JPM Fund Manager

Positioning for UK growth: Six stock ideas for core investors

The post-Brexit market environment may be uncertain, but there are several attractive and diverse stock opportunities out there if you know where to look. James Illsley, Portfolio Manager for the JPM UK Equity Core Fund, shows how he is finding growth in the UK market at the moment across many diverse areas, from housing and infrastructure, to technology and transport.

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Nov 29, 2016
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Extracting value from the housing market: Bellway

The UK housing market remains structurally undersupplied, which is an underlying fact that is easy to overlook in the noise generated by Brexit. Demographics means that the UK needs to build some 250,000 homes per year to meet demand, but new build rates are currently running at only about 170,000 units per year. Several housebuilders look attractive at the moment and we had the opportunity to add exposure to the sector as valuations fell below asset value in the wake of the Brexit vote.

We believe that One attractive stock for instance is Bellway, which is one of the smaller quoted housebuilders. The company has a sensible growth strategy to help meet housing targets, expanding from 8,721 units completed in 2016 to a medium-term goal of 12,000-14,000 units. The long-term demand for more houses will underpin Bellway’s growth at a time when many other housebuilders have reached their target size and are not growing volume. Despite this long term growth, the shares are still very good value at only around 1.3x 2017 net tangible asset value, with a price-to-earnings ratio of 6.7x and a yield of 5%--which is covered 3x by earnings (source Numis Securities).

Enabling business technology: Micro-focus.

Micro Focus is a consolidator of legacy software products that serve corporate customers. There are currently over 120 products under the Micro Focus umbrella serving a diverse customer base. These products are typically mature, offer few growth opportunities and no longer fit within the typical portfolio of “high cost, high growth” tech companies. While this means Micro Focus may not be classed as the most exciting of tech companies, its focus on these business critical but less glamorous areas gives the company a potentially strong position in price negotiations—a position that has been reinforced as it has gained market scale.

Once acquired, Micro Focus brings these products and companies onto its platform, which involves stripping out overheads, costs and running them for cash and profits rather than against unrealistic growth aspirations. The company recently announced the purchase of HP Enterprise’s (HPE’s) software assets. This will be the largest deal it has done but the upside potential is substantial. HPE’s EBITDA margin is currently 23% and Micro Focus believes it can push this over 40%, which gives an idea of the scale of the company’s ambitions. Overall, Micro Focus is a great example of quality management, with a focus on cash, driving impressive company momentum.

Building on infrastructure investment: CRH

A very topical area at the moment is infrastructure investment, particularly with the election of Donald Trump, but also with the recent announcements from the UK government of some targeted infrastructure spending in the Autumn Statement. From a wider economic perspective, investment in infrastructure is good for longer-term productivity. CRH is the UK’s largest quoted building materials company with operations spanning Europe and the US. To give an idea of the scale of the company’s US operations, CRH is the largest producer of asphalt, the largest producer of paving, and the largest producer of concreter products. Therefore, we would expect CRH to benefit from any increased government investment into roads, bridges, buildings and basic infrastructure.

We have held the stock for a number of years as it has ticked all of our three investment criteria: it was an out of favour value stock when we bought it, trading on a low valuation, with depressed activity in Europe affecting sentiment, but there is an underlying value to its assets—you can’t transport aggregates very far—and it has reserves stretching out over a hundred years in many areas. Earnings have improved as the US economy has continued to grow, with robust construction demand allied with a recovery in Europe—which is something we would expect to continue as levels of spend in its markets still remain below peak levels. Finally, management has made the right decisions for the long-term future of the company with the acquisition of assets at the right price from Lafarge/Holcim that is driving further earnings momentum as synergies are realised. Given the strong earnings momentum and strong cash generation, we believe the shares still look attractive.

More than just coach travel: National Express

The UK equity market is global in nature with around 70% of revenues sourced from overseas. Even some well-known names actually have substantial foreign operations. While many investors may just associate National Express with its iconic UK coach business, this division is actually a minority part of its operations. Even when combined with its urban bus operations, the UK accounts for only around 30% of forecast 2016 earnings (source RBC Capital Markets).

The company has a diverse business mix, including North American school bus and Spanish long distance and urban bus services, with many of these businesses operating under long-term contracts. Strong cash generation, coupled with an attractive valuation, could deliver a rising yield with a tailwind from a weaker sterling—all of which is likely boosting the value of the company’s overseas earnings stream.

Industrial private equity: Melrose

Melrose’s mission statement is as simple as: “Buy, Improve, Sell”. The experienced management team look for industrial businesses that are fundamentally attractive but underperforming their potential. The team then looks to invest to improve performance, typically by boosting sales and/or improving margins and driving greater value in the business. These improved businesses are then sold and the capital is returned to shareholders or reinvested in to new opportunities.

Melrose’s most recent acquisition, American manufacturing business Nortek, is a classic example of a Melrose asset. The characteristically conservative Melrose management team has laid out a number of areas where they see opportunities for margin improvement that, if executed, will greatly increase the value of the business. The momentum in the business is strong and the quality of the management team is quantifiable by the returns it has historically generated for shareholders. We think the market is undervaluing this potential.

Steady returns from infrastructure investment: John Laing Group

John Laing Group (JLG) originates and invests in infrastructure projects. The company’s portfolio is diverse, both geographically (over 50% overseas – source RBC Capital Markets) and in terms of its underlying sectors, with exposure to transport, social and environmental infrastructure, and renewable energy. It has a large bid pipeline of around £1.8 billion, which could offer opportunities to broaden and diversify the portfolio. The management team has a track record of bringing investments through preferred bidding stage to financial close then construction and into the secondary market, where they are either sold on or managed in-house.

In an uncertain world, infrastructure projects have an appealing defensive quality about them, particularly when politicians cite increased infrastructure spending as a way of supporting global growth. John Laing potentially offers an attractive way to capitalise on this theme and is currently trading at a discount to its peers.

James Illsley is portfolio manager of the JPM UK Equity Core Fund. Read more about the fund:

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Go to the profile of James Illsley

James Illsley

Fund Manager, JPM UK Equity Core Fund and JPM UK Equity Plus Fund, J.P. Morgan Asset Management

James Illsley is a portfolio manager of the JPM UK Equity Core Fund and the JPM UK Equity Plus Fund within J.P. Morgan Asset Management's UK Equity team.

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