Since the global financial crisis, central bank monetary policy has suppressed interest rates leading to the greatest search for income in investment history. As the yield on government gilts plunged to historic lows, premiums rose for UK stocks paying decent streams of income. Now as global growth stalls, we are seeing a new phase in the post-crisis world: the great hunt for growth.
Last week, the World Bank lowered its global growth forecast for 2016 to 2.4 per cent. With the financial crisis seven years behind us, the growth engine is stuttering. And what makes the World Bank’s prediction more foreboding is that the Bank of England has exhausted most of its means to inject life into the economy. We are thus vulnerable to even the mildest of recessions. In this low-growth environment, where deflation threatens, investors will pay more for those companies that can produce growth.
The question is where can growth-hunters still find opportunities without paying a premium? Fortunately, there are a number of UK companies trading at attractive valuations, which offer compelling long-term growth prospects. These companies share a number of commonalities, including the ability to generate and compound cash, as well as having market-leading positions.
A classic growth compounder, ITV is still the dominant free-to-air channel in the UK with a growing production unit operating more globally. High margins, cashflows and returns on capital show the quality of the underlying business. Shorter-term worries of a slowdown in the UK and long-term structural issues look misplaced as it begins to increase it viewership.
Furthermore, the recent special dividend left the balance sheet virtually unlevered and capable of more special dividends or acquisitions. Upside on retransmission revenue from satellite operators or that it might be an acquisition target potential from operators such as Liberty or BT have not been factored in into the share price.
Retail ‘roll-out’ stocks are one of the classic growth stock ‘must haves’ given their high potential rates of growth and this company is no disappointment. The core Patisserie Valerie brand continues its roll out and the format has further developed from the high street into Debenhams, service stations and other locations.
Such retail stocks have low roll-out costs, rapid paybacks and good cashflow characteristics given their cash/payment terms. The company also has a number of other smaller brands in the early stages of potential roll out which adds to the growth mix. Management is high quality and backed by serial entrepreneur Luke Johnson as chairman. As cash builds in the business, special dividend or acquisitions are a possibility.
The number two in the home collected credit loan market, Morse is a classic compounder in an unloved market. The company earns high returns over 20 per cent on equity despite a virtually unlevered balance sheet. The company’s restructuring could also drive returns higher as it modestly gears up, cuts costs further and takes advantage of current regulatory uncertainty to buy up smaller competitors.
The operating cash dynamics are therefore attractive and the company is committed to paying out the majority of earnings in dividends, which we view as a rational capital allocation choice. With dividend p.a., returns of over 6% combined with residual earnings allowing the receivables book to grow at 10% p.a., we envisage a highly attractive annual return to investors.
Eckoh is the UK’s market leader in secure payment and customer contact solutions. It is also growing strongly in the US. The key driver of demand is the increasing risk of fraud at contact centres where customer credit card information is seen and therefore vulnerable. In this area, Eckoh has a market-leading solution in ‘Haloh’ which ‘tokenisies’ data, preventing call centre operators to see it and thus improving security.
The company has an unbroken growth record from 2009. Over the last three discrete years it has posted over 20 per cent growth, and this is forecast to continue for at least another three years. Our view is there is still much further to go in the UK, but we see the US at the real opportunity standing at eight times the UK’s market size. This is a poorly followed company – we believe an ‘incubation’ investment could have great potential.
Philip Harris is fund manager of the EdenTree Investment Management UK Equity Growth fund