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UK firms come into the light

The UK corporate sector looks like gaining in value as the great macroeconomic debates continue

The last 12 months have given investors much to worry about, with concerns ranging from the outlook for debt-laden countries such as Ireland and Portugal to the prospects for China as it started to touch the brakes of its fast-moving economy.

Similarly, commentators spent much time debating the spending cuts in the UK and the prospects of a double-dip recession in the US. But a constant theme accompanying these macroeconomic debates has been the strength of the quoted corporate sector in the UK. UK profits have surprised on the upside, balance sheets are generally in rude health and company managers have increasingly demonstrated a confidence to invest and acquire. Where from here?

We will continue this year with the great macroeconomic debates of last year – the euro, the dollar, China, protectionism and a few others.

These are valuable, necessary and interesting discussions but in the meantime the global economy grows apace.

It looks likely to expand by around 4 per cent this year after doing the same last year. Even the UK’s last GDP figure did not conform to some of the more gloomy headlines we have seen of late.

In this environment, UK companies will grow revenues, generate profits and cash and increase dividends. It is not before time. After two terrible years for dividends in the UK, which produced cuts of more than one-third and where believers in the power of dividends and dividend growth had their faith sorely tested, there have been perhaps the first glimpses of light.

Compass increased its dividend by 33 per cent, Imperial Tobacco by 15 per cent. Dividends and dividend growth are likely to be a welcome feature of the March 2011 reporting season.

Also returning to the agenda are share buybacks – de rigueur as we headed into the downturn but now a source of regret for those many companies whose balance sheets were a little too “efficient” for unfolding events. As analysts pored over the minutiae of Next’s most recent trading statement, the main points of interest perhaps should have been confirmation that earnings would grow by 18 per cent this year and that the retailer would complete its £300m share buyback. These are not the results or actions of a company petrified about the outlook for the UK consumer.

Merger and acquisition activity is also likely to increase this year. As managers and share-holders become more confident in their outlook and as debt markets continue to free up for better credits, deals are almost inevitable.

For the holders of shares in the acquired firm, this will be profitable business. For holders of shares in the acquirer, academic research suggests that the odds are against much value accruing to them. When investment bankers are short of business and long of ideas, the result can be a toxic cocktail for both managers and shareholders of the comp-anies doing the buying.

So, given that when one invests in markets, one is investing in companies, we believe the array of companies in the UK makes it look like a good place in which to invest.

Of course, there is much to worry about as there was this time last year. But as each day goes past without the sky falling down, UK companies may become a little more valuable.

Richard Dunbar is investment director for UK equities at Swip



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