GKN, one of many British industrial companies that have successfully fought the recession by tapping into emerging markets, is a prime holding for Marlborough UK Leading Companies.
Let’s start the year with some positive news. Remember the death of British manufacturing? Well, maybe the reports really were rather premature.
Look at GKN, a one-time byword for West Midlands metal-bashing. In early 2009 it was struggling with mounting debts and was axeing jobs all over the place. As it went to the market in June of that year with a £423m rights issue there was speculation that it could join the list of once-great British companies going down the plughole.
But the turnaround since then has been extraordinary. GKN has swung from losses into big profits and its share price has quadrupled from below 50p to above 200p. It is still largely a parts maker for the automotive and aerospace industries – and what great industries to be in. Car production in British factories accelerated 30% last year, helped by the fall in sterling, with a big jump towards the end of 2010. Globally, car production is expected to move towards 71m vehicles this year, from 68m in 2010. GKN, an internationally diversified engineering company, reckons it is well placed to take advantage of this growth.
”Some [retail and outsourcing stocks] are just being demolished by the market”
GKN is the biggest holding in the Marlborough UK Leading Companies fund, managed by Richard Hallett. This is not because he is misty-eyed about a great British recovery, but because so many of Britain’s leading companies have, like GKN, transformed themselves into operations deriving much of their income from fast-growing emerging markets.
Over the past year, Marlborough UK Leading Companies is up 38.5%, compared with 18.4% for the average UK All Companies sector fund. It is ranked 7th out of 340 funds over the year and 13th out of 320 over three years. Industrials lie at the heart of the fund’s success. Just over a quarter of it is invested in industrials, with another 14% in technology. (article continues below)
But to characterise the fund as a small-cap growth portfolio would be unfair. Its mandate is to have at least 75% in the FTSE 350, leaving it with a maximum exposure of 25% in small caps. Hallett was defensively positioned for the first part of 2009 in the mega caps, and for much of 2008 and 2009 had nothing at all in small caps.
“At one point we had 90% in the FTSE 100 and a further 10% in the FTSE 250,” he says. “Since mid-2009 we began increasing the beta in the portfolio, buying more growth stocks and more small caps.”
Hallett likes to pick companies that dominate their market niche, enjoy pricing power and act as a consolidator in their industry.
“GKN was a restructuring story,” says Hallett. “There was a rescue rights issue a year and a half ago, which has enabled them to sort out their balance sheet, and they have taken out lots of costs. They have also benefited from the demise of rivals, and have taken market share in the US.”
But Hallett reckons that GKN still offers great value. “They are forecast on 18.5p earnings per share, which on a share price of around 215p means it’s only on around 11 times earnings. I can see the stock heading towards 280p.”
Renold, another of Hallett’s industrial holdings, makes transmission and conveyor chains, gearboxes, clutches and spindles, employing 2,500 people in locations from Britain to China. Its share price doubled in 2010 from 20p to 40p. In its latest update it says that there has been a good recovery from recession, with a strong increase in orders.
But Marlborough UK Leading Companies is not a fund in which Hallett takes big bets on any stock. It has a relatively focused portfolio of 40-45 holdings, but most are about 2.5-2.7% of the portfolio, with GKN at 3.3%. “If a stock goes above 3.5% of the fund, I tend to start taking profits,” says Hallett.
His no-go areas are retail and anything connected to public spending, which means he holds none of the outsourcers. “Yes, some of these stocks may be looking cheap but I just can’t see a pick-up on the horizon,” he says. “Some of them are just being demolished by the market.”
He is also bearish on the property sector. “We have no property at all, and none of the UK-centric banks.” He expects the banks to keep offloading property on to the market at a time when a lot of office space held by the public sector will also become free.
But in the private sector generally he sees a brighter picture. “If you strip out the obviously poor sectors, we are seeing some upbeat trading statements and analyst upgrades. Many are enjoying a double whammy of domestic inventory rebuild and international growth.”
Overall market valuations remain attractive, he says, which makes him confident about leaving his balance in small caps (18%) and the FTSE 250 mid-caps (20%).
He is particularly cheerful about the technology sector. The fund holds Arm, Imagination, Wolfson Micro and Aveva. “Wolfson is really taking advantage of the smart phone revolution, while Aveva is in a market leading position in infrastructure projects in emerging markets.”
Financials make up just 10% of the fund, a strikingly low position given that this fund is called UK Leading Companies and Britain is best known internationally for finance.
One of his favourite holdings is Hargreaves Lansdown. At the beginning of 2010 you could have picked up Hargreaves for 300p a share; now they are trading at a record high of 540p-550p. “It’s a clear business model and a clean business, picking up market share off the life insurance companies.” Then he makes a striking prediction. “I can see Hargreaves entering the FTSE 100 at some stage.”
Peter Hargreaves and Stephen Lansdown in the same bracket as HSBC, BP and Glaxo. Good luck to them.
Meanwhile, Hallett is focused on getting this fund on to the radar of bigger investors. It is only £42m in size, and Hallett laments that few strategists are prepared to look at funds much below £50m. But maybe 2011 will be the year this fund takes off.