So many shares are down 50% or more in the past nine months, but they’re not all bad companies. We look at some of the cheap cyclical stocks that could outperform when market conditions improve.
A watchlist of FTSE 350 stocks whose valuations have slumped by more than 50% this year continues to throw up some fascinating opportunities for bargain-hunting investors.
JD Sports Fashion (LSE:JD.), the income stocks Persimmon (LSE:PSN) and Barratt Developments (LSE:BDEV), and the high street bellwether Marks & Spencer Group (LSE:MKS) are among established names in the 50% Club, having been shredded by fears of a hard landing for the UK and the wider global economy.
There were a total of 41 FTSE 350-listed stocks down by more than 50% by the time of last night’s stock market close, with few betting against this figure increasing before the year is out.
But for many of these cyclical-driven stocks, the severity of their share price declines has been disproportionate to their most recent trading numbers. That’s down to the hugely uncertain outlook, including for debt costs, but investors need to be thinking how much pain is now priced into valuations.
A good example is the housebuilding sector, where shares in Persimmon and Barratt are down by 57% and 54% respectively amidst heightened worries about whether the current mortgage market turmoil will shatter customer affordability.
UBS is now braced for house prices to decline 10% next year and for volumes to slide 20%, prompting the bank to slash its average earnings per share forecasts for the sector in 2024 by 62%.
Despite these much gloomier estimates, the bank continues to regard the risk/reward as attractive after retaining “buy” ratings on Barratt, Bellway (LSE:BWY), Berkeley Group Holdings (The) (LSE:BKG), Redrow (LSE:RDW) and Taylor Wimpey (LSE:TW.).
The bank pointed out that balance sheets are significantly stronger in this cycle than the 2008 financial crisis, a factor that should provide some protection for dividends in a sector where the current average yield stands at around 6%.
UBS believes that the structural shortage of housing is unlikely to change and that this should support an eventual house price recovery.
For now, however, UBS understands that investors are engaged in a “damage limitation” exercise as shares now trade on about 0.75 times tangible net asset value compared with the financial crisis trough of about 0.7 times.
Mid-caps almost as cheap as 2008
The 2008 slide in stock market valuations provides a useful benchmark for investors as the last big recession to hit the UK economy. In its analysis of mid-cap consumer-facing stocks, analysts at Jefferies said multiples are now approaching financial crisis levels at 10.6 times earnings.
In October 2008, the same basket of stocks were on seven times earnings, but this was heavily skewed by Premier Foods and in conditions arguably more uncertain for asset prices than now.Fears that the UK retail sector is heading for a winter of discontent as households prioritise their spending on energy and mortgage bills, have contributed to shares in JD Sports Fashion and Marks & Spencer sliding by 53% and 58% respectively.
In the case of JD, this performance jars with half-year results of less than a month ago that showed “ongoing resilience” and profits of £383.5 million at the top end of expectations.
Its busiest trading period lies ahead, but for now the company continues to regard last year’s record annual results as within reach. And at a time when balance sheet strength should be a key factor for investors, JD reported net cash above £1 billion at the end of July.
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Next (LSE:NXT) is another highly-regarded retail play whose consistent record of delivery has failed to prevent its stock market valuation going into reverse. The FTSE 100-listed company, which posted largely resilient figures last week, is on the brink of joining the 50% Club at 4,594p (down 45% in 2022), but analysts at Numis regard this as far too cheap based on today’s new 6,800p price target.
Future (LSE:FUTR) shares were among 2021’s best performers but the publisher behind magazines including Country Life and FourFourTwo has fallen back to earth in spectacular fashion as investors revise their lofty expectations.
The wider flight from growth and tech stocks has contributed to the sell-off, but Future remains upbeat after outgoing boss Zillah Byne-Thorne last month told City analysts of her ambition for Future to extend its online reach to one in two users in the US.
Operating profit is also set to be towards the top end of market expectations, currently £266 million-£271 million, amid continued growth in digital advertising and encouraging trends in e-commerce. Shares have fallen to 1,253p, which is where they stood back in summer 2020, but analysts at Peel Hunt recently said the shares deserved to be above 3,000p.
Hard times at Ocado
Nowhere has the valuation impact of rising interest rates been felt more keenly than at grocery warehouse technology business Ocado Group (LSE:OCDO), whose shares are down 74% this year at 428p for a position near the top of our 50% Club fallers board.
The shares were 2,800p at the height of the online shopping boom in January 2021, but now stand at more than half the level they were trading at prior to the pandemic.
Ongoing investment costs mean the company remains deep in the red, with the prospect of more heavy losses clouding the “buy” case. But Ocado’s supporters see the longer-term potential of a market leader well placed to take advantage of an estimated $94 billion (£76.8 million) expansion of the global online grocery sector in the next five years.
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It now has six customer fulfilment centres in the UK and partnerships with some of the world's largest food retailers, including Kroger in the United States, Sobeys in Canada and Casino in France.
City price recommendations continue to be revised lower, but the latest of these from Bank of America still suggests a significant upside based on today’s estimate of 1,150p.
Mid-cap stocks in oversold territory
A daily list compiled by broker Liberum shows both Ocado and Future among the top 10 FTSE 350 stocks for under performance versus their respective sectors.
Their declines of 44% and 40% over the past three months are only beaten by speciality chemicals firm Synthomer (LSE:SYNT), which has slumped 56% after last month’s profits warning caused by the slow unwinding of high inventory levels for its nitrile rubber gloves.
Other laggards whose shares feature on Liberum’s list of underperformers, as well as in the 50% Club, include Mitchells & Butlers (LSE:MAB), Wizz Air Holdings (LSE:WIZZ), private equity firm Bridgepoint and housebuilder Vistry Group (LSE:VTY).
Overall, the broker thinks that current valuations in the FTSE 350 index now suggest that UK markets are in oversold territory. Should earnings fall another 25% on current forecasts, it notes that the FTSE 350 index would be on a price/earnings (PE) multiple of 12.4 times compared with the 10-year average of 14.5 times.
Liberum said recently: “While we expect large EPS downgrades, index levels should not drop nearly as much, and we might well be approaching the bottom of the market in the next three to six months.”
25 largest FTSE 350 fallers in 2022 so far
Source: Sharepad. Price change is up to close of business on 10 October 2022. Dividend yield and PE ratio are forecast figures.
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