Allianz Global Investors’ Matthew Tillett says he looks for stocks which would ‘horrify’ investors, as well as ‘anything with an issue or problem’.
Although value shares suffered a further decline in the second quarter this year as growth stocks continued their outperformance, Tillett is sticking with his approach, believing the value rally has yet to come to an end.
Describing his approach, he said: ‘In that area you get quite a lot of low valuations. The market doesn’t like uncertainty. My approach is grounded on absolute valuation and downside risk – people are systematically overpaying for those companies.
‘Amongst that there are opportunities with companies or sectors which have been chucked on the trash heap but might not be that bad.’
Oil & gas
One ‘horrifying’ sector Tillett highlights is oil and gas, with the market pricing ‘more
risk than is apparent’ into businesses in the sector amid concerns about the direction of the oil prices.
But he said firms in the industry, particularly Royal Dutch Shell and BP, have ‘quite significantly’ changed their business models and are ‘far more focused on returns on capital.’ This is due in part to the fall in the oil price, but also because of proactive actions taken by the firms themselves.
Earlier this month, Shell shed its stake in an Irish gas project in a deal worth £956 million as it looks to scale back exploration activities for oil and gas reserves.
Tillett added: ‘Oil demand is going up. It’s at a record high and will keep going up for many years. It’s not a hard place to be if you’ve got [cash flow] visibility on the product. People don’t seem to have realised that yet.’
Another overlooked area he has been targeting is the UK consumer market. While others have flocked away from domestically-focused companies since the Brexit vote, he has been buying up cyclical UK stocks, including housebuilders, retailers, and travel and leisure companies.
‘Before Brexit I didn’t have a huge exposure to this area as those companies were quite highly valued, but now it has completely turned on its head,’ he said. ‘They were particularly weak straight after Brexit. Companies with quite good business models got thrown in with all the chaos.’
One stock Tillett is quick to highlight is kitchen and joinery supplier, Howdens Joinery, which sells products to local builders and was trading between 18x and 21x earnings before the EU referendum.
Post-Brexit vote, he said he bought the shares at 11x earnings, noting it is ‘indicative of how these companies have been trading’.
But he added the company is a ‘clear market leader and… its profits are miles better than its competitors’, with margins remaining the same despite it experiencing ‘a bit of a slowdown’ after the referendum.
Tillett also pointed out sofa retailer DFS, whose shares plunged 22% after it put out a profit warning last month.
He said: ‘We took a small position in DFS after its profit warning. It’s got three times the market share of its nearest competitor, and it’s not facing the same pressure as traditional store-based retailers.’
At the time, shares in British store chains fell across the board as Office for National Statistics data showed that retail sales were falling. Given its market share, Tillett said DFS is well-placed to take advantage of the situation as many of its competitors are ‘scaling back’ on their marketing budgets. This, he said, is ‘one of the biggest costs for these companies’.
Despite the opportunities in the UK consumer market, a big part of Tillett’s focus is also around avoiding value traps, especially in domestically-focused companies.
He said: ‘There are a lot of value traps in UK domestic stocks. Value traps are usually a result of two things – business model problems, so buying something that looks cheap, but has structural issues.
‘So that’s companies that are exposed to the shift of spend online, for example, and don’t have a strategy to deal with that. You won’t see me owning those companies. It can take an age to sort out those problems out.’
He also warned investors to steer clear of firms with balance sheet problems. ‘If there’s a balance sheet issue, companies have to start doing riskier things to survive, and that’s not something you want to be involved in.’
Tillett’s fund has had a moderate performance over the medium-term, returning 26.9% and 76.1% over three and five years respectively to June 2017, compared to the sector averages of 24.5% and 72.9%.
But over the last year it has delivered 27.9% in comparison to a peer group average of 21.4%. Tillett said: ‘We were quite active straight after Brexit and bought quite a few mid caps which are listed on the London Stock Exchange but make most of their earnings overseas, and that paid off quite nicely.
‘We bought companies on sensible and in some cases low valuations. A lot of other parts of the market are trading on too high valuations.’