- Analysts at Citi have proposed three strategies to profit from the selloff of UK stocks since the Brexit vote
- They identify cheap domestic stocks, cheap commodity stocks, and ‘potential de-equitizers’ as the building blocks of an attractive UK portfolio.
Brexit uncertainty has led investors to shy away from British stocks. Analysts at Citi say they have spotted an opportunity to cash in.
“Many investors view the UK as uninvestable,” thanks to Brexit, the Wall Street bank said. “We get it. But see decent valuation support and continue to see upside risks to UK share prices in the absence of a negative Brexit outcome.”
Citi identified three strategies that combine to create an appealing UK investment portfolio: cheap domestic stocks, cheap commodity stocks, and potential “de-equitizers.” We look at each one below.
1) Cheapest UK domestic stocks in 25 years
Overzealous selling of UK stocks has created sizeable gaps between share prices and stock fundamentals, the analysts argue. In the past 25 years, UK shares have only been cheaper during the financial crisis.
Relative to US equities, on a dividend-yield basis, UK stocks are the cheapest they have been in more than 45 years, according to Citi. Compared with UK gilts, they’re the cheapest they have been since World War I. UK shares also offer the highest free-cash-flow yield of any major region.
“Domestic shares [look] oversold and too cheap,” Citi wrote.
“Domestic stocks, such as banks and homebuilders, are likely to be beneficiaries of reducing political uncertainty and a pick-up in UK domestic growth into 2020.”
2) Cheapest commodity stocks in 20 years
Citi’s “preferred Brexit hedge” is to own commodity stocks rather than expensive international stocks.
UK commodity stocks offer better-value dividend yields than pricier large-cap international stocks. They “have only been meaningfully cheaper on this basis once in the last 20 years; during the commodity recession of 2015-16.”
The analysts also found commodity stocks looked more attractive than large-cap international stocks in terms of surplus free cash flow, net debt to EBITDA, dividend yields and other metrics.
3) M&A, dividends, and buybacks
The funding gap between the costs of debt and equity is close to record width, according to Citi. That could encourage companies to engage in “de-equitization” – issuing cheap debt then using the returns to buy back their stock, make acquisitions, issue dividends, or purchase equities that yield a higher income.
“Reduced Brexit/political risk could lead to a swathe of corporate activity involving UK companies/shares,” the analysts wrote.
They view companies with robust balance sheets and surplus free cash flows – including Burberry, Unilever and Lloyds Banking Group – as “ripe for de-equitization.”
Brexit may be casting a shadow over UK equities, but Citi’s findings there may be value on offer for brave investors.