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Clive Beagles: rate rises will stub out tobacco stocks
Tobacco stocks are a favourite among many equity income managers. But not for Clive Beagles, who fears they may start to look vulnerable.
Tobacco stocks are a favourite among equity income managers, who like their supposed 'defensive' characteristics.
But Clive Beagles, Citywire A-rated manager of the JOHCM Equity Income fund, is not among them. In this video interview with Jonathan Miller, Citywire's head of research, he outlines why he doesn't hold any in his fund, and why they could start to look 'very, very unattractive'.
Beagles also explains why his fund has taken a big position in some of the most out-of-favour areas of the market, like oil stocks and miners, and why small companies look better value than 'mid caps'.
Can't watch now? Read the transcript
Jonathan Miller: I’m joined by Clive Beagles, A-rated by Citywire and manager of the JOHCM UK Equity Income fund. Clive, let’s start with your process. You only invest in stocks with a prospective yield that’s 10% higher than the FTSE All-Share index. Why is that an important discipline for you?
Clive Beagles: It’s something we’ve used for a number of years. It’s most useful in that it encourages us to sell stocks when they’ve performed quite well. Most fund managers tend to be quite good at buying stocks, but most fund managers don’t tend to be quite as eloquent when you ask them to describe why they sell a stock. The discipline really works when the share price has gone up, the valuation has gone up and the yield’s come down. Our other valuation metrics would be encouraging us to lighten the position but the discipline forces us to sell and replace it with a more modestly rated alternative.
JM: Conversely you can get situations when the yield is very high. If we look at some of your portfolio, oil and gas, miners are around 20% of the fund.
CB: We think we’re at a relative low point in the cycle for those sectors. The oil price has obviously fallen heavily over the last 12 months. We think supply will come out of the market and we expect the oil price to recover in time because of that, and as a result we think there is a lot of good value there. Mining is really the same situation but in a more extreme case. You had a lot more new suppliers chasing the Chinese dream, if you like, in 2007-9. That’s now beginning to exit and yet everyone has become very negative on these areas. They are currently under-earning relative to their normal margin. We’re a believer in a mean reversion in these sorts of sectors and at some point we believe some of these stocks and sectors will start to attract more attention, and indeed in the last few weeks they have begun to do so.
JM: On that point about mean reversion, you can get yield traps though. Are there any areas that you think are yielding highly at face value, but actually they are areas you would want to avoid.
CB: What we want to be careful about are stocks or sectors that are in the midst of a permanent structural decline, and that’s where you might get trapped in a situation. Ultimately we don’t own many retailers, for example, we only own one general retailer, which is Halfords. The other parts of the retail sector have clearly got challenges in terms of internet and route to market. That’s an areas of the market that we remain quite cautious about, even though the consumer is in quite a good place and consumer spending is quite robust.
JM: OK, so no tobacco in the portfolio, healthcare just 5% and that’s only through AstraZeneca. Pretty much all income managers out there hold these as core defensive positions. Why don’t you?
CB: Because we don’t think they are defensive. If you look at tobacco, tobacco is an industry that is in structural decline, volumes are in decline, they have continued to be in decline, particularly in the western world, and on top of that valuations are very, very high.
These sorts of areas have been buoyed up by very low interest rates and very low bond yields. People have viewed them as bond look-a-likes, but we think that is far from the truth. These companies are struggling to grow, their accounting is quite sharp, I think. They tend to strip out some of the bad stuff, issues involving regulatory fines they might pay or litigation, or they tend to strip out currency moves on the negative against them. If you look at it in the round, valuations of some of these companies, British American Tobacco for example, is on 15, 16, 17 times earnings, a lot of debt, in a situation where at some point interest rates will rise, the market’s tolerance for levels of debt will fall, and we think these stocks will look very, very unattractive in that world.
Pharmaceuticals has some similarities. We like AstraZeneca, we don’t like GlaxoSmithKline. Glaxo in particular we think is struggling to replace its drugs that are going off patent with those that are going to replace that in a meaningful way. It’s overdistributing: it’s paying a dividend that has not been covered by cash for at least the last three years. I don’t think that’s very defensive: I’m surprised that other people think it is.
JM: Looking at performance in recent years, mid caps, small caps among the exposure have all been a very positive tailwind for you. Have you changed anything here, are you reallocating? Especially in the last few months.
CB: Relative to our own history of 10 to 11 years on this fund, our mid cap weighting is the lowest it has ever been, because that is a part of the market as you correctly say that has performed well, there are a lot of sort-of consumer cyclical-type stocks that have done well. So that’s the lowest it’s been. Conversely and maybe slightly surprisingly, our small cap weighting is the highest it has ever been. I think people have become fixated with liquidity recently. Small caps aren’t very liquid, that’s the nature of them, but we don’t mind that if the potential upside is big enough to offset that liquidity discount. Most of our small caps are on very modest multiples, seven to eight times earnings, maybe nine times earnings. Good little companies that aren’t overleveraged, but they’ve just fallen off the radar for most investors. We don’t mind that, we’re happy to do that. So today we’ve got about 17% to 18% of the fund invested in small caps, which for us is the highest we’ve ever had.
JM: Clive, thank you for joining us.
CB: Thank you.
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by Daniel Grote on Mar 28, 2017 at 16:45