Shopping around for rate-resilient stocks (Archived)
By Esther Armstrong, BNY Mellon IM EMEA
Newton’s Paul Stephany, portfolio manager, UK equities, and Rosie Bichard, global analyst – consumer, take a closer look at the UK consumer space.
Consensus is far from achievable on when the Bank of England (BoE) will begin a rate-hiking cycle. Indeed, investors could be forgiven for thinking interest rates in the UK will never go up – the base rate has been at 0.5% since March 2009 after all.
As a manager of UK equity portfolios, Stephany is attuned to the potential implications of rate rises on the wider economy, not least for homeowners. “Mark Carney (BoE governor) has been embracing ambiguity on the parameters for interest rate policy so it is hard for homeowners to plan. That means people are sensitive to rate rises – if you are on a variable rate mortgage it will normally move up very soon after a rate rise,” he says. “Eventually interest rates will go up but it is not going to be a strong hike, especially as the BoEwill be starting from such low levels,” Stephany adds. When it comes the increase could have a negative effect on a number of areas in the equity market, including consumer stocks.
The argument against retailers and consumer discretionary stocks in a rising interest rate environment is that if homeowners have higher mortgage repayments they will have less disposable income to spend with these companies. Yet it is too simplistic to tar the whole sector with one brush, says Stephany. “Many studies say consumer stocks do well in a rising interest rate environment. If you look back to periods of relatively higher interest rates in the UK, such as 2005-2007, you can see although interest rates were going up the strong economic backdrop meant retail and consumer stocks did very well.”
This is a point Stephany is keen to stress: “If the BoE starts raising interest rates it would likely be well-flagged in advance, a reflection of a stronger economy, and a response to higher inflation readings, which would be driven by wage inflation. This in turn would mean consumers’ pockets were not hit overly hard by the tightening of monetary policy.”
That is not to say he is bullish on all consumer-leaning companies. “Interest rate moves or not I would not want to own too much that’s consumer exposed,” he says. The main reason for this is that Stephany is bearish on the housing market and thinks property prices look dangerously high, particularly in London – bolstered as they are by foreign money. Should a period of stalling house prices occur it could be followed by a dramatic reversal of consumer confidence: “There is a lot to say it is about ‘feel-good factor’ and in the UK that is driven by house prices,” he says.
In response to such risks, Stephany is steering clear of housebuilders and home improvement companies. “Many of these stocks are generally trading at high multiples and I do not think there is much margin for error. If you are currently invested in consumer-related stocks they have had a good two years of share price and earnings growth and we could see a significant retrenchment in the sector,” he explains. “There are some notable exceptions, however – mainly companies with an online story, or those that have shown resilience during tough times for consumers.”
Just Eat and Moneysupermarket.com are examples of the former; while the owner of Primark, AB Foods, falls into the latter category. A favourite of Stephany’s, Domino’s Pizza, straddles both.
On Domino’s, Stephany says: “Around 70% of orders at the pizza chain are now online and it is a very resilient business. Barely a store has ever closed in the history of the company, but it is not priced for great things with shares languishing as the market focuses on a misjudged entry into Germany.” Meanwhile, he considers Primark one of the ‘best stories’ in the whole of global retail. “It still has good growth in its UK stores and has been opening more space in France and Germany. It is a great business which benefits from the economies of scale of very large stores and does not pretend to be anything it is not.”
Bichard says one of the reasons AB Foods would be better placed to absorb interest rate-related volatility is due to the profile of the customers at Primark who are more likely to be in ‘generation rent’. This means a rise in mortgage rates would not directly impact them. In addition, the fact Primark is at the value end of the market means that when consumers are squeezed they may be even more disposed to shop there than before.
Meanwhile, although Next’s core consumers are homeowners with mortgages, its strong multi-channel offer, convenient out-of-town store locations and high market share in children’s clothing should continue to support growth, she says.
Stephany adds that Next’s management is cautious, which he likes: “I often look for companies where management seem downbeat and Next is a great example of this. They do not go out saying ‘we are going to see huge growth’, most years they say ‘we are going to see a couple of percent’ and then end up surprising the market.”
In general Bichard is sanguine on finding opportunities in the sector regardless of the interest-rate environment in 2015 and beyond. “Look at the Japanese economy, it could hardly be seen as an area of great growth in the past decade and we have had a couple of good investments there which have taken advantage of consumers looking for good value.”
In line with consumers then, selective shopping will be the order of the day.This is not investment advice. Regulatory Disclosure