Seven undervalued stocks to follow

It's the 11-letter word investors are likely tired of hearing in the run up to this month's European Union (EU) referendum - uncertainty.

Still, it's everywhere and the investors hate it. Whether it's the potential Brexit, China's economic health, the oil price, US monetary policy or November's US presidential election, there are plenty of boulders in the road to growth.

Little wonder, then, that the broker Bernstein has talked of lack conviction. So, using top-down (big picture) and bottom-up (stockpicking) analysis, its experts have come up with seven very specific ideas they reckon are 'tactically important right now', among them four London-listed plays.

Investors don't have to risk it all on debatable long positions in banks and commodities, either, which could take years to realise - Bernstein is 'overweight' here anyway. Instead, they can exploit record spreads in valuations within sectors, exacerbated by a sharp drop in inflation expectations.

BUYING OPPORTUNITIES

Some industry stocks are cheaper than they ever have been compared to sector peers, and the speed of their derating smacks of a buying opportunity, says Bernstein. It's confident profit could even be taken in a few quarters' time.

Miner Anglo American, retailer Kingfisher, supermarket Sainsbury's and far East-focused bank Standard Chartered make the line-up of UK-quoted value assets with strong fundamental backing. French utility Engie, booze giant Pernod Ricard and Telecom Italia also make the grade.

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Anglo American

Current share price: 635p

Target price: 1,010p

There's been a major rethink at Anglo HQ. Instead of pushing through a raft of hurried asset sales to quickly repair its balance sheet after the commodity sell-off, management is dressing the company up to be an attractive takeover target in three years' time, reckons Bernstein analyst Paul Gait.

So, the countdown clock has started. Anglo CEO Mark Cutifani is responding by stripping its portfolio back to an attractive baseline, slashing costs and paying down debt.

If the miner can dispose of assets at a good price, Gait reckons there are two options: either the group benefits from a recovery in commodity prices or it is bought by peers Rio Tinto, BHP Billiton or Glencore.

'We believe that this strategy does represent an opportunity to realise value for Anglo American shareholders at this point, as it can deliver an increase in free cash flow yields, and asset disposals will drive down debt and significantly increase the value attributable to equity holders of the company, even at spot commodity prices,' says Gait.

Kingfisher

Current share price: 356p

Target price: 435p

With leading market positions in the UK, France and Poland, Kingfisher has failed to take advantage of its scale by reducing its enlarged headcount, centralising operations and making its buying processes more efficient.

Decked out with a new management team, the group's just embarked on a five-year turnaround that Bernstein reckons will balloon profits by 86 per cent and increase profitability by 400 basis points.

It's not going to be easy, though, and it will come at a cost, but the retailer needs to prioritise restructuring, reducing costs and efficiency. If it does, it could return 9-10 per cent total shareholder return over the next two years, with a compound annual growth rate of 16.8 per cent by the end of its overhaul.

'Kingfisher is currently trading at c. 13.6 times next 12-month [NTM] p/e [price/earnings], slightly below its 10-year historical average absolute p/e multiple (13.9 times),' says analyst Jamie Merriman.

'If Kingfisher succeeds in dramatically improving margin, as we expect it will, we believe the company will also trade on an above average multiple - suggesting both upside in estimates and the potential for multiple expansion.'

Sainsbury's

Current share price: 239p

Target price: 330p

After some disappointing first-quarter results confirmed sales growth lasted just one quarter, Sainsbury's is the most unloved stock in the sector, trading at a 16 per cent discount to peers.

It trades at a more significant 30 per cent discount to Morrisons, which has worse long-term growth prospects, argues Bernstein analyst Bruno Monteyne.

Praising its quality food offering and exposure to four growth channels - online, convenience, discount and general merchandise - the analyst is backing the grocer. Its controversial acquisition of Argos should catapult its presence in the general merchandise market even further.

While the market is pricing in margin growth at Tesco and Morrisons, Sainsbury's has been left in the cold and its valuation assumes next to no earnings growth.

'We see Sainsbury's as one of the strongest generators of EPS [earnings per share] growth in our coverage (16 per cent NTM to NTM+1) versus a sector average (ex-Tesco) of 14.5 per cent.

Our sector has a standard rule for valuation that has held up overtime (and for the mainland European stocks holds today) that the relative p/e is proportional to relative EPS growth.

Sainsbury's is trading well below this rule at present and our target price only bridges half of this gap,' adds the analyst.

Standard Chartered

Current share price: 503p

Target price: 600p

The Asia-focused bank is paying the price for jumping with two feet into India and commodities, giddy on the success of its short-duration Trade & Cash business (trade finance and cash management).

Saying this, the group has an unrivalled emerging markets network and its trade business is still pumping along, recently benefiting from returning price power.

'Risk is a classic cyclical line and for a bank which has been driving with their brakes on for the past few years, we see quickly getting back to normal levels,' explains analyst Chirantan Barua.

'Management has taken the right step in attacking the cost base top-down - a strong lever that Asian banks will pull in the next few years as growth slows down.'

If Standard can de-risk its Indian, commodities and unsecured exposure, execute successful disposals and improve cash and margins structurally, it could generate over $16 billion (£11 billion) revenue over the next three years.

Not quite the $19 billion heyday, but much better than the current $14 billion. A cyclical benefit will go a long way, too.

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