We all like to acq-uire things for less than their worth. Whether it is houses, antiques, cars or groceries, it is always nice to secure a bargain. What makes Henry Dixon and George Godber of the Matterley undervalued assets fund excited is their quest to find cheap firms in the UK market.
Cheap is a subjective word and is all about context. Some cheap items are not worth paying up for and you have to be selective. As Warren Buffett said: “Price is what you pay, value is what you get.”
The Matterley managers are looking for two specific features when considering cheap or undervalued shares. First, they look to identify companies where the share price does not fully reflect the value of the assets, that is, the company is trading at below its replacement cost. Second, they hope to find businesses whose profit streams have been under-estimated by the wider market.
These criteria tend to filter out a disparate range of firms both large and small, so this fund could not be accused of being a closet tracker hugging a benchmark. The 40-60 stocks in the portfolio enter it based on merit, rather than as big constituents of the FTSE 100.
Dixon and Godber spend a long time analysing company reports and trading updates. This fundamental analysis leads them to con-struct a valuation matrix that places companies in one of three groups: undervalued assets, undervalued returns or overvalued. Looking at the FTSE 100, they estimate that 25 per cent of companies are overvalued, 25 per cent are in the undervalued assets camp and 50 per cent qualify as undervalued returns.
Their database covers almost 800 companies and it is interesting to compare the numbers now to 18 months ago, when they believed more than 55 per cent of companies in the FTSE 100 were over-valued. This focus on the balance sheet and future cashflows helps them avoid the value traps – companies that look cheap but are fundamentally in decline.
One company they are currently excited about is Sainsbury’s, where they think the market capitalisation of the company is way below replacement cost. The current market cap is about £5.5bn but it would cost, in Matterley’s opinion, approximately £14bn to replace its retail space, so for every £1 you invest in Sainsbury’s, you are buying far more in physical assets.
Since the current CEO Justin King arrived in 2004, sales are up by 50 per cent, profits have increased and the dividend has doubled, yet the share price has basically gone nowhere.
A more recent addition to the portfolio is Cairn Energy, which Matterley believes has about £1.5bn more in cash in the bank than the current market capitalisation.
Dixon and Godber believe the UK market will remaining an interesting hunting ground. One-third of the companies have net cash on the balance sheet, that is, more cash than debt, and dividends are well covered by earnings.
However, they also anticipate some serious pitfalls, such as companies with big pension deficits. As gilt yields have reached historic lows, pension fund deficits have ballooned, requiring companies running final salary schemes to increas-ingly top up contributions.
It often takes time for the market to recognise under-valued companies, so this is definitely a fund to buy and tuck away for the long term.
Although Matterley is probably a fund management company you have never heard of – it is owned by the more widely known Charles Stanley Group – Mr Dixon and Mr Godber are a management team worth following closely.
Ben Yearsley is investment manager at Hargreaves Lansdown