Interactive Investor

Four cheap shares Schroders is excited about

9th February 2023 10:57

by Sam Benstead from interactive investor

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Roberta Barr, manager of the Schroder Global Sustainable Value Equity fund, speaks to interactive investor deputy collectives editor Sam Benstead about how the strategy is managed. She goes into detail about the environment, social and governance (ESG) policies of the fund, and reveals which companies she thinks are both undervalued and ESG leaders. Barr also speaks about why Europe and British stocks are better bets for value investors than US shares. The fund is a member of interactive investor’s ACE 40 list of recommended sustainable funds. It took on an ESG mandate and was repurposed from Schroder Responsible Value UK Equity in July 2021.

Sam Benstead, deputy collectives editor, interactive investor: Hello and welcome to the latest Insider Interview. Our guest today is Roberta Barr, manager of the Schroder Global Sustainable Value Equity fund. Roberta, thank you very much for coming into the studio.

Roberta Barr, manager of the Schroder Global Sustainable Value Equity fund: My pleasure, thank you for having me, Sam.

Sam Benstead: So, tell me a bit about the fund, how do you invest and what makes it sustainable?

Roberta Barr: Of course. So very simply, this is a fund of undervalued ESG leaders with an overlay of active engagement. So, I guess the first thing to say about the fund is, it is a value portfolio. So, it's only holding companies we believe are trading on valuations significantly below the intrinsic value of the company. So, what we think they are actually worth and that's something that's true for all the funds run by the Schroder's global value team, including our sustainable value fund.

But we're not just holding any undervalued company in this fund, we're only holding undervalued companies, which are also ESG leaders. And we've decided to define an ESG leader as being a company that both does more good than harm, so has a net positive benefit on society. But it's also got to be best in class versus its industry peer group. So, it's also got to be leading the way to a sustainable future, among its industry peers. And just for a bit of rationale behind that definition. First, it was really clear to us that as a sustainable fund, you obviously don't want to hold a company which is doing more harm than good, like, say, a tobacco company or thermal coal.

But equally, we didn't want to hold, say, a pharmaceutical company, which, by virtue of the industry it’s in is doing more good than harm, but actually if we look at its pricing of its drugs or if we look at its product quality and safety practices, maybe it's lagging behind and we don't think that it's actually doing the best that it can do, to really lead the way to a sustainable future, among other pharmaceuticals. So, in our opinion, that sort of company also should not have a place in a sustainable fund. So that's how we came to this two-pronged definition, to our ESG leader definition, to make sure that the companies we hold are both meeting that net positive benefit to society angle, but also are really leading the way to a sustainable future.

Sam Benstead: And are there any hard exclusions from the fund, say, the mining or oil sector, for example?

Roberta Barr: Yes, I mean, theoretically, that definition would exclude sectors like thermal coal, tobacco and so on, because they're just never going to have that net positive benefit. But for the comfort of our clients, we do have a revenue-based exclusion list, going on in the background. But often it doesn't bite. What bites is our own definition. So, for example, we'll have companies like BIC, which makes shavers, lighters, the pens and so on. And BIC has got no tobacco exposure, but we know that Bic (EURONEXT:BB) sells lighters in developed markets, and we know that in developed markets, the majority of lighters are used for lighting cigarettes.

So, it's not obviously a tobacco company, but we know that it's got a significant exposure to the tobacco industry and it really benefits from the tobacco industry doing well. So, for us that breaches that doing more good than harm piece. So, we wouldn't hold that company in the portfolio either, despite it not being an explicit exclusion.

Sam Benstead: It's a value fund. But you also like high-quality companies. So, what are your definitions of quality and value? And can give me some examples of some stocks in the top 10?

Roberta Barr: Of course, we would define in the value team roughly a value company as one that's in the cheapest 20% of the market on some valuation metrics. So, for example, that could be EV (enterprise value) to NOPAT (net operating profit after tax), so the enterprise value, the overall valuation of a company, to its 10-year normalised operating profits after tax. So, the amount of profit after tax that we expect that company would make in a mean reverted standard year.

But I'll also look at some spot metrics like say, free cash flow yield, or if I'm looking at financials, it will be price to tangible book. But broadly on one of those metrics, it's got to be in the cheapest 20% of the market. But I guess if you're asking what I mean by a good value stock, then essentially what we're looking for are companies where, for whatever reason, there's something going on in the business or in the market or the economy, where for whatever reason the market is putting this company on severely depressed multiples, that just aren't justified.

So those are the sort of companies that we're really looking for, the ones where the market's acting irrationally. And we can see significant value within the business today, buying it at the price the market has put it on. And it leads me to a point I often get pushback as a sustainable value investor that, sustainability is a quality style attribute. And any company that's an ESG leader, the market's going to love that fact and it's going to put it on a higher sustainability premium multiple. So, you're really going to struggle to find companies which are both ESG leaders and have that severely depressed multiple. But that's just absolutely, for the majority of the time, not true. Yes, there are a handful of companies where the markets got overexcited about some sustainability story, and it's overvaluing the companies perhaps. But for the vast majority of the time, as soon as something negative happens in a business and the market is not sure about what's going on, it will just slam down its multiple regardless of the fact that it's ESG leader. So, if you just take companies like, say, GSK or AXA, then, they're undoubtedly ESG leaders, they're doing a lot of good for the world and they're really leading the way in pharmaceuticals and insurers respectively. But the market's so concerned about product pipeline cliffs or interest rate inflation environments, that it'll smash them on to severely low multiples today, despite them being ESG leaders.

Sam Benstead: And what have been some exciting trades you've made over the past couple of years where you've identified a company which is a sustainable leader, but actually other investors haven't appreciated how good it is and what a great investment it would come to be?

Roberta Barr: I could probably talk about all the stocks in the portfolio, but I [choose] two that I'm particularly excited about today. First, NatWest Group (LSE:NWG) is just a clear standout, if we look at the valuation it's trading on today, it's below price to tangible book, despite management guiding to a 14% to 16% return on tangible equity. So, a really solid return that they're guiding to, but it's still trading at less than the tangible book value of the business. Plus, it's paying out a very healthy dividend at the moment - I think it is an 8% or so dividend yield. Plus, if you look at the capital position of the company and the capital surplus that they have [at] the moment, especially after the unwinding of Covid provisions, if that happens, you've got a really nice valuation story there, a really attractively valued stock, which just isn't being appreciated by the market. Plus on the ESG side of things, NatWest is really leading the way when it comes to, say, fossil fuel financing or using their influence as key capital provider to ensure that companies [and] individuals who rely on NatWest as a banking agent for providing loans or so on, [it] is using its influence over those customers to ensure that they in turn wind down to net-zero in a pragmatic and sensible, but also Paris-aligned, way.

Plus, I think it's probably also worth mentioning that, coming into 2023, the cost-of-living crisis, hard times and so on, NatWest really does a lot when it comes to access to finance and making sure that they're providing loans to smaller businesses and microfinance, that sort of thing, which for us is a real benefit to society.

For the second example, I'd highlight eBay Inc (NASDAQ:EBAY), which I think is a really interesting company. So, eBay, it never got that whole FANG bubble uplift. But if you look at the valuation that eBay is trading on today, it's a high single digit for cash flow yield. And also they’ve spent the past few years simplifying the business and building it down into just a pure-play marketplace with a small marketing arm. And they've also shored up their balance sheet, which means that as you come into this year, it's got an interesting cyclical play, it's got an interesting tech play, it makes a really nice addition to our portfolio. Plus, obviously eBay has got a strong sustainability story when it comes to supporting the circular economy and providing a platform that has got basically no barrier to entry, tech or cash-wise for buyers, and sellers like you or me [can] just go on and start buying and selling our pre-loved gifts.

Sam Benstead: And you're looking for value shares globally. Are there any markets where there are just more opportunities at the moment? And what's your view of the UK market? Everyone talks about it as this kind of value market, but is it that exciting to you or do you find other opportunities elsewhere?

Roberta Barr: Yeah, I must say the UK is exciting, Europe is also exciting. And also I point out that that's true from a value perspective, but it's also true from a sustainability perspective. Europe has been steps ahead for a long time when it comes to sustainability. We are also quite keen on Japan. We can see some really attractive valuations there and I guess Japan's focus on having that positive societal benefit really shines through in a few of the companies that we see there. We're pretty underweight when it comes to the US, as [its] neither attractive generally on a valuation perspective or on a sustainability perspective for most of the time. And we also haven't managed to find any companies yet in emerging markets where we think they reach that high standard of sustainability that would be required for the fund.

Sam Benstead: You're bottom-up stock picker, but value shares also respond to macroeconomic conditions, particularly interest rates. So, are we now in a better environment for value investing than perhaps the past decade?

Roberta Barr: What I'm most sure about is that I've never been more unsure of what's actually going to happen. The range of possible outcomes is, I think, the broadest it's ever been. So, what's going to happen with Russia and Ukraine? What is going to happen with interest rates, with inflation? Are they going to settle? Are they going to go up loads? Are they going to come down again? Who knows. And you've also got things like Covid still going on in the background; is that going to make a comeback with new strains? So, those are a whole handful of known unknowns. Plus, I think if the last few years have taught us anything, it is to be afraid of unknown unknowns as well, because they can have significant impact too. So, I guess now more than ever, I think it's time to diversify both at a stock level in portfolios, but also at a fund level, making sure that you have good exposure to all different styles. As well though, if I just take a step back from the macro environment, which ultimately I have to do as a value investor, and I just look at the portfolio of stocks that we hold today, the portfolio of stocks that we have on the bench ready to go, and if we look at the valuations of those companies in absolute terms, then there are some really attractive valuations that we've managed to achieve.

These stocks are trading on multiples, which at least historically, bode very well for future performance over the next few years. So, I think there's a lot to be cautiously optimistic about when it comes to these funds. As a sustainable investor, I have to point out that sustainability is very important when times are good, [and] sustainability is crucial when times are tough.

For example, we hold a number of supermarkets in these funds and the delicate balance they face in this year. So, they've got this cost-of-living crisis going on. They've got a large number of employees who are lower-income employees. So, they need to make sure that they keep on paying them a fair living wage. But it's not like they can just hike up the prices of food because they also need to be able to provide affordable nutrition to the nation, who are also suffering from that cost-of-living crisis.

Plus, don't forget [there’s] a supply chain squeeze going on at the moment. And we are also still in a global obesity epidemic, society holds these supermarkets pretty responsible, pretty accountable, when it comes to driving customer behaviour to really promote healthier choices, reformulate their products, to remove the high fat, sugar and salt content, and to really make sure that all their marketing is aligned with trying to get customers, nudging them towards those healthier choices.

And it's not like these supermarkets have got the juicy profit margins that a software company might have. These are thin margin businesses, there’s no room for error, if they get it wrong for one stakeholder, that's going to have dire consequences for another. And to just take another example as well, a lot of companies have now set these really great, really ambitious net-zero targets, and that's wonderful. But these are now the years where they need to start implementing the groundwork to reach those interim targets in 2030. Now's the time when they need to get the operations ready. They need to really make sure they're making those changes in the business [and] that they can feasibly reach those targets. And climate change isn't going to wait for a perfect economic environment, they need to act now. I think, as a sustainable investor, I'm very lucky that when I look at our portfolio, I know that we have all these companies [that] are ESG leaders. I trust, and I back each and every one of these companies to act in a responsible and sustainable way, which I think is just so critical coming into 2023.

Sam Benstead: Supermarkets, cheap, essential, but why is it a good investment? Why are they good businesses to hold?

Roberta Barr: Well, they have all these issues going on, the market hates that, the market has smashed their valuations. So, we're not saying that they don't have difficult times ahead. We're just saying that the price that they're trading on today is not justified by those investment risks that you're taking on. So, I think, we hold a number of supermarkets, and I'm pretty excited about the valuations we see in some of those, especially when we know that they're ESG leaders and we trust the management to act accordingly.

Sam Benstead: Roberta, thanks very much for coming into the studio.

Roberta Barr: Thank you for having me.

Sam Benstead: And that's all we've got time for today. You can check out more Insider Interviewson our YouTube channel where you can like, comment, and subscribe. See you next time.

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