JOHCM duo sees ‘vicious’ derating for defensives as results disappoint

Poor results from companies such as Unilever, AstraZeneca and Shell last week showed the valuation gap between defensives and cyclicals is closing in a “vicious” fashion, according to JO Hambro Capital Management’s James Lowen.

The senior fund manager on the £919m UK Equity Income fund, alongside Clive Beagles, said the portfolio is very underweight defensives as indicators are pointing to an improved environment for cyclical stocks.

“All the defensive companies were re-rated last year and we have started to see this reverse quite viciously in the last 14 days. The valuation signals are very powerful. We are starting to see these valuation extremes unwinding with the disappointing results from companies such as Unilever and AstraZeneca.”

Lowen added if the macroeconomic environment stablised from here, some of the cyclical companies could see upgrades of 50%.  “The businesses we are seeing day in and day out are saying the macro situation is getting better. Things are much better in the economy than people were pricing in at the end of last year.”

He pointed to improved manufacturing and consumer confidence data as evidence of this. The fund’s largest overweight sector position is in travel and leisure for this reason, while other consumer plays include Tesco, Debenhams, The Restaurant Group, and property exposure. 

In the travel sector, Lowen and Beagles favour TUI Travel, which amounts to 2.4% of the fund. It has benefitted from the near bankruptcy of competitor Thomas Cook.

Tesco has not fared as well due to its first profit warning in 20 years but Lowen said he has “modestly increased” the position on share weakness.

“I do not think it is going to race away as there is a lot of noise still, but on a two-to three-year view, what happened in January is a positive and we could see a higher return on capex in the UK.”

Other overweights are in the financials sector where the fund has only one bank - HSBC, alongside Aberdeen Asset Management, Close Brothers, and L&G, as well as recently added property exposure including Picton and Invista Foundation Property.
“Some of these have a covered dividend of 7% and could go up as much as 20%-30%,” he said.

Top income stocks in numbers

AstraZeneca

10% – size of dividend increase pledged this year.
$2.4bn – profits for the financial year increased last year to $12.37bn. $2.05bn – pre-tax profits fell compared with $2.28bn in 2010.

Imperial Tobacco

7% – first quarter volumes declined year on year, with growth dented by rising tobacco prices in the US. 1% – year on year revenues fell more than analysts’ expectations.

Shell

4% – reported weaker than expected fourth quarter results as net profit came in at $6.5bn, down from $6.79bn in 2010.
$13.77bn – group revenue increased in 2011 to $119.13bn, compared with $105.53bn in the fourth quarter of 2010.

Unilever

6.6% – increase in fourth quarter underlying sales.
5.1% – sales growth projection for 2012, with business expected to grow ahead of market and improve margins.

BP

$25bn – settlement the US Department of Justice is expected to agree on for all outstanding civil penalties and damages relating to the Gulf of Mexico disaster, taking the total bill for the disaster to $54bn. $3.56bn – increase in profits for the third quarter of 2011, to $5.14bn, up $3.56bn year on year.