Two outstandingly cheap UK stocks in an age of mad valuations

In these times of nutty company valuations, there is still plenty of opportunity around, says Merryn Somerset Webb. Take these two stocks, for example.

A note comes from Ian Lance at RWC Partners – which runs the Temple Bar Investment Trust many MoneyWeek readers hold. 

Back in May 2020 he wrote a blog (which you can read here) about a group of stocks he felt were so cheap that large parts of the business were effectively free. In each case one division alone was (on his valuation methods at least) worth more than the market capitalisation of the entire group. It seemed mad at the time – and it was. 

Since then, the share prices of each of the companies mentioned have soared. Royal Mail is up 170%, Marks & Spencer up 145% and the rest (Capita, ITV and BT) are up between 35 and 68%. Over the same time, the FTSE All Share is up 30%. 

Of interest are two other stocks Lance points to for similar reasons – Shell and Vodafone. I’ve copied his rationale for both below – not necessarily to suggest you buy them (I hold Shell) but as a reminder that in these times of slightly nutty valuations, there is still plenty of opportunity around for those prepared to take non-consensus views. 

As we discussed at length at yesterday’s Moneyweek Wealth Summit, today’s markets are fragile. When the ice begins to crack, better to be in stuff that is already cheap than stuff that is going to get cheap very quickly indeed.

Royal Dutch Shell

Third Point, the US based activist fund manager, recently announced that that they had taken a significant position in Royal Dutch Shell in the belief that the entirety of the company’s stock market value is accounted for by what they termed its Energy Transition businesses (Integrated Gas, Marketing and Renewables) leaving its upstream, refining and chemicals businesses ‘in for free’.

The former businesses generate EBITDA of $25bn which is valued on 10x would amount to the current enterprise value of $250bn. The latter three business units account for around 60% of the company’s profits and if accorded even a modest valuation (say 5x EBITDA) would crystallise upside of around 80% in the share price.

Third Point are arguing for nothing short of a breakup of the company in order to realise this value and whilst they may or may not be successful, their action has demonstrated the potential inherent value that exists in the business.

Vodafone

A similar argument can be made for UK telecom operator Vodafone, although estimating what the constituent parts of Vodafone are worth is made considerably easier by the fact that certain parts of their business are listed (Vantage, Vodacom, Safaricom, Vodafone Idea and Indus Towers). 

Adjusting for these quoted assets, we can see how the stub is being valued and at today’s prices, it trades on around 4x EV/EBITDA and a 25% free cash flow yield. 

With the stakes in Vantage and Vodacom accounting for 60% of the equity value of Vodafone, there would appear to be a reasonable underpinning of the valuation of the residual business.

Recommended

A cheap investment trust with a good record
Investment trusts

A cheap investment trust with a good record

This cheap investment trust’s yield of almost 9% may look too good to be true, but should be sustainable, says Max King.
25 Jan 2022
Which assets will benefit as the “jam tomorrow” bubble pops?
Investment strategy

Which assets will benefit as the “jam tomorrow” bubble pops?

With tech stocks, cryptocurrencies and many other “long duration” investments crashing hard, the “jam tomorrow” bubble looks to be bursting. John Step…
24 Jan 2022
Three innovative Asian stocks to buy now
Share tips

Three innovative Asian stocks to buy now

Professional investor Fay Ren of the Cerno Pacific Fund highlights three of her favourite Asian stocks to buy now
24 Jan 2022
Why GSK should turn down Unilever’s billions
UK stockmarkets

Why GSK should turn down Unilever’s billions

Unilever has offered GSK £50bn for its consumer division. But while the cash will be a temptation, the deal is not in the interests of shareholders or…
22 Jan 2022

Most Popular

Shareholder capitalism: why we must return power to listed companies’ ultimate owners
Investment strategy

Shareholder capitalism: why we must return power to listed companies’ ultimate owners

Under our system of shareholder capitalism it's not fund managers, it‘s the individual investors – the company's ultimate owners – who should be telli…
24 Jan 2022
Three innovative Asian stocks to buy now
Share tips

Three innovative Asian stocks to buy now

Professional investor Fay Ren of the Cerno Pacific Fund highlights three of her favourite Asian stocks to buy now
24 Jan 2022
Ask for a pay rise – everyone else is
Inflation

Ask for a pay rise – everyone else is

As inflation bites and the labour market remains tight, many of the nation's employees are asking for a pay rise. Merryn Somerset Webb explains why yo…
17 Jan 2022