The year-long UK stockmarket rally ran out of steam this summer against a backdrop of global monetary tightening. Through this period, we have seen some of the domestically-focused small- and mid-cap businesses outperform their larger peers, as falling bond yields and some recovery for sterling weighs on the mega-cap dollar earners.
Despite this recent outperformance, the outlook for UK-exposed businesses remains dogged by the multitude of unknowns around Brexit.
Valuations for UK domestics have de-rated to lows not seen since the global financial crisis, with the market pricing in growing fears of a “hard Brexit” and a pessimistic outlook for consumer spending.
With so much bad news currently anticipated by the market, either a modest strengthening in the consumer outlook or a marginal reduction in wider uncertainty offers considerable upside potential to the share prices of domestically-focused companies.
This has recently proved the case for some retailers. For example, Next saw its share price rise 10 per cent after announcing improved second quarter sales and a slightly more upbeat outlook. Beyond short-term share price performance, however, Next’s valuation is at all-time lows.
It continues to return cash to shareholders via a normal and special dividend, already paying two of four special dividends scheduled for this year and now, with greater visibility of full-year cash flows, expecting to be able to pay a fifth from additional surplus cash. The dividend is backed by strong cash flows and flexibility both online and in store.
Another area worth mentioning is specialist UK real estate. Companies like Derwent London, Shaftesbury and NewRiver Reit have been trading at significant discounts to asset values and continue to return cash to shareholders.
Derwent London’s strong earnings growth, letting activity and strong pipeline enabled the business to increase its final 2016 dividend by 25 per cent. It has continued its strong 2016 performance through the first half of this year, with interim rents up 48 per cent year on year.
Its recent £165m sale of The Copyright Building provides reassurance of sustained demand in the central London office investment market, as does the high rental demand for its White Collar Factory development.
Shaftesbury’s broad-based portfolio in London’s West End should provide some resilience in the event of a softening in economic growth and consumer spending. The diversity of tenants – a mix of restaurants, leisure and retail – fulfils the rising trend for a more complete retail offering, experienced through distinctive destinations and a range of activities, supporting long-term pricing power.
NewRiver invests in retail properties located across the UK. Its convenience-led portfolio, affordable rents and active asset management continues to support income, underpinning one of the highest dividend yields in the sector.
Finally, freight transportation business Stobart Group also offers opportunities, having delivered a 50 per cent dividend increase this year, with plans for further progressive quarterly dividends from this level.
Additional value will be returned to shareholders via the recently announced £3m share buyback programme, the creation of Stobart Capital (a new unit focused on the business’s core energy, aviation, rail and infrastructure operations) and through the listing of subsidiary business Eddie Stobart Logistics on AIM at the end of May, which generated a £133m windfall for the wider group.
Mark Barnett is head of UK equities at Invesco Perpetual