Justin Jordan, the manager of the Credit Suisse UK Mid 250 fund, says that “we’re set for a two-year recession in the UK … and people are starting to think how best to position things for a recovery.” Jordan sees Britain emerging from recession in the second quarter of 2010 and is looking to move back into cyclicals that “will come out of this recession in good shape.”
Equity markets will show recovery this year and outperform cash over 2009, he predicts. “The stockmarket, being a long-thinking beast, discounts things at least six months hence.” Jordan also notes the trend for rights issues and says he expects to see “30 to 50 rights issues on the FTSE 350 this year.”
“Bond conversion,” in which corporate debt is switched to equity, is taking place because so many businesses have the “wrong capital structure for a recession,” he says – highlighting companies like Punch Taverns, whose market capitalisation is about £99m but which carries £4.3 billion of debt. “That shows how extreme the situation can get.”
But despite this, he argues that “among recovery sector plays are pubs and restaurants – the pub sector has been decimated in share price terms over the last two years…I am looking to find ‘best of breed’ in the pub sector, the long term winners.”
Jordan is interested in the pubs group Mitchells & Butlers, which dropped out of the FTSE 100 in 2008. “This company is best known as the owner of the O’Neills pub chain and the All Bar One chain – large freehold managed pubs, which are reasonably female-friendly and typically serve large amounts of food.” He also holds shares in Toby Carvery.
He became a shareholder in William Hill – the bookmaker – before its rights issue last week. Its debt exceeds its market capitalisation, but Jordan says: “What people are expecting is that trading in the bookmakers in the UK is quite resilient. It has not dropped off a cliff…Sorting out the balance sheet problem at the company will be well received.”
The gambling sector is promising for value, he says, because “valuations for these companies have been really beaten up from mid-2007 onwards because of their debt levels. The market is trying to identify the survivors and it has indiscriminately marked down the good and the bad.”
For the future, he is looking at buying Debenhams. “The rights issue everyone is waiting to see in the retail sector is Debenhams. They have a market capitalisation of £350m but their debt is approaching a billion. People have speculated they might do a rights issue…that could be an interesting recovery stock later in the year.”
He is also looking at house builders and even estate agents, among which the winners will grow thanks to the demise of some of their peers. “We may be at the bottom of the recession for trading activity for house builders: the slope of decline seems to have flattened,” he says. “But I think it is possible that we will see house prices continue to fall in the UK for most of 2009.”
He notes promising early-2009 performance from Bellway and Persimmon, joining other analysts in predicting a further rights issue from Persimmon this year.
Over the past 10 years the FTSE Mid 250 index has significantly outperformed both the FTSE 100 and FTSE Small Cap indices, notes Jordan. He argues that mid caps, at their best, can offer dynamic growth without the financial and liquidity risks associated with small caps.
The £30.3m UK Mid 250 portfolio, which he has managed since July 2007, holds 50-70 stocks, comprising “core holdings” of up to 3% and higher-risk holdings of about 1%. It is structured as an Oeic.
Jordan says he favours companies with “strong niche market positions”. The top 10 holdings include Chemring, a classic defensive, at 3.1%, and Balfour Beatty, the engineering and construction firm which has been touted as a possible beneficiary of the Obama stimulus package, at 2.1%. Babcock International, the support services provider, comes in at 3%.
He has 2.1% holdings in NBrown, the internet retailer, which he says has expanded through “clever use of marketing over the internet and by launching new catalogues appealing to younger demographics” – making the unusual move from an older to a younger customer base.
The fund outperformed its sector during recent doldrums. It fell 23.45% against an average decline of 31.25% for the Investment Management Association’s UK All Companies sector, in the 12 months to February 27, 2009, according to Morningstar. Over three years, it fell 30.71% against a sector decline of 35.71%.