Piling into the defensives..

26th Jun '09 by MrT

9 comments 1372 reads

Slightly old news but, for those of us that believe that we are in for a long, hard recession and that those "green shoots" are just weeds messing up the pavement, there were Interesting articles in MoneyWeek and the Times a couple of weeks back: http://www.moneyweek.com/investment-advice/how-to-invest/pick-up-defensive-stocks-while-theyre-cheap-44006.aspx

It was based on some research from Citigroup which I haven't yet seen unfortunately which showed that, since the end of last year, pan-European defensive stocks (telecoms, healthcare, food & beverage, food retail and utilities) have slumped from a 70% premium to cyclicals to a 20% discount. They now look "cheap in absolute and relative terms". The prospective yield on European telecoms groups is apparently 80% higher than the rest of the market...

A basket of Citigroup's biggest buy-rated European defensives with strong balance sheets (Nestlé, Vodafone, Glaxo, Telefonica, Unilever, Sanofi-Aventis, Eon, BAT, GDF Suez and Enel) is on a forward p/e of under ten for the first time since 1990. "Time for a sniff?"

If this is true, I am astonished at the turnaround in valuation as defensives were so rich at the end of last year...

http://business.timesonline.co.uk/tol/business/columnists/article6489479.ece

http://www.citywire.co.uk/personal/-/news/markets-companies-and-funds/content.aspx?ID=344025

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promethean

1st Jul '09

Defensive - is that a euphemism for ex-growth?

Gradders73

No, the theory is it is ones with inelastic demand, who can feed through costs to consumers and who's revenues tend to stay fairly constant.

Classics are - tobacco, healthcare, utilities etc. My favourite is chocolate, always does well in a downturn.

Imperial Tobacco is looking like a good one at the moment. Share price took a bit of hit when they had nasty earning, but they seem to have taken the opportunity to clear the decks and I am sure they took the opportunity to buy tobacco leaf in major size when the world went mad a few months ago.

Not sure about utilities, as they may have problems with the official inflation data staying too low relative to true costs...

MrT

2nd Jul '09

Agree in theory re: chocolates, although interestingly Thornton's share price has been surprisingly erratic. Maybe it's less true for specialty chocolate makers... http://www.stockopedia.com/forum/view/27036/recession-play

demully

5th Jul '09

Devil in the detail, but it's easily possible with:

a) cyclical sectors that were heavily oversold in Q4 last year, rebounding 30+% while defensives are flat-to-down-to-up-a-few-%.

b) the weakness in cyclical-sector earnings that was being anticipated when they sold off last Q4 has then fed through. Lower E leads to higher PE. In some sectors, eg autos and semiconductors, earnings have fallen to effectively zero so the premium valuation is effectively infinite.

In short, be very suspicious of PEs around cyclical tops and bottoms - you need to adjust for the cycle, and even then earnings looked cheap this time around and weren't. And trying to compare cyclicals to non-cyclicals is hopeless, unless you can find a common measure other than earnings that isn't cyclically sensitive. Dividend yields and sector price-to-books, relative to their price-history-relative (yes two relatives, to deal with the fact that pharma and staples PBVs are 3x+), are much safer than earnings in this respect.

This said, I sense that "defensive laggards" are indeed the place to be rotate right now, from early-cyclical in Q1. So back one step before froward two rather than into late cyclicals, what with the green shoots getting a little ahead of themselves and the actual path of recovery in the economy.

best,

DEM

Fangorn

7th Jul '09

I've been looking at some defensive nibbling myself recently, based on the assumption that we are in for a longer recession that most are anticipating. Current favourites are Bae(although there are concerns here with MOD expenditure cuts I feel this is more than offset by the company's expansion into the US, the biggest defence market in the world), Glaxo, UU, Centrica,and some BT(the latter seems to have picked up favourable comments recently from some institutions despite the worrying pension situ and the continuing losses at Global Services.

And, as always, looking to pick up some BP on the cheap (imv anything around the 4.50 mark)

Not sure about BAe, the expansion into the US is tricky and they have lots of enemies there. US military expenditure may get cut back as well.

Glaxo - interesting one here, the share price has done nothing for seven years and there has been general negativity about poor pipeline and expiring patents, but on a forward P/E basis of 10, it is very cheap.

BT - not in a million years, please see other post, but the pension is going to cause enormous pain for shareholders.

UU - interesting as it's a regulated utility, so the equity is more like a bond in it's characteristics. As profits are essentially restricted, with growth linked to inflation, they could suffer if we have official deflation, but real world inflation rises. You should consider their bonds as well.

Centrica could be a growth story, with the Energis deal. If there is a push for nuclear, and this seems the most popular choice, they could do well.

I would suggest looking at Imperial Tobacco as well, unless you have a moral objection to cigarettes.

8th Jul '09

Was thinking PMI ( or whatever the International side of the old Altria is these days) for my tobacco exposure :)

No moral ojection to the ciggies here given I'm a Marlborough man myself :)

Thanks for your thoughts re my other stock musings. Glaxo, Centrica and UU are my priorities, as well as BP. Bae I've been a big fan since 1990 so am waiting for that to tick down a bit further.

Am also looking to pick u psome miners, Kazakhmys and EnRC. Lots of things to peruse at the moment.

9th Jul '09

PMI looks interesting, but you may find there is more juice in Altria, which is probably discounted owing to litigation risk, but I suspect they are through the worst.

I've got a soft spot for Imperial as I know the finance department pretty well from my old days and they are without doubt one of the smartest teams around. They have a very good geographic mix.

As for BAe, I am not as much of a fan, as I am reluctant to buy into military and my experience of military procurement projects tells me the true profitability is unclear. Basically, the govt takes bids for a project, awards it and then spends the next decade constantly changing the parameters and but insisting the price can't change. What factors do you think are more positive?

On that front, Rolls Royce is worth a look, despite the British Airways risk, (if you take the view whatever happens to the compnay, the planes will stay flying.) The juice in RR is the servicing contracts on the engines which kick in after a certain number of flying hours. Clearly given the drop in flying, there is a risk there, but they are not as exposed to the US market (GE dominates that) but as a rule of thumb, the ones that fly Airbus use RR. I have been continually surprised by just how resilient the company is, a great company with lousy customers. However, they have lucrative military contracts, and I am sure the demand for helicopter engines and servicing is strong, given the state of the world. Because they have the more "simple" job, they don't have the change of spec risk that BAe has.

Speaking of aerospace, I am considering changing a habit of a lifetime and shorting a stock, namely Boeing. The numbers look woeful, particularly commerical and the balance sheet has a big pension/ healthcare overhang. In the first half of 2009, the net orders for commercial aircraft was one. That's correct, one. The problems with the Dreamliner will take time to fix. Who knows, maybe the Chinese will get their wish and be able to buy the commercial wing, but then the rump of the business will be dominated by the $50 billion pension fund (which is about 20% in deficit).

13th Jul '09

Will take a look at Altria too but my first concerns would be that Altria is now purely domestically focused, having shed PMI, the domestic market is I beleive on a hiding to nothing, what with all the anti smoking regulation. More growth prospects in outside of PMI imv.

I can understand why you wouldn't be a fan of Bae, particularly as in the past it has had some enourmous cockups, and huge writeoffs. Makes the stock more volatile yes, but underpinning it is a decent defence business. Its the largest European defence manufacturer, wars arent going to go away unfortunateloy so there will always be a demand for their product(albeit at lower levels one would assume given how indebted the UK and Europe currently are). What is more interesting though is their expansive foray into the US, the world's largest defence market. And it is here, despite probable US defence budget cuts that the gravy exists imv. both now and for the future. But if I had to pick only one defence contractor for my portfolio then it'd have to be General Dymanics. Consistentyly well run, with some key projects. Well worth a look.

Funnily enough I'd considered shorting Boeing myself. And yes it was shocking their net orders were "one" as you say. I don't see Airbus being much better though going forward - the next generation of aircraft will be chinese produced, of that I am sure. European cost base is too high, and having the manufacture of planes contracted out to each participant country according to their involvement(wings for UK previously until Bae sold) just makes the whole project unwieldy imv)

I was also thinking of shorting airlines in general, with their cumulative losses forecast to be $6bn or so this year I think it was. Not a fan of airlines at all. Too many unknowns :)

Piling into the defensives..

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MrT

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