The undervaluation of UK domestic companies is going “too far” as a response to sterling devaluation post-Brexit but the trend will soon change, according to Fidelity’s fund manager Michael Clark.
Clark, who is well-known for holding larger caps in consumer staples such as tobacco, continues to hold UK domestic names in his portfolio such as Next and Lloyds Banking Group, believing valuations have reached a tipping point.
Speaking to Fund Strategy Clark says: “Because of the fall in sterling the price to earnings ratio of UK domestic stocks is at a deep discount from the rest. The undervaluation of these companies versus the international companies is very significant and almost certainly is going too far so I think they are going up in value. We have them anyway and added to those recently.”
The fund manager has bought retailer Next as its valuation touched similar levels of 2008 and says it represents as much of a buy today as it did then.
Clark says: “Next has a very good track record of high returns and it is very well managed and very transparent. They make their earning statements twice a year and they are very clear unlike many companies. It has a price per earnings of 8 to 9 times although you don’t know what might happen this year to the earnings.
“We bought it because it went into a similar situation in 2008 and it was a buy then. The present environment though is nothing like 2008. Now it is just a subset of the market going down.”
Within the £1.1bn Fidelity MoneyBuilder Dividend fund, the flagship fund Clark has been managing since 2008, Lloyds is also part of the portfolio alongside HSBC but he shuns other UK banks, as there’s “no income, or not enough”.
Clark has made it in the top 10 list of UK Equity Income fund managers to provide the highest total returns and income over the past decade, according to Hargreaves Lansdown.
The fund manager had total returns of 89.9 per cent over the period, with £4,333 income on £10,000.
When the manager took over the fund in 2008, he changed the investment approach, buying firms with higher cash flows and where he is able to make up to five-year growth forecasts.
He says: “I took over in 2008 and we wanted to approach it in another way and not just buy into high yielding stocks. If you do that you construct the portfolio for the weakest stocks in the market because often high yield is a sign of weakness in equities and this is a problem, especially when there is a big recession.
“I wanted to pursue a new approach by buying the most secure yield backed by the best cash flow with some prospect to growth which wasn’t deeply cyclical. So companies that have a robust business that you can make a forecast two, three or five years. The idea was to produce income growth and have low risk.”
Profiting from the ‘FMCG revolution’
Another top holding for Clark is giant consumer staple Unilever, which makes 3.3 per cent of the fund. There is a “revolution” happening within fast moving consumer goods, Clark notes, which is set to unlock the potential of many European firms.
The leaked and “failed” bid from Kraft Heinz to acquire Unilever earlier this year has indeed shown to what extent companies need to speed up processes to grow their earnings.
Clark says: “If [Kraft Heinz] had made the approach and it hadn’t been leaked it would have been just pushed away and there wouldn’t be a story. It’s a surprise in a way but there is another development going into business today, which is the revolution in FMCG. It started with tobacco.
“There’s not been growth in tobacco for many years and the companies have been run in a very strict way with no cost, no marketing, just there to produce cash. It started to sip into other sectors, the way of running companies, it went into beer and came into mature packed food like Kraft and Heinz.”
Kraft Heinz is run by private equity 3G and since then it has quickly grown profits from 18 to a staggering 28 per cent.
Clark adds the Unilever-Kraft Heinz kind of story is not over.
He says: “The European companies that stood apart from this [management] process will have to change and the evidence of that is proved by the Unilever bid because there’s plenty of room for Unilever to earn much more money than it does – by cutting costs.
“A mature business like that with a bureaucracy got a lot of people being there for a long time and paid a lot, a lot of corporate jets, a lot of sloppy budgeting, that’s what happens. The story is not over, there will be more of this.”
The 2008 shadow
Clark admits the current Brexit era is “difficult and uncertain” but he keeps focused on the companies he holds and the power they have of keeping sustainable dividends over time. With less UK firms merging, Clark says some of those had the time and strength to keep paying “solid dividends.”
Clark says: “Sometimes we worry about the sustainability of dividends when we make changes in the fund. It is important that firms don’t cut their dividends.
“That event in 2008 of firms cutting dividends cast a long shadow over the market and business in the UK and what it meant was that companies became more conservative in the financial sense so they ran for cash and cut out the optimistic and expensive acquisitions and they reined in capital spending.
“That is why UK firms haven’t made many acquisitions. The benefits of UK companies being run this way are visible in terms of solid dividends because there’s plenty of cash to support the dividend and it is a positive thing.”