Royal Dutch Shell, SSE and Home Retail Group – three stocks to profit from a value rotation

2nd April 2014

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Edmund Shing of BCS Asset Management takes a look at the prospects for value investing

Momentum takes a beating, Value remains near highs

So it is true: what goes up quickly, can also come down quickly! The month of March has seen US momentum stocks fall sharply, while in contrast value stocks have held up very well. Figure 1 shows that momentum stocks (the line in black) have hardly outperformed value stocks (the line in yellow) over the last half-year, after a torrid month of March.

1. MOMENTUM STOCKS TAKE A HIT, VALUE HOLDS UP WELL

Source: Author, Bloomberg

Three sub-sectors in particular have been hard-hit (Figure 2):

  1. Biotech has lost 13% from its high at in February (line in yellow);
  2. Social media stocks such as Facebook and Twitter have lost 14% in aggregate from their peak (line in green);
  3. Recent IPOs retreat 6% from the peak, judging by the First Trust US IPO ETF (FPX; line in black).
2. BIOTECH, SOCIAL MEDIA AND IPOS CAUGHT IN THE MOMENTUM RETREAT
Source: Author, Bloomberg

 

 Yield back in vogue

Long-term government bonds have performed well of late. Both European and US long-term government bond funds have gained significant ground over the year-to-date. This, in spite of the poor yields being offered by both (2.1% for a UK Gilt ETF; 3.1% for a US 20+ year Treasury bond ETF).

We can see that yield is becoming very popular once again as an investing strategy; this is evident from the recent performance of both US high yield corporate bonds (in black) and also US real estate trusts (REITs; in orange) in Figure 3.

3. HIGH YIELD BONDS, REAL ESTATE SURGE AHEAD
Source: Author, Bloomberg

 

Value in the Lead

High dividend-yielding stocks have come back into vogue both in Europe and in the US. Indeed the Euro STOXX dividend 30 index has gained over 30% since its low in June 2013, recently posting a new multi-year high (and still offers a 5.2% dividend yield; yellow line in Figure 4). The same is also true for US high dividend yielding stocks (black line), which hover around multi-year highs.

4. INVESTORS LOVE DIVIDEND STOCKS
Source: Author, Bloomberg

Some of the best performing value related sectors include Utilities (Figure 5; European Utilities sector in black, US Utilities sector in yellow), Oil & Gas and even Eurozone Banks.

5. “BORING” EUROPEAN, US UTILITIES BREAK NEW HIGHS
Source: Author, Bloomberg

 Value is winning even in Technology

Even in the Technology sector, we are witnessing a rotation towards value and out ofmomentum.

While Facebook has seen a sharp share price correction following recent acquisitions, in contrast Microsoft has surged to new multi-year highs (Figure 6). Remember Microsoft trades on an ex-cash PE of around 11-12x and offers a dividend yield close to 3% at present.

6. DIVIDEND-PAYING “OLD TECH” NOW BEATING “NEW TECH”
Source: Author, Bloomberg

 A tired Bull Market? Play safe, Play value

Remember, this current market is now over five years old. It is thus hardly surprising to see that high valuation, high beta stocks such as biotech, social media and recent flotations (IPOs) should see substantial volatility. Perhaps a return to lower valued, higher dividend yield stocks in sectors such as utilities, banks and real estate should be favoured at this time by investors…

Three UK value stocks to highlight now: RDSA, SSE, HOME

As I pointed out above, two sectors that have started to perform particularly well during this Value renaissance are the Oil & Gas and Utilities sectors.

Oil & Gas: What about Royal Dutch Shell?

I would have a look at Royal Dutch Shell (code: RDSA.L) of the UK major oil companies, as it offers a P/E ratio of just over 10x and a dividend yield in excess of 5%, both of which would look attractive to a value investor, particularly given relatively stable global crude oil and natural gas prices. Should geopolitical tensions flare up again and push crude and gas prices higher, Royal Dutch could be a good way to play this while benefiting from the generous yield.

Utilities: Plump for SSE

In the Utilities sector, the power generation and distribution company SSE (code SSE.L) looks attractive on a combination of value and share price momentum, trading currently on a forward P/E of 12.5x and a dividend yield around 6%.

At a time when 5-year UK gilts yield under 2% and the SPDR UK investment-grade corporate bond ETF offers a 4% yield, 6% from a solid utility company with prospective 4-5% dividend growth is an attractive dividend yield indeed!

Shopping for Value in Home Retail

The final UK value share that I would consider is Home Retail Group (code: HOME.L), the owner of the Argos catalogue shops and Homebase DIY centres. Recent trading has been strong as per their last trading statement on March 14 of this year, and yet Home Retail still trades on very cheap valuation multiples of 0.25x sales, 0.6x book value and 5.3x enterprise value/EBITDA.

With UK retail sales growing at 4.2% year-on-year (as of February this year), property prices heading skywards and click-and-collect online shopping penetration growing vigorously, both Homebase and Argos look well set to benefit further from these domestic household trends.

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