- Cautious: GSK
- Balanced: Legal & General
- Adventurous: Ashmore
- Income: Lancashire
“The UK stock market has, once again, frustrated those who were convinced it was cheap and lived down the expectations of those who asserted it was cheap for good reason. The FTSE All-Share’s 6% advance in 2023 lags that of most major indices and really only beats the Shanghai Composite and the Hang Seng, which are both down for the year,” says AJ Bell investment director Russ Mould.
“However, that gain is supplemented by a dividend yield north of 3.5%, share buybacks and also mergers and acquisitions, so the total cash return will still be in the low double-digit percentage range. That beats inflation, government bond yields and returns on cash. The takeover activity witnessed in the UK again hints that there is value to be found, especially as many deals have been done at a big premium, and as we enter 2024 the UK market may still feature stocks that could appeal to a wide range of investor requirements and risk appetites.”
Cautious – GSK (GSK) £14.32
A major overhaul of the group structure, four profit forecast upgrades in the past two years and a promising drug development pipeline are yet to boost shares in GSK (GSK), which can point to little by way of progress in 2023. But the combination of increased forecasts and a static share price leads to a valuation that looks tempting in absolute terms, relative to the company’s own growth targets and also in the context of the price tags attached to its global peers.
GSK is now focused purely on the development and sale of medicines and vaccines. That immediately offers the prospect of exposure to long-term demographic trends such as population growth (in developing markets) and increased longevity (in developing and developed arenas).
The relatively predictable demand, high margins and consistent cashflow that can result from a successful drug development model can also appeal at times of economic uncertainty, so GSK may appeal to those investors who fear that an unexpected recession could creep up on the UK equity market next year.
The earnings upgrades already reflect the impact of complementary acquisitions and GSK’s own ongoing drug development efforts and CEO Emma Walmsley is targeting compound trend sales growth of more than 5% a year and compound adjusted operating profit growth of more than 10% per annum, as profit margins expand from the 30% mark recorded in the first six months of 2023. Attainment of such goals would leave the stock looking cheap on barely 11 times forward earnings with a yield of 4.3%.
One reason for the turgid share price performance is the raft of lawsuits that allege there is a link between the heartburn drug ranitidine (better known as Zantac) and cancer. But the lowly valuation prices in a lot of bad (legal) news and the rejection of lawsuits in Florida and Canada, and a settlement in California whereby GSK did not admit liability, mean the news flow here has not been as bad as was first feared when the legal cases became public, and the share price tumbled, in summer 2022.
Balanced – Legal & General (LGEN) 246p
Shares in Legal & General are contriving to underperform the wider UK stock market in 2023, as they are broadly flat, thanks to investors’ worries over the impact of higher interest rates on the life insurance, pensions and investment giant. But the cycle of higher borrowing costs may be nearing its end and the company’s financial performance this year offers evidence that higher interest rates can bring benefits, too.
The negative headlines in 2023 have surrounded Legal & General Investment Management (LGIM). Net outflows are partly the result of market volatility but savers’ withdrawal of cash could also be attributed to dissatisfaction with fund performance thanks to another dull year from the UK stock market, or because people need the money to help them pay bills in the current inflationary environment.
But LGIM contributed just 13% of first-half divisional operating profits. By contrast, the institutional pensions business (LGRI) is going well, and that provided 40% of group first-half operating profit. Firms are looking to offload their pension risk through what is known as a bulk annuity agreement and LGRI is well placed here. After November’s full buy-in deal with Boots, Legal & General has written £13.4 billion in UK pension risk transfer (PRT) in 2023, compared to £8.3 billion in 2022 and £7.2 billion in 2021.
The lowly valuation on an earnings basis, and forecast 8.5% dividend yield for 2024, offer the potential for capital appreciation and income generation, and management has a plan to increase its shareholder distribution by some 5% a year. Moreover, the balance sheet is strong, as evidenced by a first-half Solvency Ratio of 230% that more than meets regulatory capital requirements.
Adventurous – Ashmore (ASHM) 213p
Emerging markets are out of favour and so are shares in UK-based fund management houses, especially if their portfolio performance lags that of peers and key benchmarks in recent times. This all helps to explain why shares in emerging markets specialist money manager Ashmore trade at levels last seen in 2009, but it also may be enough to persuade contrarian and risk-tolerant investors to do some more research on the FTSE 250 member.
Unloved can mean undervalued, after all. The 16.9p-share dividend looks well backed, and equates to an 8% yield, while there is a net cash pile to provide support to the company’s £1.4 billion stock market valuation.
Granted, management’s decision, released alongside September’s full-year results, to lay out the terms of the bonus pool pay-out ratio in favour of staff (and thus to the potential detriment of profits and shareholders), does not sit well. But there are some signs of better times ahead for emerging markets. Emerging market central banks were faster than their developed market counterparts in spotting the dangers posed by inflation and they began to raise rates accordingly. They are now reaping their reward, if interest rate cuts from Peru, Hungary, Paraguay, Chile and Poland are any guide, while tax reforms in Brazil and the possibility of a new broom in Argentina are potential further positives. Talk of economic collapse in China is just that – talk – and dollar weakness, as the US Federal Reserve nears the peak of its hiking cycle, could be helpful too, if the historic inverse relationship between the greenback and emerging equities is maintained.
Income seekers – Lancashire (LRE) 609p
With the valuation low, balance sheet strong and pricing firm, further positive total returns via share price gains and dividends remain quite possible from Lloyd’s of London insurance specialist Lancashire.
A 23% increase in gross premiums written in the first nine months of 2023 is testament to strong pricing across the Lloyd’s of London syndicate manager’s specialist areas of property insurance and reinsurance, aviation, terrorism and political risk. Meanwhile, natural disasters in the US, New Zealand and Turkey have not led to losses of any great substance and higher interest rates and bond yields have helped boost returns on the $2.5 billion investment portfolio.
All of this means Lancashire has just launched a $50 million share buyback and – even better – paid a $0.50 special dividend worth $119 million (£97 million) on 15 December. This is the first special dividend since 2018 and analysts’ forecasts for a total dividend in 2024 of $0.83, enough for a 10.6% yield, suggest there could be more to come.
There is always the risk of an unforeseen event in 2024 and it can be argued that climate change further raises the stakes. But the manager of Lloyd’s syndicates 2010 and 3010, which is also in the process of laying the groundwork for the next leg in the FTSE 250 firm’s long-term growth story with 2024’s launch of Lancashire Insurance US, has paid out dividends worth a total of just over 878p a share since its listing in 2008. That figure looks good next to the current share price, and with more to come Lancashire could yet re-establish itself as an attractive yield play.
