We invest in attractively valued companies with the potential for positive change. This typically means investing in overlooked stocks where there is little or no value ascribed to any recovery potential. The market is often slow to recognise change in out-of-favour stocks, which gives us time to undertake our due diligence and build conviction in the positive change thesis. It can be centred around either internal or external change; ideally, a combination of both. If things improve as we expect, there should be significant upside as the consensus view changes and new investors buy into the story.
Overlooked European stocks
Imperial Brands (LSE: IMB) has undertaken a significant turnaround under new management, improving the execution of its strategy and strengthening its balance sheet. It is catching up with the competition in developing a range of less harmful next-generation products. Our investment thesis is two-pronged. We can make very strong returns simply from its generous dividends and share buybacks. Imperial is returning the equivalent of 16% of its market value to shareholders this year alone.
However, if regulations governing next-generation products do tighten, as recent signs in the UK and, importantly, in the US suggest, then these categories can grow much faster and be far more profitable. Over time this could be transformational, as a much larger proportion of the firm’s products will boast far greater longevity than the current tobacco business.
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DCC (LSE: DCC) is a global distributor of liquefied petroleum gas (LPG) and oil, as well as medical and technology products. The group has proved its ability to build scale in fragmented sectors through a disciplined approach to mergers and acquisitions. It boasts a high-quality business, a strong balance sheet and a long record of generating attractive returns.
However, its shares are trading on multiples usually seen at the trough of a cycle owing to investors’ concerns that its energy division will come under significant pressure as demand for fossil fuels declines. We expect the decline in demand to be slower than the market anticipates and offset by higher margins thanks to the consolidated nature of the market. Additionally, we believe that the company’s ability to distribute alternative lower-carbon-intensive energy sources to customers cheaply through its existing infrastructure is underappreciated. It should help the group sustain or even improve high returns.
Banks have been another unloved sector since the global financial crisis. However, more stringent regulatory oversight has forced banks to increase capital ratios, boost funding levels and refrain from riskier lending. Higher interest rates have allowed them to improve their profitability significantly.
One of our largest holdings in the sector is Standard Chartered (LSE: STAN), a diversified banking group with a focus on emerging markets, especially Asia. Management is focusing on better cost control. Revenues should be supported by the group’s broad sensitivity to global interest rates and the structural growth of its wealth and financial markets divisions, which account for 40% of revenues. A strong start to 2024 and a plan to buy back a significant portion of its shares (around 9%) gives this story credibility.
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