- Three shares where weak investor sentiment does not reflect the longer-term prospects.
- NatWest missed its Q3 numbers but the balance sheet is strong and there is a potential share sale on the cards.
- GSK – Zantac litigation continues to weigh on sentiment but trading is strong and the Arexvy vaccine had an impressive launch.
- British American Tobacco is being held back by weakness in US cigarettes. However, yield is at a near 10-year high.
Derren Nathan, head of equity research, Hargreaves Lansdown:
“Some stocks are entering 2024 looking a little unloved – but that can throw up value opportunity for investors. Value is of course a very different thing to price, and lower valuations tend to signal caution from the market because of ongoing risks or uncertainty. But sometimes jitters can be overdone, or mask potential. Certain defensive sectors have been out of favour and the relatively depressed valuations could mean that the downside risk is limited. The new year also throws open the doors to economic predictions for the next twelve months.
There’s no doubt the UK faces challenges to get growth going but should a softer-landing arrive on this year’s welcome mat, there could be an upwards revision of the value of UK stocks. Of course, nothing is certain, but by focussing on companies with strong cash flows and clear strategic direction, value investors may be able to enjoy decent returns whilst perhaps avoiding the wild swings that go with more aggressively priced sectors.
Here are 3 share ideas where weak investor sentiment may not reflect the prospects for 2024 and beyond.
NatWest
Chancellor Jeremy Hunt said in his 2023 Autumn Statement the UK government would investigate selling its 38% ownership of NatWest. Part of this plan could well be a potential share sale to retail investors in the next 12 months.
Valuations in the UK banking sector are well below the long-run average. NatWest has had its own challenges this year. Concerns about corporate governance led to significant changes to the board of directors.
More recently the group’s seen a greater than expected rush by its customers switching to higher interest longer-term deposits. That’s impacting profitability. Based on analyst forecasts for forward earnings, the valuation is now at close to 10-year lows.
But there‘s a lot to be positive about. Management are confident that the drop in net interest margin (a measure of profitability in borrowing/lending), will be less pronounced in the final quarter of 2023. In 2024 things are expected to stabilise, although there can be no guarantees.
Provisions set aside for debt defaults were better than first thought and full-year guidance remains intact. This is something to keep a close eye on, but default levels are staying low for now.
It’s not a preferred pick in terms of mortgage quality, but on the flip side, NatWest boasts one of the lowest levels of higher-risk unsecured lending in the sector.
Costs are an ongoing point of note, and a key focus for the new CEO. It’s been good to see continued progress on reducing the cost:income ratio (51.4% third quarter) – medium-term targets look for sub 50%.
Keeping costs in check is an ongoing challenge, especially in a high-inflation world. Running on CET1 ratio – which essentially shows how well capitalised banks are – of 13.5% is still very comfortable. We think this underpins the 7.4% dividend yield.
NatWest is poised to benefit from some of the structural tailwinds that should lift sector earnings over the medium term. Mortgage pricing is currently a pain point, as more profitable business written over the pandemic is replaced. That should be a headwind that eases over 2024.
There’s also the benefit from the structural hedge to come through – think of this like a bond portfolio that’s set to roll on to better rates over the coming years.
All in, at current valuations, the potential for returns look attractive for both the business and shareholders.
GSK
With two earnings upgrades over 2023, GSK would appear to be in a good place. But the valuation remains below the long-term average and lags lots of its peers in the pharmaceutical space.
Lingering question marks over cancer links to heartburn drug Zantac could be the reason for the valuation gap. Significant progress has been made to limit potential legal claims, but it remains a risk to be mindful of with the result of a key ruling expected early next year.
Vaccines are proving to be one of the biggest growth drivers. Further growth is expected for Shingrix, used for the prevention of shingles as it targets higher patient acceptance and new markets. The recently approved respiratory syncytial virus (RSV) vaccine, Arexvy, has made a good start following its commercial launch. There’s also strong regulatory progress towards approvals for a wider patient population.
The group has a strong presence in HIV treatments too, which make up about a fifth of total revenues. Its newer HIV treatments are a key part of GSK’s future, as generic competitors eat away at pricing power for some of the group’s legacy treatments.
Over the first nine months of 2023, it was encouraging to see a growing contribution from the group’s ‘Innovation’ therapies – two drug and long-acting regimens now make up over half of total HIV sales.
Looking ahead, the preventative treatment Apretude could fuel further growth. It’s already authorised in some territories and importantly the EU has been recently added to that list.
Net debt currently sits at about 1.8x forecast cash profits. That’s a comfortable level, and a position that looks set to improve given the strong levels of cash generation and recent £0.9bn disposal of Haleon shares.
The solid financial position supports a prospective dividend yield of 4.2%. But while forecasted pay outs are more than twice covered by forecasted free cash flow, no dividends can ever be assured.
Strong execution of the growth strategy and clinical pipeline are likely to be the key focus for shareholders going forward. So far so good, but remember the drug approval process is long and expensive, with many treatments never seeing the light of day.
British American Tobacco
British American Tobacco (BATS) is fighting hard to maintain market share in traditional combustible products (cigarettes and cigars) in its largest market, the United States. This is proving challenging and it’s weighing on financial performance.
In other territories, the picture looks brighter. There are also rays of hope that BATS’ efforts to stem the tide in the US are bearing fruit. But it’s against the backdrop of a declining market. For the immediate future, combustibles remain the key driver of profitability. That means any further slowdown could further dent investor sentiment.
The group was early to recognise changes in consumer behaviour and is increasingly pinning its hopes for the future on its portfolio of ‘smokeless’ products, like vapes.
These categories are set to become profitable in 2024, two years ahead of the original plan. There’s now a target in place for them to generate over half of total revenues by 2035.
The ambition is admirable, but with pressure building for tighter regulation and higher taxes on these products, there will be challenges along the way. Only time will tell if they can achieve the same attractive margins that BATS has become accustomed to.
Consistently high cash flows mean the company is well placed to make the investments necessary to keep pivoting away from cigarettes. It also leaves room to support an attractive dividend yield which is now in double-digit territory. But share buybacks remain on hold and are unlikely to be reconsidered until net debt drops a little further.
The weakness seen in the valuation suggests there’s still a job to be done in convincing investors that New Categories can underpin BATS’ future. Successful execution of the strategy could well drive a re-rating. But there are likely to be bumps ahead, so investors need to be prepared for some volatility.”
