Twelve for 2012 – Part 1

In a recent email exchange with some of the leading share bloggers in the UK and Ireland I proposed that we each sit down and draft our thoughts for how the markets will behave in 2012, and what stocks we’d like to own to play some of those themes. Given resource limitations (I don’t know of any blogger who has a team of analysts working for them!), there will, I’m sure, be quite a bit of selection bias in the names we highlight – generally speaking, people invest in what they know! I illustrate that perfectly by choosing 5 Irish listed names in my core picks, although all of them are firms with a distinct international dimension (none of them could be described as plays on the Irish domestic economy). But despite the selection bias I do think that this is a worthwhile exercise, and one that will no doubt contribute to idea generation. As ever, readers are strongly advised to do their own research and consult a professional financial adviser if they want to invest their own money.

 

2012: The Macro Call

 

Looking ahead to next year, I see no grounds to assume that the macro situation will be materially different to that which we saw in 2011. Sclerotic growth across the leading Western economies, limited credit availability, rising unemployment, political uncertainty and austerity are all likely to be key themes over the coming 12 months. Added to the mix is likely to be a pronounced deterioration in the Chinese economy. I am gravely concerned at the rise in economic nationalism and see further policy incoherence at a European level as countries pull in different directions. However, my sense is that the euro will survive, given that its failure would lead to a deep and prolonged depression on a scale not seen for close to a century. That said, its survival will come at the expense of a weaker euro as monetary policy here is loosened to ensure its survival (given the lack of political consensus on how to fix the issue, I don’t see a solution that doesn’t involve some form of quantitative easing).

 

For me there are five key tactics to mitigate against this pressure:

 

1. Choose firms with strong balance sheets
2. Choose defensives over cyclicals
3. Choose firms with significant exposure to markets outside of the Eurozone
4. Hedge against inflationary pressures / political risk
5. Choose firms with attractive and well-covered dividends.

 

This screen leads me to highlight 6 ‘core’ conviction investments as being particularly interesting at this time. I’ve also looked at 6 more speculative plays for people with an appetite for risk. In today’s blog I outline my six conviction picks for 2012. In the next one, I will outline my six speculative plays – PetroNeft, Marston’s, Bank of Ireland, Petroceltic, Ladbrokes and Aer Lingus. Some of my readers suggested a number of other names that didn’t make the cut for a variety of reasons (French Connection, LoQ, Software Radio Technology, Sportingbet, Orosur Mining, Soco International, C&C, St. Ives, De La Rue, M&S, Tullett Prebon, Antofagasta, Morgan Sindall, ICON, CRH, élan, Ocado), which I hope to tackle in other blogs over the coming year.

 

Six Conviction Picks for 2012

 

Origin Enterprises (Current Price €3.05, Market Cap €406m)

 

Origin has successfully repositioned its business model over the past few years, merging its fishmeal and food operations (both of which are now treated as associates) and focusing on its core agri-services business. Its recent trading update revealed a positive start to the FY12 financial year (to end-July). Origin will also benefit from a full-year contribution from the businesses acquired last year (UAP and Rigby Taylor) and the integration benefits they provide. The firm has significant firepower to expand its businesses over the coming year, helped by a strong balance sheet, while it also has the option to raise extra capital through selling off one or more of its JVs. Trading on less than 6.5x forward earnings and with a net debt / EBITDA of less than 1x, this stock is overdue a re-rating.

 

Balance sheet strength: High, with net debt of less than 1x EBITDA.

Defensive/Cyclical: Defensive.

Non-EZ exposure: Just under 60% of Origin’s FY11 revenue came from the UK. Most of the 17.5% Origin says came from the “rest of the world” (i.e. outside of the UK and Ireland) comes from Norway, Poland and the Ukraine.

Dividend yield and cover: Origin yields 3.6% covered just over 4x.

 

DCC (Current Price €18.53, Market Cap €1.6bn)

 

(Disclaimer: I have an indirect shareholding in DCC). “Consistency” is a word that comes to mind whenever I think of DCC. The company has delivered growth in EPS every year since its IPO in 1994. In this financial year (to end-March 2012) that record looks like it will draw to an end, with unusually mild weather putting pressure on earnings in its core energy division (60% of group profits).  The shares have struggled in recent times after management lowered guidance due to this weather effect, but as I’ve previously argued, this looks overdone. Profits in its four other divisions (IT, Food, Healthcare and Environmental) are all rising. The company has a consistent record of generating high ROCE (19.9% in 2010, 18.4% in 2009), helped by a solid track record of making astute investments across its business areas. While this financial year looks like a ‘blip’ due to abnormal weather, the next financial year should see a strong rebound in earnings, assuming a more ‘normal’ winter and the benefits from this year’s acquisitions.

 

Balance sheet strength: Very high. Net debt / EBITDA for the current year is likely to come in around 0.6x.

Defensive/Cyclical: The vast majority of DCC’s businesses are defensive.

Non-EZ exposure: 72% of DCC’s revenue comes from the UK, of the balance, while most of this is euro DCC has a presence in several non-EZ countries such as Sweden and Denmark, while it also has a small US business.

Dividend yield and cover: The shares currently yield 4.0% and are covered 2.7x.

 

Total Produce (Current Price €0.38, Market Cap €127m)

 

(Disclaimer: I am a shareholder in Total Produce plc) It’s hard to imagine a more defensive business than the one that distributes fruit and vegetables. Total Produce moves 250m cartons of the stuff around Europe each year, making it the largest player in the sector. Its strategy is simple – it aims to consolidate a highly fragmented industry (despite being the biggest player, it commands only about a 5% market share) and squeeze out higher margins through achieving synergies in a mature market. Trading on just over 5x next year’s earnings and yielding around 5%, its valuation is an anomaly. I see scope for a considerable step-up in M&A activity over the coming year that could lead to earnings upgrades, while further share buybacks (which would also be EPS enhancing) cannot be ruled out.

 

Balance sheet strength: I estimate that Total Produce will exit 2011 with net debt of around €70m, or 1.2x EBITDA.

Defensive/Cyclical: Very defensive

Non-EZ exposure: Roughly 50% of its H1 revenue was to the UK and “Scandinavia”, which in TOT’s case is mainly Sweden.

Dividend yield and cover: Currently yielding 5%, the dividend is 4x covered.

 

Irish Continental Group (Current Price €14.71, Market Cap €366m)

 

(Disclaimer: I am a shareholder in Irish Continental Group plc) It’s relatively plain sailing for marine transport operator ICG. While market conditions remain tough, competitors are exiting the market, which is helping ICG to gain market share. In the first 9 months of 2011 revenues in the Ferry division were flat, while Container & Terminal revenues were up just under 10%. A higher oil price hasn’t helped the bottom line, but the firm should still do about €50m of EBITDA this year (it did €40m in the first 9 months of 2011). I estimate that it’ll finish the year with net debt of only €5m or so, which highlights its balance sheet strength. At the rate at which it’s throwing off cash, I wouldn’t be surprised to see talk of a special dividend (or a rise in what’s already the 2nd highest yield on the ISEQ at 6.8%) over the next year or two.

 

Balance sheet strength: ICG is virtually debt free

Defensive/Cyclical: Like Ryanair, I would argue that it’s at the defensive end of what is a cyclical industry.

Non-EZ exposure: 23% of its 2010 revenue came from the UK

Dividend yield and cover: 6.8% yield covered about 1.7x by free cashflow. This cover will rise sharply once volumes pick up.

 

Ryanair (Current Price €3.75, Market Cap €5.5bn)

 

(Disclaimer: I am a shareholder in Ryanair) With consumers watching every penny, this is music to the ears of cut price airlines like Ryanair. Last month the carrier raised its full-year earnings guidance by 10% as passenger numbers and yields (helped by a better mix of airports) continue to rise. The big catalyst for 2012 is likely to be  a special dividend worth as much as €500m. That’s equivalent to circa 9% of RYA’s current market cap.

 

Balance sheet strength: Very strong. Depending on the timing of the special dividend, the company could be in a net cash position as early as the middle of the 2012 calendar year.

Defensive/Cyclical: Probably the most defensive stock in a cyclical industry!

Non-EZ exposure:33% of Ryanair’s FY11 revenues were non-euro (primarily sterling)

Dividend yield and cover: Special dividend equivalent to a 9% yield likely in the next financial year.

 

Gold (Current Price $1,608/ounce)

 

With central banks busily debasing currencies across the West, a strategy that will only result in more inflation, that would normally be reason enough to hold gold, given its proven qualities as a hedge against rising prices. In these testing times another reason to hold it is as an ‘insurance’ against the really ugly political and economic risks we face – including the possibility of an all-out collapse of the euro. And if that happens – what would you rather own? Something that has been a store of value for thousands of years, or a new Irish currency? This video provides an excellent overview of the merits of owning gold as part of a diversified investment strategy.

 

* All share prices and market cap details taken from the Irish Stock Exchange website. Gold price from here.