Six stocks to weather the recession
Economists are, on the whole, pessimistic about prospects for the global economy. But some stocks could see you through, say John Stepek and Tim Bennett. Here, they pick six.
Economists are often accused of being overly gloomy. But in fact, they are optimistic to a fault.
While markets may have predicted six out of three of the last recessions, as the saying goes, the track record of the so-called dismal profession is nowhere near that good. According to the New York Times, a recent study examined average economic forecasts made ahead of 60 different national recessions during the 1990s. In 97% of cases, economists failed to predict a recession a year before it happened. "On those rare occasions when economists did successfully predict recessions, they significantly underestimated the severity of the downturns," and many "failed to anticipate recessions that occurred as soon as two months later", it noted.
So the fact that so many are now predicting recession tells you that things must be getting serious out there. And in fact, the most important economy in the world, the US, is almost certainly already in recession. If the UK isn't already in recession, it will be by Christmas. Europe's economy isn't looking too hot, either; nor is Japan's. We're heading for a global slowdown. And judging by the historic performance of the pundits, it will be much worse than anyone expects.
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Recessions are not pleasant. People lose their jobs. Consumers stop spending. Companies shut down. But there is a silver lining: money is just like anything else. When it's cheap and plentiful, people take it for granted. They don't treat it with respect. That means it gets ploughed into unprofitable ventures, vanity projects and trophy assets. The past 10 years or so in particular have been very forgiving ones. How many cafs does one high street really need? How many estate agencies? A wide range of businesses have been set up that have never felt the pain of a weak market. But those days are over. And part of the process of a recession is to clear out and unwind all those bad investments and bandwagon-jumping businesses that survived on easy money. That's bad news for the less-efficient, less-dominant players, who will be faced with falling sales and collapsing profits. But it can be good news for those companies strong enough to survive the recession they will find themselves in a world with fewer competitors, which means they have more of the pie to themselves. We've looked at four of the sectors that have been hit worst by the downturn and picked out what we think are the strongest players in each area, or the stocks that will pull through.
Financial services
One of the sectors that has been hardest hit by the downturn is, unsurprisingly, the one where all the trouble began financial services. This is a perfect example of how easy money encourages bad investments. Banks ignored risk, competing instead to sell as many loans as possible, in order to make money from the fees involved in parcelling up the debt and selling it on. But this took them into areas, such as sub-prime, where they really weren't qualified or experienced enough to operate.
Meanwhile, genuine sub-prime lenders, such as door-to-door lender Provident Financial (LSE:PFG), saw their customer base squeezed as people who would once have gone to them for loans, found they were able to get cheaper credit from high street banks. But now, with bad debts rising and the chaos in the financial markets, the big banks are cutting back their lending sharply.
That's driving people back to companies like Provident. And that makes the stock a buy. The company is the biggest player in the sub-prime lending sector. It has 12,000 agents who literally go door-to-door, lending and collecting payments. Unlike the banks, the company is used to dealing with bad credit risks about 40% of its customers are on benefits, "many have impaired credit histories", as The Times puts it, and it writes off £12 in every £100 it lends. And its risk management stretches all the way down the line. Unlike in the investment banks, agents are paid a cut of whatever payments they collect so there's a real incentive for them to make sure that the clients they lend to are good prospects. Provident also has a credit card business, Vanquis, which became profitable for the first time last June and made a £3m pre-tax profit in the first half of 2008.
With traditional banks only set to tighten lending further, Provident should continue to find itself spoilt for choice for customers, even though it has no plans to relax its own criteria. In fact, bad debts as a percentage of revenue actually fell in the first half of the year. It trades on a forward p/e ratio of just under 13 and pays a nice dividend yield of more than 7%. UBS analysts reckon the shares should reach £10.50.
Media
The late Sir John Templeton advised investors to buy at the point of "maximum pessimism". And things couldn't look much more pessimistic for ITV (LSE:ITV) right now. Most analysts rate the firm a "hold" or "sell" after a set of grim recent results and a share price fall of 50% this year alone. Looking ahead, the fog thickens net advertising revenue is expected to fall by 20% in September, while key front and back office stars are defecting Dawn Airey, former head of programme making, is off to Channel 5, while Harry Hill is said to be in talks with the BBC.
Yet, as Merryn Somerset Webb points out, "ITV has a few good things going for it, too", which are not reflected in its disastrous recent share price performance. It is still the UK's largest commercial broadcaster and rates well against rivals for programme making for both young and old audiences, with around 23.5% of the total UK viewing audience. That's an attractive statistic when credit-crunched advertisers are trying to figure out where to spend their smaller budgets. On a p/e of 12 and a price to earnings growth ratio (PEG) of just 0.84, the shares could reward a brave investor over the long term, particularly if the company succumbs to a takeover bid.
As for those advertisers, WPP (LSE:WPP) looks well-placed to ride out the downturn in the sector. The group's massively experienced chief executive Sir Martin Sorrell, who has been at the helm for over 20 years, chose to announce a 14% first-half revenue increase from Beijing, reflecting impressive growth of 17% in the expanding Chinese market, against just 4.6% in the UK. What's more, as Catherine Boyle notes in The Times, WPP's huge spread by "function, discipline and client list" with a strong presence in public relations, public affairs, healthcare and market research, makes the group "relatively defensive", an almost unique trait in the media sector. The shares trade on a forward p/e of just over nine.
Retail
"Middle class Britons are shopping at cut-price Aldi but stuffing their purchases in Waitrose carrier bags to avoid neighbours' stares," says the FT's Lex. That pretty much sums up the trend in UK food retail, as families grapple with tighter budgets and soaring food price inflation. Obviously, people need to eat whether we're in recession or not but right now, cheap retailers are in fashion whilst expensive rivals are suffering. Take upmarket Marks and Spencer. M&S was Britain's first retailer ever to make £1bn in operating profits some years ago and until recently was undergoing something of a revival under Sir Stuart Rose. But the latest TNS Worldpanel research group's figures show the company lost 1.4% of the UK food market in July alone, with total same-store sales declining by around 8% over the same period, results described simply as "awful" by Nick Bubb of Pali International on Bloomberg. While M&S might be a strong brand, and highly unlikely to vanish from the UK high street, we're just at the start of the hard times, and there could be plenty of pain to come.
The firms set to thrive now are those that "stack it highest and sell it cheapest". Unfortunately the big price discounters such as Aldi, Lidl and Netto, who are thought to have grown market share by a record 6.1% year on year, says Clare Harrison in The Times, are not available to buy. But good alternatives are Tesco (LSE:TSCO) and Wal-Mart (NYSE:WMT), the owner of UK-based Asda. A Sunday Telegraph investigation revealed that Tesco can undercut a typical basket of 30 products ordered from Ocado by 10%, while at Asda you could save 14.5%. The latter has also enjoyed sales growth of 9.5%, according to TNS, making it the fastest-growing supermarket in the UK. And of course, it enjoys the backing of Wal-Mart, the world's biggest retailer by volume. Rival Tesco is also well-placed to ride out a downturn thanks to both international diversification stores have been opened recently in countries as far-flung as the US and India and sheer clout, with £1 in every £4 of UK food expenditure thought to ring through one of its tills. In Sir Terry Leahy the group also has one of the world's most experienced and long-serving food retail chief executives. Given that Walmart trades on a forward p/e of 17, while Tesco is available on a p/e of 13, overall we'd favour the latter.
Construction
With share prices for housebuilders on the floor, the more daring pundits are suggesting that now's the time to buy Persimmon, the biggest British housebuilder. But there's still far too much trauma to come in the UK housing market to go bottom-fishing yet.
Rather than searching among British housebuilders, whose primary market will be under pressure for a long time to come, what you really need to do is find a global builder that has exposure to a wide range of markets and projects. And Germany's largest construction firm, Hochtief (Frankfurt:HOT), fits the bill nicely. Unlike the litany of misery from housebuilders, the group, among the five biggest construction firms in the world, recently saw a sharp jump in second-quarter profits, and raised its expectations for the full year, as new orders jumped 35%.
The group's exposure to Asia and Australia mean it has benefited from the mining boom, but even its US unit, Turner Construction, saw a rise in new orders. The group is building healthcare and education facilities, and transport infrastructure in the US, while telling Bloomberg that business hasn't been hurt by the sub-prime mortgage crisis or rising raw material and energy costs. It is also gradually moving into "areas with steadier earnings than building", says Bloomberg. It has stakes in airports "from Dsseldorf to Sydney", and has also expressed an interest in buying any airports sold by UK aviation group BAA.
Hochtief's share price has risen recently amid speculation that the company might be broken up though its main shareholders, Spanish builder ACS, denied the report. But even if no sale materialises, the stock is still worth buying, says analyst Ralf Dibbern at MM Warburg Investment Research, who has a target price of 82 euros on the stock, which currently trades at around 55 euros.
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