As UK share prices are now likely to fully reflect the possibility of an upcoming recession and the “opportunities are compelling”, Temple Bar Investment Trust (LSE:TMPL) PLC said it has been buying undervalued shares over the past few months.
“Despite the UK equity market holding up better than most overseas markets so far this year, UK equities continue to be valued at a significant discount to global equities generally.
“Accordingly, we believe that, notwithstanding the shorter-term uncertainties, UK equities are priced to offer relatively attractive returns into the future,” the FTSE 250-listed trust’s investment managers said in a statement alongside its half-year results.
Based on this belief, fund managers Ian Lance and Nick Purves said they think UK equities are “priced to offer relatively attractive returns into the future”.
While the pair did not add any new companies to the trust’s portfolio during the first six months of 2022, they did lift their level of gearing in late June in order to top up holdings of their “most undervalued” holdings after reducing borrowing in February on concerns that “even prior to the war in Ukraine, the deteriorating economic outlook was not being adequately reflected in share prices”.
The topping up process reflected the belief that “the valuations of those shares now fully discounted a likely recession”.
Acknowledging that the economic backdrop is “highly uncertain and there is much for investors to worry about”, they noted that “the stock market is a discounting mechanism and much of this will already have been factored into share prices”.
“From the starting point of today’s depressed valuations, for those who can extend their time horizons, the opportunities are compelling, with stocks in the portfolio offering the potential for significant upside to a reasonable view of intrinsic value.”
Temple Bar’s portfolio is predominantly made up of FTSE 100 and FTSE 250 companies, with its blue-chip names helping lift returns for the period but offset by falls from its mid-cap holdings.
Net asset value total return fell 4% versus a 4.6% decline for the FTSE All-Share index, three energy companies (Shell PLC, BP PLC (LSE:BP.) and Total Energies), Standard Chartered, Vodafone and Pearson PLC (LSE:PSON) were positive contributors to return, whereas four domestically focussed names, Royal Mail, Marks and Spencer Group PLC, ITV PLC (LSE:ITV) and Currys PLC (LSE:CURY) were detractors.
Offering some commentary on some of the stocks in the portfolio, the managers said that while they cannot predict where oil and gas prices might end up in the next few months, “we would point out that the share prices of all three companies already discount commodity prices that are much below where we are today”, with sensitivity analyses from BP, Shell and Total Energies being valued on price to earnings ratios of 8x to 9x assuming US$60 Brent oil, which has been hovering around US$100 in recent months.
As a result, the pair take the view that “there is a considerable margin of safety built into the share prices of all three companies”.
Another holding is Royal Mail PLC (LSE:RMG), which they see as “more vulnerable than most” to inflationary wage pressures and may lose money this year, but its “relatively modest” valuation of 10 times underlying earnings for its international arm alone, “suggesting that investors are placing a substantial negative valuation on RMG’s UK business” and offers shareholders “a margin of safety against continuing problems in the UK”.
Similarly, Vodafone Group PLC shares have performed poorly for some time, which is attributed to the company experiencing price deflation in its European markets and management coming under pressure to demonstrate the value that exists within the business, with activist investors now also taking stakes in the company to accelerate the pace of change.
Lance and Purves believe that if Vodafone were to monetise its Vantage Towers business and return at least a portion of the proceeds to shareholders, the remaining business would be valued on a price earnings ratio of around 8x and have the potential to improve its margins through market consolidation.