By Victor Reklaitis, MarketWatch
Many strategists fear the United Kingdom’s coming exit from the European Union will whack British companies, especially since the exact terms of the divorce remain unclear.
But the hand-wringing means there are Brexit bargains for brave investors willing to bet that the worst-case scenarios won’t come to pass. One place to look for deals is within sectors closely tied to the U.K. economy, which skeptics consider shaky. In their recently published midyear outlook, strategists for insurance and financial giant Allianz warn that Britain “seems set to endure a significant period of economic uncertainty and weakness now.”
The value-minded stockpickers at San Diego–based Brandes Investment Partners, on the other hand, consider such fears overblown, and they’re investing in British retailers and property-services companies.
“Uncertainty tends to lead the market to price in the worst, and that’s really what we’re seeing at this point,” says Amelia Morris, a member of the firm’s international large-cap investment committee.
Brandes generally likes to buy out-of-favor stocks, so it’s typical that these two U.K. sectors would serve as “hunting grounds,” as they “probably show the lowest optimism out there in the market.” However, she adds, companies in these groups are telling her that “they’re seeing no changes in consumer habits yet.”
Top 10 holdings
Valuations and dividend yields are a big part of what Morris likes about retail and property-services shares. Among Brandes’ top 10 holdings—listed here with their London Stock Exchange ticker symbols—are U.K. grocery chains Tesco /zigman2/quotes/203761082/delayed UK:TSCO -2.76% , J Sainsbury /zigman2/quotes/206038250/delayed UK:SBRY -1.10% and Wm. Morrison Supermarkets , according to its most recent 13F filing.
The investment firm also holds apparel, furnishings, and food seller Marks & Spencer Group /zigman2/quotes/206225481/delayed UK:MKS -1.80% , department-store operator Debenhams , and home-improvement retailer Kingfisher /zigman2/quotes/200571451/delayed UK:KGF +1.14% , plus property-services plays LSL Property Services /zigman2/quotes/207034049/delayed UK:LSL +0.25% , and Countrywide , which isn’t tied to the U.S. mortgage outfit that became a poster child for the housing bust. Morris won’t discuss individual stocks, but says her shop’s holdings remain relatively similar to what’s shown in the 13F.
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The British retailers don’t look that pricey. Tesco trades around 18 times forward-year earnings and plans to reinstate its dividend in fiscal 2018, while J Sainsbury has a price/earnings ratio of about 13 and a dividend yield of 4%; the corresponding figures for Wm. Morrison are 20 and 2%. Meanwhile, a popular U.S. retail play—the SPDR S&P Retail exchange-traded fund /zigman2/quotes/206947004/composite XRT -0.81% —has a forward P/E around 21 and a dividend yield of about 1.5%.
Among the U.K. property-services stocks, LSL changes hands at 10 times forward-year earnings and offers a dividend yield of 4%, while Countrywide has a P/E of 10 but didn’t pay out a final dividend in 2016.
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The British pound /zigman2/quotes/210561263/realtime/sampled GBPUSD +1.1363% has been bashed by Brexit jitters, but Morris says the U.K.’s food retailers are weathering the drop. The currency has been wallowing around $1.31 lately, down from about $1.50 just before the June 2016 vote to leave the EU. Sterling’s slump has helped fuel inflation, which the Bank of England predicts will peak around 3% in October.
“Looking at credit-card data, food inflation is coming through obviously because of the pound, but we have seen that food spend as a percentage of disposable income has been at an all-time low of about 12%. So it seems there’s actually some room to absorb the inflation, and that’s what’s been happening,” Morris says.
Some companies have been able to pass higher prices along to customers “because there’s been so much deflation in that market for several years,” she observes.
She also suggests it’s wrong to project the problems of brick-and-mortar retailers in the U.S. on their British cousins. The British market is much different, she asserts, with far fewer retail locations and with many companies owning their properties. Morris visits Britain from California three or four times a year.
As for property-services stocks, Morris says they’re “where a value investor like us would want to be investing, at the lower end of the cycle.”
Adds Morris: “They are impacted currently by some online competitors, which are gaining some share.” But these rivals look “priced for maximum success, while the incumbents are priced for maximum failure.”
The right pricing might be “somewhere in the middle,” she says. Shares in one British online player, Purplebricks /zigman2/quotes/203490954/delayed UK:PURP +0.91% , have more than quadrupled since their December 2015 debut, even though analysts don’t expect it to be profitable until its 2019 fiscal year.
As for Brexit itself, “there are a lot of potential negatives,” and investors “don’t know the outcome of the negotiations,” she says, referring to the talks that have begun with Brussels about terms for the split.
Nonetheless, for investors who follow Warren Buffett’s maxim to “be greedy when others are fearful,” these two British sectors look tempting.