According to Morgan Stanley, UK equities seem cheap, in comparison to their worldwide counterparts, who provided a number of reasons why investors should put their money right now.
Morgan Stanley equity strategists provided six reasons why it may be time for investors to reconsider the often maligned United Kingdom in a note earlier this month.
The United Kingdom is leading the way in M&A.
In 2021, the United Kingdom’s merger and acquisition activity is expected to outpace that of the United States, Europe, and Japan. According to Refinitiv data, UK M&A deals as a percentage of market capitalization have reached 12% in the last 12 months, the highest level since 2001.
“Although equity investors appear to have limited appetite for buying into the listed UK equity market, private equity investors appear to have fewer reservations, accounting for 30% of all UK acquisitions by value over the last year — a level of engagement that is high relative to historical trends,” Morgan Stanley strategists wrote in a July 9 note.
The UK stock market is the most affordable in the world.
According to Morgan Stanley’s strategists, one reason for increased M&A activity in the United Kingdom is that corporate assets are “materially cheaper” than in many other countries.
They claimed that the United Kingdom is by far the cheapest major global market, with a price-to-earnings ratio of 13 times for the next 12 months. The global MSCI ACWI index, by comparison, has a price-to-earnings ratio of 19 times. A price-to-earnings ratio is a key metric that traders use to determine whether a stock is under or overvalued.
Morgan Stanley strategists identified a number of UK stocks that appeared undervalued in comparison to their global peers, selecting some for a “overweight” rating. Chemicals company Johnson Matthey, grocery store chain Tesco, oil major Shell, broadcaster ITV, information and analytics company RELX, and aerospace company BAE Systems were among them.
The value of the pound has been cut in half.
Since 1966, when England’s soccer team won the World Cup, the pound has lost half its value against the US dollar and more than 80% against the euro.
On the one hand, a falling pound makes it more affordable to hold the currency. However, if the pound continues to fall, many of the largest companies listed in the UK will benefit because the majority of their earnings are generated outside of the country.
“The last 54 years haven’t been kind to the England football team, and it’s a similar story for the international value of UK financial assets (yes, we know England isn’t the UK, but we’re rolling with it anyway!”) said Morgan Stanley’s equity strategists.
Meanwhile, the FTSE All-Share stock index in the United Kingdom has risen more than 4,000 percent in that time, but it has stalled in recent years. The FTSE All-Share was down 5% since its peak in May 2018, according to Morgan Stanley, while Europe’s STOXX50 was up 14% and the S&P 500 was up 60% during the same period.
UK stocks are performing better “below the surface.”
After years of underperformance, Morgan Stanley strategists believe the UK stock market’s relative performance is beginning to stabilize.
According to them, the United Kingdom had just experienced its best nine-month period of relative performance to the MSCI ACWI in a decade. Furthermore, the average UK stock has been the second-best performer year to date, trailing only the median US stock.
Smaller companies in the United Kingdom outperform large corporations.
The FTSE Small Cap index in the United Kingdom has more than doubled its performance since a low last year and is up 60% in the last five years. In comparison, the FTSE 100, the United Kingdom’s blue-chip index, has underperformed the smaller companies index by more than 40% in the last year and has been broadly flat over the last five years.
Italian small-caps are the only group of stocks that have outperformed UK firms year to date, with both up more than 20%.
Earnings growth in the United Kingdom
According to estimates, the MSCI U.K. stock index’s earnings per share, which indicate company profit growth, will increase by 65 percent in 2021.
The United Kingdom “looks set to post a faster earnings rebound than any other major global country/region this year,” according to Morgan Stanley strategists.
They did, however, point out that oil and mining companies are expected to generate 34% of the UK stock market’s earnings per share.
Goldman adds Alcoa to its conviction buy list, says aluminum stock can gain more than 50%
Aluminum prices should stay high in the foreseeable future and, according to Goldman Sachs, offer a significant boost to the stock price of Alcoa.
In a note to clients, analyst Emily Chieng reiterated her buy call on Alcoa and added the stock to Goldman’s conviction list, claiming that the company’s operating leverage and low-carbon business model were underappreciated by the market.
“In light of our positive aluminum outlook, we believe Alcoa is well positioned to benefit from our higher price expectations, underpinning strong free cash flow generation and rapid deleveraging,” according to the note.
According to FactSet, aluminum prices are up roughly 26% year to date, and Goldman believes they will continue to rise over the next two years.
Alcoa could also be a relative winner as environmental concerns grow in the industrial sector because its footprint is smaller than competitors, according to Goldman.
“As the focus on decarbonizing the aluminum production chain intensifies, we expect Alcoa’s low-carbon supply chain to benefit, with AA’s lower carbon portfolio comparatively superior to the global average,” according to the note.
Goldman has set a price target of $51 per share on the stock, which is nearly 55% higher than the stock’s closing price on Friday.
The stock is up 43 percent year to date, but the majority of that gain occurred in the first few months of 2021. Over the last three months, the stock has dropped by more than 8%.