Six quality contrarian plays

A professional investor tells MoneyWeek where he'd put his money now. This week: Clive Beagles,manager of JO Hambro Capital Management UK Equities Income Fund.

It looks like growth in UK equities will be solid but unexciting in 2005. Because our focus is on stocks yielding more than the market, this leads us to adopt a naturally contrarian style. Many commentators, for example, are negative on the dollar at present, which continues to have a significant impact on some of the larger UK companies with dollar exposure. But I believe this could be a year when the dollar does not decline - note that US interest rates are likely to rise considerably during 2005. Another contrarian call we're making is on UK interest rates. Despite unclear signals from the housing market and a slight increase in inflation, I think they'll be falling by the end of the year.

At a sector level, we are positive on general retailers, such as Marks & Spencer (MKS, 364.3p), Boots (BOOT, 673p) and Halfords (HFD, 314p). Current trading for many of the retailers is relatively weak, and some had a difficult Christmas period, with sales ending up below expectations. But valuations still look fine and the share prices of those firms with asset backing, free cash flow and good quality management are still performing reasonably well and should continue to do so. There is also the chance that they could be approached by venture capitalists.

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Our belief that the market is expecting too much dollar weakness means that some of the dollar-related names look cheap to us. Hanson (HNS, 497.3p), for example, generates more than 50% of its profits from the US and is a big bet within our portfolio, even though it has risen recently. The aggregates industry has pricing power at the moment as well as attractive assets, and Hanson has margins and a valuation lower than the rest of the UK aggregates industry. One potential negative is that the company is facing litigation over the use of asbestos in construction materials. It appears, though, that there is a falling appetite for legal action in the US, and President Bush is keen to introduce legislation that will reduce the number of such class actions.

Many of the UK life insurance analysts still find their thoughts dominated by the two to three years of negative sales growth and bad press over mis-selling. Despite this, Legal & General (LGEN, 116.5p) is one of the larger holdings in our portfolio. Many seem reluctant to believe the growth story, but in the last six months, UK life and pensions business has grown by around 20%, and demand is showing signs of improving. The regulatory environment also appears to be easing; there is perhaps less pressure from the regulator now than at times in the past.

We also hold a number of small-cap stocks. One which has done very well recently is Gaming VC Holdings (GVC, 495p), an online casino firm with a market cap of around £160m. It operates in a market that has limited barriers to entry, but already has a huge share of the German market, and owns a subscription casino-players magazine. It came to market in December when few fund managers were interested in new issues (perhaps they were too busy lunching) and so ended up priced on a p/e of only six with a yield of 10%. We believe it could run quitea long way from here, as there are very few capital requirements on the business and growth rates are substantial. It is currently up around 35% from its float price, and in mid-January rose some 20% in just one week.