Three ‘ugly duckling’ shares I am buying

Contrarian investors refuse to the follow the crowd, and instead focus their sights on unfashionable companies that they believe are for whatever reason being unjustly mispriced by the market.

The idea behind so-called value investing is that a catalyst will occur to revive an underpriced company's financial fortunes. This could be in the form of a restructuring, refinancing or management change, which leads to the firm increasing its earnings and dividends.

Alasdair McKinnon, manager of the Scottish Investment Trust, founded in 1887, is a value investor. He scours global markets for contrarian opportunities and ideally likes to find what he calls ‘ugly duckling’ shares: businesses that are challenged and overlooked by the majority of investors.

Below, McKinnon runs through some out-of-favour shares that he is backing to return to form.

Marks & Spencer

On a three-year view the retailer’s share price performance makes grim reading, 24 per cent in the red. Fierce competition from online rivals such as Asos and Boohoo has been chipping away at the firm’s market share, and specifically its clothing division, which accounts for more than half of its overall profits.

A new chief executive – Steve Rowe – was appointed last year; he has put a five-year turnaround strategy in place and reshuffled the management. McKinnon is backing Rowe’s plans to succeed.

He adds: ‘There’s a 6 per cent dividend yield, so I feel compensated while I am waiting for the firm to address its structural issues. I feel that Marks & Spencer has a solid brand, which is one that will last.’

Royal Dutch Shell

With a forecast dividend yield of 6.6 per cent, the oil major is a stock that continues to divide opinion. Royal Dutch Shell has long been a staple of UK equity income funds - it has not cut its dividend since 1945, and in 2016 became the largest payer in the world, returning £11.1 billion to shareholders throughout the year.

But the big concern for those in the bearish camp is that its dividend payout has become less and less well covered by earnings. According to SharePad, a date service for private investors, Shell’s forecast dividend cover score (based on analysts’ expectations in one year’s time) is 0.8 times, meaning that the firm may have to borrow money to keep the dividends flowing.

-Four warning signs a dividend cut is on the cards

McKinnon thinks it is ‘inconceivable’ the firm will cut its dividend, particularly now that oil prices have somewhat recovered their poise, having slipped below $30 a barrel 18 months or so ago.

‘Oil majors were living in a dream world of high oil prices, but have had to readjust. In the case of Royal Dutch Shell, the firm has got itself into a position where it is still strong enough to bully the oil services companies, and in addition has been cutting costs effectively,’ he says.

British Land

His third and final pick is UK’s second largest real estate investment trust – British Land. In the months leading up to and the year following last June’s Brexit vote, investors adopted a more cautious stance towards the property sector.

But while house price growth has cooled over the past year, particularly in London and the South East, fears of a property crash have yet to materialise.

‘British Land managed to sell a 50 per cent stake in the Cheesegrater office building in the City of London at a premium to a Chinese buyer; yet prospects for the firm are viewed by the market as ugly, so much so that overall it is trading below book value,’ adds McKinnon.

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