Still plenty opportunities

Oct 1 2008 by Andrew Miller, The Journal

THE past few weeks will undoubtedly live long in the memory of many investors. But while shareholders and the media alike remain fixated on the current difficulties in the US – and specifically Main Street’s currently stalled rescue of Wall Street – it is worth remembering that some blue-chip names are still performing robustly despite the undeniably difficult backdrop.

Tesco is a case in point. Yesterday the company delivered first-half numbers that were in line with market expectations, with underlying profit before tax coming in at £1.45bn, driven by 14% top-line growth.

While these numbers were impressive, it is perhaps more encouraging that CEO Terry Leahy was at pains to point out that while conditions are extremely tough for the UK consumer, it is an exaggeration to say that they are the worst for 30 years, as some sector analysts have recently proffered. Trading down, the focus of much media attention in recent months – has been selective and non-food growth has slowed a little, but remains in positive territory.

To further support this, one only has to look at the progression of like-for-like sales for Tesco in the UK, which have accelerated from 3.1%, to 3.5% to 4% over this half. Elsewhere in the business, the international business looks fine and currency trends here have also been helpful. The share buy-back has been suspended, with the proceeds of property sales now going towards paying down debt– a sensible move in the current climate.

Perhaps unsurprisingly, Tesco remains our preferred haven within the retail space. It trades on 12 times next year’s calendarised earnings for double-digit earnings growth, property backing of £20bn at cost price and a strong, defensible price message. It is in our UK equity portfolio and we are keeping the Buy recommendation.

In contrast to Tesco, there was much less good news from H&M, confirming our view that the area of discretionary spend faces a rocky ride in the months ahead, even if the immediate political and financial uncertainties in the US are resolved. H&M missed expectations for its third quarter by around 10%, with lower gross margins and slower sales.

Margins suffered as the weaker dollar failed to offset higher than expected product cost inflation and transport costs. We were not expecting cost inflation emanating from China to hit stores until at least next Spring, so this came as something of a surprise.

Basically, there was very little good news, apart from the fact that the company looks very lean on stock, which should reduce the level of markdowns going into the fourth quarter. For the moment we are keeping our Buy recommendation on the shares, which partly reflects a lack of any genuinely plausible alternatives within the sector.

Markets are undoubtedly in a tumult at the moment but, at the stock level at least it’s clear that in the short-term the focus will be on companies with the best balance sheet metrics, regardless of sector. But if Sir Terry is right about conditions not being as awful as analysts suggest, there will undoubtedly be plenty of opportunities for investors in the months ahead, assuming of course the gridlock in the US Congress can be resolved.

Andrew Miller is regional office head of Barclays Wealth