child a pair of school shoes every year no matter what happens really and Shoe Zone gives you a very good value option for that.
But what I really like about it, is its quite owned by the management team still, they own roughly 50% of the company. They are very tied in and your interests are aligned with them and because of that they are really cost focused. And they get their rent down pretty much every year and we really like that as investors. You can see that they are really paying attention to costs. So they are actually managing to be quite resilient on what's a pretty difficult high street.
Black: I was going to say a lot of people are concerned about the outlook for retail at the moment, but Shoe Zone is bucking that trend?
Foll: Pretty much, they are managing to keep earnings about flat which in the context of the U.K. high street and a lot of retailers going under is a good outcome and they are managing to do that because they are just keeping the costs nailed down.
And I think you might actually see that earnings return to growth because they are managing a lot through their website and they are actually making quite good margins from the website as well which is pretty unusual for a retailer. Often when you sell online you are not actually making much money from that, but they are actually making good margins from their website.
Black: So what's a final name in the portfolio that you are particularly excited about?
Foll: I am going to pick another controversial one which is RBS (RBS), Royal Bank of Scotland which has been a new position for Lowland this year. Still 60% government owned hence the slight controversy around it. But I think because of that government ownership that is causing a real valuation overhang on it. And if it wasn’t for that 60% government stake I think the value would be a lot higher.
The reason we like it is that they have got a much stronger balance sheet than they have had historically and I think that gives them puts them in a good position to return some of that cash back to shareholders. And we have already seen them announce a special dividend earlier on this year and I think there could be more to come. In that regard I think they'll also do a buyback possibly of the government stake. Its more of a capital return story. I think you'll get a good dividend yield plus a buyback and I don’t think that’s currently factored into the shares.
Black: Why does the government ownership weigh on the share price?
Foll: I think there is a question mark about if there is a change of government what the plan would be under possible Labor Government for that 60% stake. So what the Conservatives have said is that they will sell it down gradually, but it seems to be that under possibly John McDonnell that they would look to keep that 60% stake possibly even nationalize the whole bank. So there is that question mark about it because of the possible change of government.
Black: Well, thanks so much for your time.
Foll: It's alright.
Black: And thanks for joining us.
