U.S. stocks are at all-time highs, but it’s a different story in the United Kingdom. Undervalued U.K. stocks abound. Here are 3 that I like.
With the S&P 500 reaching new record highs, value investors may wonder where to look for opportunities. One market that has many bargains is the United Kingdom, the island nation that includes Britain, Scotland, Northern Ireland and Wales. We’ll get into these undervalued U.K. stocks in a minute.
The U.K. is facing two major challenges. First, on January 1, it fully departed the European Union following a long and winding Brexit negotiation. The exit leaves the country somewhat on its own, with likely slower growth and higher barriers to trade. One measure of Brexit’s scope: nearly 50% of the U.K.’s foreign trade is with EU members. Brexit will impact nearly every citizen’s daily life.
At the same time, the country is slowly emerging from the Covid pandemic. Its per-capita death rate was among the highest in the world, higher than the United States’.
These issues and others have weighed on U.K. stock indices. While the S&P 500 has produced a 61% total return over the past three years, U.K. stocks as measured by the MSCI U.K. index have actually produced a loss (of 5%) despite a recent bounce.
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However, there may be a contrarian opportunity developing. The December 24, 2020 Brexit agreement proved less severe than feared, with an orderly transition that so far has prevented border chaos. London’s financial status as the EU’s largest capital market (by far) appears less threatened, as terms for these services were left alone, to be discussed down the road. And, the U.K.’s vaccine rate, among the fastest in the world, is leading to an earlier and more robust recovery than previously anticipated. Also, the British pound has been strengthening against the U.S. dollar, providing an additional tailwind.
United Kingdom stocks offer U.S. investors some defensiveness should the exuberant domestic stock market take a tumble and the dollar continue to weaken. Listed below are three U.K.-based companies that are likely to participate in a U.K. recovery. Each have some company-specific turnaround traits and sell at a discount price.
3 Undervalued U.K. Stocks to Consider
Undervalued U.K. Stock #1: NatWest Group (NWG)
Once the world’s largest bank, the then-named Royal Bank of Scotland was crippled by the global financial crisis a decade ago, saved only by the U.K. government taking a 62% stake, which it still holds. However, the bank hasn’t wasted the last decade, and is now in remarkably strong financial condition, with a high 18.2% capital ratio. While profits remain modest, hampered by low interest rates, weak fees and subdued lending profits as well as elevated credit and regulatory costs, new CEO (November 2019) Alison Rose is pressing for faster improvements as well as an upgrade of its digital banking capabilities. Its capital markets group is being slimmed down, as well. The bank has a solid retail franchise, and its mortgage lending business is performing well. NatWest will likely restore its robust dividend and repurchase the government’s stake, helping boost investor appeal of this discounted bank. NatWest shares trade at a low 70% of tangible book value.
Undervalued U.K. Stock #2: Pearson (PSO)
This publishing company, which focuses on educational, academic and other learning-based materials, has struggled as the world transitions to digital-based media. Its shares began a precipitous decline starting in 2015, eventually falling 75% to their nadir in early 2020. To reverse Pearson’s decline, Andy Bird, a Pearson board member and the former head of Walt Disney International, took the reins as CEO this past October. His plans include simplifying the company, building its digital capabilities and strengthening its leveraged balance sheet. Early progress is encouraging, with organic revenues showing positive growth in the most recent quarter. At the recent strategic update, Pearson outlined how it will push hard into digital learning and enter the direct-to-customer segment but likely divest its international courseware operations. The stock has responded favorably, yet more upside is likely as the turnaround continues. The shares trade at an unchallenging 10.6x EV/EBITDA.
Undervalued U.K. Stock #3: Reckitt-Benckiser Group (RBGLY)
Reckitt-Benckiser is a major household goods producer with iconic and category-leading brands including Lysol, Mucinex, Woolite and Airwick. Its efforts to rejuvenate its growth, including the $17 billion acquisition of baby formula company Mead Johnson and its $4 billion divestiture of its food business to McCormick (both in 2017) were not productive. With its shares remaining flat for over six years, Reckitt hired Laxman Narasimhan, a highly-regarded PepsiCo executive, as the new CEO in September 2019. He is executing a plan to reinvigorate the company’s growth to the 5% range, partly by spending more on new product development and partly by upgrading its infrastructure, simplifying its operations and reducing its costs. One indicator of the new management’s resolve: it announced the sale of its Chinese infant nutrition business. If the turnaround strategy isn’t successful, we would not be surprised to see an activist investor get involved. RBGLY shares trade at a discounted 19.4x next year’s earnings.
Do you own any U.K. stocks in your portfolio? Tell us about them in the comments below.
Bruce has more than 25 years of value investing experience, managing institutional portfolios, mutual funds, and private client accounts. He has led two successful investment platform turnarounds, co-founded an investment management firm, and was principal of a $3 billion (AUM) employee-owned investment management company. Now he is helping his Cabot Undervalued Stocks Advisor readers find those undervalued stocks that let you buy low and sell high!Learn More >>