UK
With UK markets still seen as undervalued, what catalysts might help trigger a recovery/re-rating?
Ian Lance, co-head of the UK value & income team at Redwheel and co-fund manager of Temple Bar (TMPL)
Most investors are aware that UK equities look cheap relative to other equity markets (especially the US) and relative to their own history. They will also know that this has been the case for several years now and quite rightly will ask what the is catalyst going to be for the realisation of this value.
I don’t see a wall of money coming back into UK equities (although it is extraordinary how the market can change its mind from hating to loving something), but despite this I do see two potential catalysts. The first is foreign takeovers of UK companies. US companies currently have highly valued equity and, arguably, a highly valued currency and therefore most takeovers of UK companies are going to look attractive at the moment. Little wonder that in the past couple of weeks we have seen the Mars takeover of Hotel Chocolat (HOTC) and a private equity takeover of bowling alley operator Ten Entertainment (TEG).
The second catalyst is companies buying back their own shares. If investors have no interest in buying a company on an earnings yield of 20 per cent, then it is incumbent on the company to buy back their own stock and create value for shareholders that way. As Warren Buffett opined on this subject in Berkshire Hathaway’s 1984 letter to shareholders: "When companies with outstanding business and comfortable financial positions find their shares selling far below intrinsic value in the marketplace, no alternative action can benefit shareholders as surely as repurchases."
In light of this, we were very happy to read recently that UK companies themselves have been a “massive buyer of UK equities” – with the current run rate in the region of £200mn a day, which is a run rate of £1bn a week, or £50bn a year. Imagine if rumours circulated that there was going to be a UK buy programme trade every day for the next year of c£200mn – how might the market react?
I have no expectation that this will change anyone’s mind, and BP (BP.) will probably continue to be sold on five times earnings in order to buy Amazon (US:AMZN) on 85 times earnings. But UK companies are not patiently waiting for investors to realise their value, and through increasing buybacks have started to do it themselves. Unfortunately, at that point, it could be too late to allocate back to the UK, and investors who have been paying record valuations for US equities may be left hoping that this time really is different.
December 14, 2023