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Fund managers shop around for value in troubled retail sector

Concerns over a number of high-profile businesses going into administration and profit warnings have left fund managers wary of the retail sector.

The sector was shaken last week by Tesco’s sales fall over the Christmas period which saw its stock price fall by 14 per cent.

A total of 183 retailers went into administration in 2011, according to figures from Deloitte, with Blacks Leisure and La Senza becoming the latest high-profile casualties.

Signature managing director Andrew Morris says the rate of retail insolvencies can only be expected to increase in the first quarter of this year.

He says: “There are a number of factors to which this can be attributed. The intense competition by retailers fighting to sell to a very hard pressed consumer has resulted in acute margin pressures. These have been further hit by fairly acute raw material inflation.”

Morris adds that the gloomy outlook for the economy suggests things are unlikely to improve much, although inflationary pressures should start to ease.

However, some fund managers are finding stockpicking opportun-ities. Sanjeev Shah (pictured), manager of the £2.2bn Fidelity special situations fund, is “slightly overweight” in the retail sector. This is driven by stockpicking and does not reflect a positive stance on the sector.

He says: “There are some good individual stock opportunities in that area. I invested heavily in King-fisher three years ago as I thought DIY would be more resilient than other areas.”

Shah, who had a 2.9 per cent holding in Kingfisher at the end of November, says his investment in the B&Q-owning company was based on its potential for growth in new markets and strong foundations in its established markets. “In my mind, it is 60 per cent of the way through turn-round and I think there is more to go.”
Shah also holds Argos and Homebase owner Home Retail Group and Sainsbury’s.

Liontrust special situations fund manager Julian Fosh is fairly hostile to the sector with a few exceptions. He says: “These companies do not generally have the attributes we look for, which are intellectual property and a high degree of recurring revenue.”

Fosh says exceptions include Morrisons, WH Smith and Carpet-right, which are held in the £146.1m UK growth fund. Carpetright is also held in the £205.4m UK special situations fund.

Although both Morrisons and WH Smith outperformed significantly over 2011, Carpetright was the portfolio’s worst performer despite rising by 22 per cent in December. Fosh is holding on to the stock as he believes the share price does not reflect the firm’s quality.

He says: “The reason it has done so badly is the deterioration in its econ-omic environment has been worse than the stock-market expected. I believe it will survive, gain market share and when the current environment improves, it will be able to lift profits up to new, higher levels.”

Richard Moore, Source FE Trustnetmanager of the £993m Santander UK growth investment trust, has been reducing his weighting in Tesco since last year from 2.5 per cent to 0.3 per cent over concerns about its posit-ioning in the market.

Tesco’s Christmas trading results show sales fell by 2.3 per cent on the previous year.

Moore says: “Tesco’s poor figures came as no surprise to us. The discounters such as Asda and Aldi are doing well and those at the high end of the scale, like Marks & Spencer, have done well. Those left in the middle are being really badly squeezed.”

He adds that City analyst earnings downgrades of 10 per cent over the next year from where they are now are underplayed. Moore says: “The outcome may be worse than that. There remains a risk of Tesco being a wild card in the sector. We may well be selling the rest of our holding in Tesco.”

The trust also has a 1.6 per cent exposure to Morrisons and a position of less than 0.5 per cent in Halfords.

Premier income manager Chris White says the fall in Tesco shares was a “market over-reaction” and he still sees value.

He says: “The landscape may become more competitive if Tesco does more aggressive pricing. Consequently, if the market does become more competitive, investors may decide that they would rather hold the market leader with a large overseas business rather than its competitors.”

White has a 3.5 per cent weighting in Tesco and says food retailers offer good value. “Food retailers are cheap, have got good balance sheets and are very cash-generative,” he says.

He sees interest in the retail sector growing as the economic environment improves. He says: “It is a condition of the economic environment that the sector is struggling. It is possible there will be more interest in buying retailers this year. The pressure on consumers will ease as inflation falls.”

Fund sector weighting for luxury goods and retail

Fleming Family & Partners UK equity income 14.1%
Franklin Templeton Franklin European small mid-cap growth 13.4%
Fleming Family & Partners Small-cap UK equity 8.3%
MFM Slater Growth 7%
Smith & Williamson Sylvan Beech 6.7%
Franklin Templeton Franklin European growth 6.6%
JP Morgan Europe select 130/30 5.5 %
Legal & General (A&L) capital growth 5%
Fleming Family & Partners Concentrated UK equity 4.7%


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