MoneyWeek's Roundtable: Twelve stocks that will weather the storm

At this month's Roundtable, four investment experts tell us which shares they are buying now.

John Stepek: Is this rally going to continue?

Giles Hargreave: There are two views on this. To me, it seems the monetary expansion created by zero interest rates and quantitative easing is feeding through to asset prices. You're seeing it in house prices already, certainly in London. I recently bought a flat and I'm delighted I did because there is very little stock on the market and there's a lot of competition. I think this is also getting into stock prices. This market has a lot of momentum. In the short term the rally's going to take a lot of stopping.

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The other view is that the market has gone mad and has no idea what's coming government spending cuts and the squeeze on consumers and so there is going to be a very unpleasant double dip. I don't agree with that I'm rather more bullish. But there are two views.

John: What makes you think we'll avoid the double dip?

Giles: Cheap money. Our clients have a lot of money on deposit. When the market wasn't going up, it was just about all right to leave it in cash, or maybe corporate bonds. But now the pressure to get their money into the market is increasing. I'm sure that's true of fund managers all over the UK. They've all been expecting the economy to get worse. But it's not, it's getting better. Whether it will last is another matter altogether.

Victoria Stewart: The housing market has been hugely supported by close-to-zero interest rates. People are still reluctant to take current prices, and are hanging onto properties and not putting enough stock on the market. That's sustainable while their mortgage costs are incredibly low. But if we get a recovery, base rates will have to move up, and there will be more pressure on people who are hoarding property to accept lower prices.

As for the stockmarket, what I think is a bit different this time is just how flexible the labour market has been. I don't think companies have ever had such a benign environment to adjust the labour side of the equation the downturn has been so severe that even the trade unions are more amenable to discussing cut backs. So one big feature of the results we've seen in recent weeks has been just how dramatic and rapid the cost-cutting has been, and how much companies have been able to protect profits. That's really given the stockmarket a boost. We've gone from adjusting from crisis levels to normalised levels to now factoring in recovery levels. The autumn will be when we see whether we get delivery on this, or whether the equity market has gone just that little bit too far ahead of what's happening in the real economy.

Marina Bond: We're still in a real sweet spot for equity markets. For the first time ever we've seen monetary and fiscal policies around the world combine, producing one hell of a powerful force. And there's a sufficient number of bears around still to suggest the market is going to keep going for a bit. But at some point we will face higher interest rates, higher taxes, and probably higher oil prices. Markets will anticipate that well in advance so probably in 2010 we'll have another reasonably powerful dip down. But in the near term I think this is going to carry on.

John: Paul?

Paul: Valuations look stretched. The S&P 500 is on a p/e of 18 for this year, plus it's building in a 35% earnings increase for next year, which seems pretty optimistic. We've slowed our rate of deceleration, sure. But until we've seen unemployment peak, I can't see how to avoid a second wave of bank defaults. If you turn the clock back four months, the International Monetary Fund was saying that, globally, banks would see $4 trillion of write-offs by the end of 2010. We're not even half way through, yet people have just forgotten about it. Even if it's just $3 trillion, we've still got much worse to come. That will mean a fresh dearth in credit availability, which will hit the whole corporate sector.

So while I'm bullish in the long term for equities, I'm very nervous of the recent rush for high beta stocks. Everything that went down the most and has got leveraged balance sheets and leveraged operational gearing your banks, your commodity plays, your retailers has gone up the most. I agree that the acid test will come in the autumn. Unless the economic fundamentals start to reflect the optimism currently in the market, I can only see it going one way.

John: Are you concerned about interest rates rising again any time soon, Giles?

Giles: I don't think they will put up interest rates. Gordon Brown will do everything he possibly can to stimulate the economy over the next six months. He's pretty certain he's not going to win the election, but he might as well have a go and he won't care if he does a lot of damage long term. It's quite serious, actually, to have him in control right now.

Paul: Yeah, the scorched-earth policy could well transpire.

Marina: Also, the money multiplier is still not really working. There doesn't seem to be enough demand for loans. It seems the banks are actually lending, but they are not being taken up. So I don't think interest rates are going up yet.

Giles: Yes, I'm not impressed by this idea that banks aren't lending to small companies. Most of the companies I speak to complain about their banks, but they all seem to be able to agree finance quite happily. In fact, I was told by one company that they've had RBS on the phone saying: "Please can we lend to your company?"

John: So what sectors are you bullish on at the moment?

Victoria: We're taking a fairly neutral view, because it's hard to tell whether we are facing a double dip or not. Taking a big view either way is quite heroic right now. We spent most of 2008 being very underweight on balance-sheet leverage and operational gearing and the industrial side of things. We're now taking baby steps towards being a bit less risk-averse. We're sticking to the core investments, but spreading those between preferred secular growth-type holdings things like specialist healthcare recruiter Healthcare Locums (LSE: HLO) or medical technology group Axis Shield (LSE: ASD) then adding plays that are a bit more cyclical.

Rightly or wrongly, UK house builders have decided it's time to start building again, for example. That may or may not come back to haunt them, so perhaps don't invest directly, but you can invest in their suppliers, who'll get the business whether the house builders make any money or not.

Then there are situations which aren`t dependent on the wider market. Take VT Group (LSE: VTG). It's reinventing itself as a support-services group, having got out of ship building. But it isn't yet valued as highly as the rest of the support services sector, so you've got an opportunity there. Or stocks where you've got some sort of catalyst, such as speciality pharmaceutical company ProStrakan (LSE: PSK). It's got a drug to market now, and there is news on the horizon of how that's doing, so that's a completely separate driver to whether or not we're in for a W-shape recovery.

Marina: I quite like technology. This is a generalisation, but tech stocks seem to have more cash than a lot of other sectors. Also, the last time anyone really invested was 2000, when we had the tech bubble and burst. So the tech sector has already had its bust, and hasn't really recovered much.

Paul: Overall, Id be looking to invest in companies with long-term growth fundamentals and strong balance sheets, so that if there is a wobble they will be able to survive. And with small caps it's really important to avoid counterparty risk. If you have just one customer accounting for, say, 60% of your revenues, you're going to get squeezed hard on costs as they decide to improve their productivity. Or if they go pop, it's going to be terminal.

Giles: You want niche businesses, preferably not dependent on the UK consumer who is clearly going to come under more pressure. I like stocks I'm sure we all do where the downside is relatively limited and you can see plenty of upside.

But the problem right now is that it's all the cyclicals that are going up. You need to be in the Travis Perkins of this world, stuff which is going up much faster than boring stocks like, if I may say so, VT, which I also own, and which sits there like a pudding and does nothing.

The same goes for all those outsourcing stocks like Babcock and even Connaught. They are very fine companies and not particularly highly rated, with strong balance sheets, good order books and everything else but they are not going up. What is going up is the house builders and such like.

Paul: Yes, but who will have the last laugh? I think you'll be smiling at the end of this six-to-nine-month period.

John: Will all the cheap money around, can anyone see any bubbles on the horizon?

Victoria: Well, 'pump priming' gave us the housing boom. It will be interesting to see where all the liquidity ends up if it's not finding its way into investments of the type that the authorities intend.

Giles: The amount of cash that seems to be available is extraordinary look at Standard & Chartered raising £1bn in ten minutes the other morning.

Victoria: But why not if you can? You might as well just tuck a little bit away and give yourself a bit more flexibility. If the double dip comes, you don't want to be asking at that point.

Marina: I think anything that China needs or wants is probably going to be a massive growth area. I should think that will lead to a bubble at some point, but we're not anywhere near that yet. About 55% of the population is still rural the industrialisation process normally doesn't mature until the rural population goes below 20% or even 10%, so we are only one-third of the way through.

John: What about alternative energy?

Marina: I struggle with those companies unless they actually make money without subsidies and I can't find one yet.

Paul: I totally agree. In the long term we need alternative sources of energy. But if they struggled to make money when oil was $100-odd a barrel, then they are really going to struggle at current levels.

Wind seems to be the one area that has a lot of activity wind farms are being put up everywhere. If you find a niche company that's profitable and is putting technology into that particular area, you've got a much better chance. But too me, it's too risky at the moment anyway.

John: So what about individual stock tips?

Giles: You'll love this one cement producer West China Cement (Aim: WCC). It's got quite a lot of debt, but it's interesting. One of the terms attached to its recent loan was that the group should achieve a full listing on a recognised exchange within 30 months. If it lists in Hong Kong, for instance, which is the likely place for it to go, a comparable company would sell on 12 or 13 times earnings, whereas WCC is just now on a p/e of around four going down to three.

The other good thing is that it is controlled by a Chinese man, who is rather better at getting licences and permissions than its competitors. And the cement market in China is pretty good at the moment for obvious reasons. Sure it's speculative, but the upside is such that it's worth the risk.

Another I like is Niger Uranium (Aim: URU). It owns 15% of Aim-listed Kalahari. Kalahari in turn owns a large chunk of a company called Extract, which owns Rossing South in Namibia, potentially one of the world's biggest uranium deposits. It's next door to Rossing North, which is owned by Rio Tinto. The 15% of Kalahari is worth 42p or so per Niger share and Niger sells at 28p, so that's a 40% discount. It's got its own uranium assets too, but it's not spending any money on that at the moment because it doesn't want to have to raise more money and dilute its holding in Kalahari.

The third one is Beximco (Aim: BXP), which makes generic drugs in Bangladesh. It's also listed in Bangladesh over there it's on a p/e of about 30, whereas over here it's on a p/e of about ten. At some stage those valuations have to come together. It's a perfectly sensible company, it's forecast to make £14.5m Ebitda this year and £9.5m pre-tax profit.

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Our Roundtable tips

Marina: I like Pace (LSE: PIC), which makes set-top boxes for pay-TV broadcasters. It's in a high-growth market, so it's one of the few stocks where you can see top-line growth and organic growth too, which is really good. The balance sheet is strong, and it's got high barriers to entry: it's quite difficult to dislodge the technology because it would really annoy users. It's had a decent run, but I think it's still cheap. You've got a huge amount of growth there.

Giles: It's our largest holding actually.

Marina: And I like infrastructure services and engineering group Hyder Consulting (LSE: HYC). It does work both in the UK and overseas demand doesn't look great in the UK, but I think that's in the price.

The balance sheet is reasonably strong and it has improved its cash collection, which was my main problem before. The dividend was actually hiked 50% in the last results. It looks cheap on a p/e basis, but, of course, no one really knows whether the forecasts are right or not. But if you believe the forecasts, it is on a p/e of five.

I also quite like Volex (LSE: VLX). It does electronic and fibre-optic cables and leads and power cords, which is quite boring really. It was a simple contract manufacturer, but it is moving more towards contract engineering, which is higher margin.

New management came in this year, and there's loads of low-hanging fruit to deal with, particularly on the supplier side. It has lots of debt, but that's been renegotiated with the banks at a reasonable rate, working capital has been improved a lot, and it's looking reasonably cheap.

The top line probably isn't going anywhere yet that's dependent on the bigger picture so for now it's about improving profit margins, which the firm is continuing to do.

Paul: The infrastructure stock I like is Costain (LSE: COST) the company went through its turnaround two years ago. I've met the management team and it is excellent. The firm has won new contracts hand over fist this year in lots of regulated industries 80% of the £2.5bn order book is either regulated or government contracts. So they have little exposure to the broad economic cycle. It has a good balance sheet after doing the rights issue, with £100m of net cash. The stock is currently on a single-digit p/e ratio and I think there's still another 25% upside.

I also like Genetix (LSE: GTX), an image screening and diagnostics business. It makes lab equipment that allows you to screen cells in early-stage research and design. It focuses mainly on the high-growth biologics area and has large-cap customers like AstraZeneca and GSK. It also has an even higher-growth segment involved in cancer diagnostics, which has a very good position in that market. However in its last trading statement it warned that because of industry consolidation mergers between the likes of Wyeth and Pfizer, for example it is starting to see a slowdown in decision making. So given these headwinds, I would only buy on the dips.

I would also go for Regenersis (LSE: RGS), which is a play on recycling and repairing electronic gadgets. It's a £15m market cap company with a £100m turnover and about £4.3m of debt. It has two big benefits. First off, blue-chip clients such as Tom-Tom, O2, Vodafone and Apple save on costs by outsourcing their warranty claims to the company. In an upcycle you would throw your BlackBerry away but would you throw it away now? You might actually get it repaired or send it off to get it fixed assuming it was under warranty. So Regeneris should do well.

It has also taken good advantage of the need for companies to recycle old electronic and electrical goods, under the European WEEE directive, which came into force in the UK about 18 months ago. It is the only pan-European company which does that. It's a tough area, but the company's valuation is ludicrous at the moment.

Last week Regeneris said it was on track to hit its full year numbers and also announced the acquisition of UK rival TRS for £6.25m in an all equity deal at 40p a share. Despite the transaction being dilutive for shareholders I believe the stock is a buy due to its strong industry fundamentals and rock bottom valuation. Trading on a trailing EV/Ebitda multiple of only 4.2, I could see the shares more than doubling over the next two years.