Top 10 stock picks

Which UK shares will be hot in the coming 12 months? Will they all fall into one sector? Will they be blue chips, mid-cap, small-cap, micro-cap? Rupert Walker asks ten experts – from stockbrokers to fund managers – to pick a share each and explain why they think their pick is a winner

Which UK shares will be hot in the coming 12 months? Will they all fall into one sector? Will they be blue chips, mid-cap, small-cap, micro-cap? Rupert Walker asks ten experts – from stockbrokers to fund managers – to pick a share each and explain why they think their pick is a winner

Concern about the weakness of the UK economy over the next 12 months leads many investors to search for defensive or counter-cyclical shares, or, among the more adventurous, shares that have particular ‘stories’ to support them, irrespective of market conditions.

Among many factors pointing to a slowdown, perhaps three of the most important are a stagnating housing market, high levels of personal debt and the impact of energy prices. All will probably have negative effects on consumer confidence and spending, and hence hurt the bottom lines of many UK companies, particularly retailers and the leisure sector.

Companies showing clear revenue visibility and cashflow generation become increasingly attractive. Utilities, support services, telecommunications and defence suppliers are all viewed as appealing sectors. Curiously, bank shares also have some support – largely because they are currently so undervalued, and are possible take-over targets. But a clear message comes through – cash will be king.

Mary Haly, Head of UK Institutional Equities

Barings Asset Management

Resolution (Britannic) (stock ticker: RSL)

“The merger of non-quoted Resolution and Britannic brought the two main competitors for buying closed-life funds (not open to new policyholders) together.

It has led to cost savings and efficiencies, particularly in back-office operations and administration, where just one IT platform is being used, so avoiding some of the problems suffered by Norwich Union and Commercial Union when they merged. Management has a clear strategy and has pushed for close integration.

“ Management at Resolution had a clear strategy of buying closed-end with-profit policy funds at low points of the markets about two years ago, when insurance companies were in disarray. Resolution buys at discounts to embedded value and will continue to look for opportunities to do so in the future. There is likely to be a good news flow of further merger synergies and new deals.

“ Cashflow is very strong, so, although the share yields just 3 per cent, the dividend should grow at 11 per cent p.a. up to 2009. The share is a medium term play and should expect about 15 per cent upside.”

Ted Scott, Director of Stewardship Funds

Foreign & Colonial

Barclays Bank (ticker: BARC)

“Bank shares have been weak in the last year or so, as the UK economy has slowed, while a stagnant housing market has led to an increase in bad debts. However, this is not a recession on the scale of the early 1990s. A further interest rate cut this year and more cuts in 2006 should also alleviate some of the pain.

“Barclays is particularly attractive because a large part of its re-venue comes from its capital markets operations and corporate relationships, so is less vulnerable than others to problems in the personal banking market.

Its valuation is undemanding historically, trading with a p/e at 20 per cent discount to the market. US investment banks, like Goldman Sachs, trade at much higher multiples; so there is always the possibility that Barclays might be a takeover target if there is no rerating. Also, at a time when dividends make up a significant part of a share’s overall total return, a yield of 4.5 per cent (Dec. 2005) compares very favourably with an average 3 per cent for the market.

“F&C hold Barclays in its £2 billion Stewardship Funds and its £25 million UK Equity Growth and Income Fund, and we for ecast 15-20 per cent relative outperformance over the next 12 months.”

Dan Heron, UK Equity team, Gartmore

Cable and Wireless (ticker: CW.)

“Cable & Wireless (C&W) has experienced a dramatic improvement since it sold its cash haemorrhaging US arm nearly two years ago. Since then, it paid £600 million for rival telecommunications firm Energis. Economies of scale have created cost savings and synergies, while the acquisition has also broadened C&W’s customer base, to include more large government and corporate clients.

The company has an additional £300 million set aside for further strategic deals.

“It’s not an especially cyclical share, so it shouldn’t be a major casualty if the economy slows significantly next year; neither is the oil price that important. Although its retail broadband provider, Bulldog, has received some negative comments for poor customer service, C&W should be able to solve those problems. It is currently ‘reasonably priced’, but is not a p/e share and should be valued as the ‘sum of its parts’.

It has a large market capitalisation and is well-supported by leading investment institutions. Gartmore holds C&W in its UK Focus, UK Growth and UK Income Funds, and forecasts 15-20 per cent upside for the share price over the next 12-months.”

Sebastian Jantet, Health Care Analyst, Investec Securities

(No. 2 UK stock picker, Sunday Times/StarMine Awards 2004)

Care UK (ticker: CUK)

“The NHS is spending £4.5 billion a year on privately provided clinical care and facilities management as the second wave of independent treatment centres (ITCs) come on stream. And there could be a significant increase in private provision once the government’s white paper on ‘Care Outside Hospital’ is published next year. Care UK, a broad service provider for the NHS and local authorities, and of specialist services for the elderly and for child care, took 15 per cent of the first wave of ITCs, and is likely to be a key beneficiary in the future.

“The company has contracted earnings growth of 20 per cent p.a. for the next three years. So on a p/e of 18, it is not particularly cheap. However, there is potential for long-term contract gains which would lead to a rerating. In any case, high earnings visibility – because of existing contracts – ensures a guaranteed 20 per cent growth rate in an uncertain economic environment, while macro-trends, for example demographics and improving technology, are also very supportive.”

John Monnelly, Co-manager UK Active Products, Martin Currie (works with Duncan Goodwin, who, when at Merrill Lynch, was rated No.1 UK stock picker by Sunday Times/StarMine 2004)

British Energy Group (ticker: BGY)

“Facts are more important than a ‘story’ when searching for shares that have been overlooked by the market. Screening helps identify those companies that are under-going positive operational changes. British Energy is cash-rich following the conversion by its bondholders of their debt to equity, and cash-generative because of increasing electricity prices.

“The company has no debt burden to service, nor does it suffer from significant input price increases because it generates electricity from nuclear power, not oil, gas or coal. The government’s commitment to sustaining electricity levels should also be supportive, as will its obligation to assist with decommissioning.

“The shares trade on half the market’s p/e when projected to 2008 (i.e. 6x), when the full benefit of price increases should help earnings. US nuclear energy companies trade at much higher multiples (16x), and the partial listing of French provider EDF should focus investors’ attention on British Energy’s undervaluation.

“Winning shares are held when the fundamentals remain the same, so the preference is not to make share price forecasts.”

David Lis, Head of UK Specialist Team, Morley Fund Management

Protherics (ticker: PTI)

“Protherics is an almost profitable biopharmaceutical company, with high expectations for its CytoFab anti-blood poisoning treatment, currently awaiting licence, and for which the company is close to a deal with a larg
e pharmaceutical company, ready to exploit a potential $500 million market.

Another product, Voraxaze, used to combat the toxic effects of chemotherapy, has completed its European filing and is expected to get the go-ahead from the US in the next few months. Other anti-cancer treatments and a high blood pressure product are in the pipeline.

“Meanwhile it has a profitable product with CroFab, a snakebite antidote, whose sales have been given a recent boost following the floods in the wake of the hurricanes in the southern US.

“It is a long-term growth stock, is basically counter-cyclical and with a market capitalisation of just £100 million is nevertheless well supported by leading UK institutions – Morley holds 11 per cent of the shares. Currently trading at 6x sales, Protheric is priced at 55 pence, fair value is estimated at 140 pence, and are targeted to reach 95 pence.

James Ridgewell, UK Special Situations Fund, New Star

ArmorGroup International (ticker: ARG)

“ArmorGroup International can be viewed as a ‘play on terrorism’. It’s a top-end security provider, supplying ex-SAS soldiers as bodyguards and consultants for companies and governments operating in dangerous parts of the world.

For instance, it has contracts with the UK and US embassies in Iraq. It is a high-margin niche business, earning quality earnings in a growth industry.

“Its US management chose to take the IPO route to get working capital as increasing demand for the company’s services put pressure on its cost base. Its biggest problem is finding suitable employees. Although earnings for 2005 are estimated at 30 per cent and forecast at 27 per cent for 2006, ArmorGroup trades on a p/e of just 11x (December 2005) and 8.5x (December 2006). It should reach a multiple of 13-14x earnings, and is well off its price high of £2.70.”

Glen Pratt, Senior Equity Fund Manage, Newton

Vodafone (ticker: VOD)

“Vodafone is an undervalued growth stock. First, historically it has traded on 15-25x earnings growing at 10 per cent a year, but currently has a p/e of just 12, which is even less than the market average of 13-14. Secondly, spending on mobile phone usage is increasing worldwide – China and parts of Africa are concentrating on building a mobile network rather than improving landline infrastructure.

New services coming through over the next 3-4 years will further enhance the ‘penetration story’. Third, cost savings will come through as back offices are further integrated, following the spate of mergers and acquisitions that has made Vodafone the largest mobile phone company in the world.

“Fourth, its cash flow position is improving, with capital expenditure likely to decline from 15 per cent of sales to 10 per cent. Its free-cash flow yield is more than 10 per cent pa, so money can be used to pay higher dividends and repurchase shares. Currently trading at £1.50, the shares should exceed £2.00 and will also be a strong relative performer.”

Colin McLean, SVM Asset Management

Carphone Warehouse (ticker: CPW)

“Carphone Warehouse is a hybrid – part retailer, part telecoms company with plenty of new product coming on-stream. As a retailer, it’s winning market share from competitors like Link and is demonstrating excellent sales growth as a telecom supplier. Its Talk-Talk product, in competition with Centrica’s One-Tel, is an alternative to fixed-line and incorporates broadband technology. It has one million customers in the UK, adding 100,000 new customers each quarter. The company has a price advantage over BT, undercutting domestic calls by 10 per cent. As a telecoms company it should avoid the worst of the problems that high-street retailers might suffer next year.

“Although the dividend yield is low at one per cent, the company scores well for its free cashflow yield. Discounting future revenues suggests a price target of £2.50, a 25 per cent increase over the next 12-months. With a p/e of 18x, the shares are at a premium rating to the market, but 30 per cent earnings growth is forecast during the next two years. Once all the infrastructure is in place, earnings should come straight through to the bottom line. Carphone Warehouse is held in the SVM UK Alpha Fund.”

Derek Stuart, UK Special Situations, Artemis Morgan

Crucible (ticker: MGCR)

“Morgan Crucible has a strong management with a strategic vision, healthy margins and improving financials, and its shares are cheap. The recent sale of its Magnetics division for £300 million-will reduce the group’s costs and is part of its plan to shift production to low-cost, high growth markets.

“It leaves the company able to concentrate on developing new products in growth areas such as technical and thermal ceramics and carbon, helps simplify the group structure, emphasises the management’s focus on cash generation and also provides money for future acquisitions and share buy-backs.”

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