The UK market has risen 11.2% so far this year (as of 16 Aug), and 17.2% over the past 12 months. However, it is still 7% below the pre COVID-19 high and 10% below the all-time high. In addition to a very sharp recovery in average EPS growth of over 60% this year, a key reason for Citi’s overweight position is the cheap market valuation of 13X.
There are now clear catalysts for some of the value to be unlocked, with the sharp rise in share buyback activity, companies resuming dividend payments and many raising the dividend payouts. Firms that are not cost-cutting and streamlining their business models to drive the necessary cashflow are increasingly facing the threat of takeover. Many of these takeovers are from foreign companies, which are encouraged by the fact that the Brexit fallout is less than feared and the COVID-19 vaccine progress has been rapid.
At a global level, Citi is increasingly focused on quality companies as the pandemic progresses. The UK has many listed companies that meet Citi’s quality criteria, including strong brands built up over many years, and strong balance sheets and cashflows. However, for a prolonged period, local institutional demands have been mainly for high income and less for capital gain, while the five-year Brexit negotiations held back foreign portfolio investor interest. As a direct consequence of these two factors, the stock valuations of many of these quality companies are cheap even after the 17% market rally over the past 12 months.
With companies either being more proactive in using their cash piles or risking predators, there is very likely to be rising institutional interest in the market. Underpinning this growing institutional interest is low ownership in a cheap market with great cyclical exposure, value, and dividend attractions.