We have been talking for some time about how the UK stock market has been undervalued and ignored by global investors, and the catalysts that might trigger a rebound in demand for UK Plc.
The UK market is undervalued versus history and versus other markets, and returns have trailed those of the more technology-heavy US market since the Covid pandemic. This may be starting to change. The FTSE 100 and FTSE All Share indices have notched record highs this year. Global investors remain underweight the UK, but we see signs that the catalysts are working, and we think this makes an appealing backdrop for UK equity income investors. We aren’t expecting the general election in July to have a significant impact on markets, and aren’t expecting major policy announcements from either of the main parties.
The first of the catalysts we have cited is corporate merger and acquisition activity. There were over 50 transactions in the UK market last year — mostly small and mid-size companies that many people haven’t heard of. What was missing was a blockbuster deal to grab the attention of global investors. This happened starting in April with a 31 billion-pound offer (which was later increased) from Australia’s BHP for miner Anglo American, one of the 10 biggest companies on the London market. We wouldn’t be surprised to see other big deals this year.
73% premium
A smaller but interesting potential transaction was Czech investor Daniel Kretinsky’s offer for Royal Mail’s parent company in April. The offer premium was 73% above the company’s share price, which highlights to us that corporate buyers understand the value in UK companies. An April approach for Hargreaves Landsdown from a private equity consortium came at a 30% premium. Another catalyst is easing inflation and the potential for Bank of England rate cuts this year. Figures released on May 22 showed inflation at 2.3 percent, the lowest in nearly three years. Bank officials have said they are considering reducing interest rates this year as inflation slows. This is particularly important for small and midcap companies because inflation has a significant impact on their operating costs. The final catalyst we have cited is the remarkable pace of share buybacks from UK companies in the last 2 ½ years. We expect to see around 50 billion pounds in buybacks this year, and a total of 150 billion pounds over three years. We haven’t seen this before -– typically FTSE 100 companies buy back 10 billion to 20 billion pounds of shares a year.
$14 billion buyback
BP announced a two-year, $14 billion buyback program, while Barclays shares have surged since it announced a plan to return 10 billion pounds to shareholders in dividends and buybacks over three years.
We talk to company executives regularly, and they are frustrated about share prices. Buybacks make strategic sense when a company’s shares are undervalued. They also are positive for us as income investors because a company won’t initiate a buybacks program unless their dividend is secure and their balance sheet is strong.
Another thing about the trend in share buybacks: It comes as UK pension funds wind down their sale of UK equities. Pension funds cut their holdings from 590 billion pounds in 1997 to 120 billion pounds currently, to diversify their portfolios. We see a potential inflection point for the market from these selling and buyback trends.
Catalysts playing out
To be sure, challenges remain for the markets in the UK and globally. Some cyclical companies are struggling, UK economic growth lags that of the US and serious geopolitical tensions are present that could impact markets.
Nevertheless, we think it’s an exciting time for UK equity income investors. We look for companies with robust balance sheets, strong cash flow profiles and a willingness to reward shareholders with payouts. We aim for our strategy to deliver income with the prospect of capital returns as the companies we invest in prosper.
The FTSE 100 reached 12 new all-time highs over a recent four-week period. The last time that happened was 1984. It’s interesting to consider where the market may be headed, how the catalysts will play out and whether momentum will continue to build in the market.
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