UK stocks are attractive on a free cash flow basis compared with the rest of the world.
As Christmas approaches, it’s not only the discount retailers bearing gifts at bargain prices: it’s Brexit – more particularly, the political uncertainty hanging over UK plc.
This month’s chart plots the free cash flow* of London-listed stocks against that of global equities. All else being equal, the higher the line, the cheaper and more out-of-favour UK stocks are compared with global peers.
Source: Datastream, Ruffer calculations
Since free cash flow can fund expansion or acquisitions, pay down debt, and fund dividends or buy-backs, the more you have, the better. Since Britain’s Leave vote on 23 June 2016, British-listed equities have been shunned by global investors. Surveys reveal global fund managers’ allocations to UK stocks are at historical lows.
Yet for those prepared to look through the uncertainty of Brexit, fortune may favour the brave.
What about investors worried by what may happen to the British economy post-Brexit? Four-fifths of the FTSE 100’s earnings come from overseas. For many international businesses which happen to be listed in London, therefore, falls in sterling actually aid profitability.
Furthermore, sterling’s weakness in the aftermath of the referendum has encouraged a range of suitors – both foreign and domestic – to drive M&A activity in the FTSE 100 to record levels in 2018.
Earlier this year, for example, Japanese pharma firm Takeda successfully bid for UK-peer Shire. In September, US telecommunications giant Comcast paid £30bn for Sky, whilst only a month earlier, soft-drinks titan Coca Cola (the brand that turned the formerly green Father Christmas red) splashed out nearly £4bn for Whitbread’s Costa Coffee. The Coke bid was just the caffeine shot required, and the shares pepped- up 14% in a day.
Takeda’s bid is particularly interesting, coming as it does from another market we see considerable value in: Japan. In the land of the rising sun, debt is cheap and domestic growth hard to come by. Overseas acquisitions make a lot of sense. Japan’s banking sector, struggling with modest margins courtesy of negative interest rates, have been only too happy to provide financing for overseas adventures.
Last month, we wrote about the ‘golden opportunity’ presented by the huge disconnect between prices of gold and gold mining shares. London-listed Randgold was one stock we acquired as a result. This proved fortuitous when Canada-based Barrick promptly swooped for Randgold to create the world’s largest gold miner. For Barrick, sterling’s fall burnished the miner’s attraction.
Not all approaches have been successful, of course. International Paper’s bid for packaging manufacturer Smurfit Kappa fell through in June, for example.
But nor has it been simply the Blue Chips that have attracted attention. FTSE 250 firms have also generated interest from overseas bidders this year. Fidessa, the market trading software business, and NEX Group, which owns valuable infrastructure for capital markets, have both been subject to successful foreign bids.
The UK’s relatively liberal takeover regime has been an added attraction for overseas suitors. Change may be in the air, however, as Western nations toughen their rules against takeovers by companies from potentially hostile states. Consultations are ongoing. Nevertheless, since the new rules will be aimed principally at China, and most bid interest for UK stocks in recent years has come from North America and Europe, this is unlikely to make much difference in the short run.
With sterling still at historically depressed levels, there could be more foreign-led M&A activity to come. Of course, if the politicians serve up a turkey of a deal rather than a Christmas cracker, prices may stay at bargain levels a while longer!
*Free cash flow is money available to investors after capex and working capital have been covered
Past performance is not a guide to future performance. The value of investments and the income derived therefrom can decrease as well as increase and you may not get back the full amount originally invested. The value of overseas investment will be influenced by the rate of exchange. The information contained in this document does not constitute investment advice or research and should not be used as the basis of any investment decision. References to specific securities are included for the purpose of illustration only and should not be construed as a recommendation to buy or sell these securities. Ruffer LLP is authorised and regulated by the Financial Conduct Authority. © Ruffer LLP 2018. 80 Victoria Street, London SW1E 5JL.