Investors’ Chronicle: Reckitt Benckiser, HSBC, BAE Systems

Buy: Reckitt Benckiser (RB.)

Management described 2020 as a turning point, but growth will slow in 2021 after a year of stellar demand for hygiene and health products, writes Harriet Clarfelt.

Reckitt Benckiser was buoyed in “uncharted waters” last year by mega sales of cleaning products and vitamins, as customers focused on hygiene and wellness during the coronavirus pandemic.

Fourth-quarter sales for the consumer goods group’s hygiene business increased by more than a quarter on a like-for-like basis to £1.6bn, with strong demand for household names Lysol and Finish.

In turn, the group’s full-year like-for-like sales rose 11.8 per cent to £14bn. While Reckitt’s nutrition business saw little movement over the 12-month period, with revenues sitting at £3.3bn, this masked an uptick in mineral purchasing. Sales for the immunity supplement Airborne more than doubled.

Reckitt’s free cash flow was up by about two-fifths to a record £3.1bn, while net debt contracted by 17 per cent to £9bn. This underpinned a full-year dividend of 174.6p, in line with 2019. Admittedly, Reckitt expects like-for-like sales to rise 2 per cent at the most in 2021. But its big brand portfolio and cash generation keep us on side.

Hold: HSBC (HSBA)

As it seeks to move on from 2020, HSBC is in a unique position among UK-listed lenders in that it has a compelling story to tell, writes Alex Newman.

“Economic growth and wealth creation make Asia the largest banking opportunity in the world,” the group trumpeted alongside full-year results, while promising a 10 per cent return on tangible equity in the medium term.

On reflection, The Year of the Rat could have been worse. Expected credit losses of $1.2bn (£852m) in the three months to December, though up from the third quarter, brought full-year impairments to $8.8bn and toward the bottom end of the $8bn-$13bn guidance range given in August. 

Increases in book value and capital also beat consensus forecasts, while the reinstatement of the maximum cash dividend permitted by regulators can hardly hurt relations with the bank’s legions of income-focused investors.

However, analysts’ focus understandably turned to the outlook, buttressed by management’s encouragement in the start to 2021 so far. Investments worth $6bn have been earmarked for further expansion in China, Singapore and Hong Kong — unsurprisingly, given the latter has powered most of the group’s profit generation in the past decade.

At the thick of the issues that define modern business — from geopolitics to governance and the uncoupling from fossil fuel finance — HSBC is a fascinating corporate tale. Investors who embrace the China-led growth story will no doubt view it as a textbook example of a value stock, too, given that it still trades at a 20 per cent discount to forecast tangible book value.

Yet a long-term holding requires a long-term idea of the future, which feels too much like guesswork.

Hold: BAE Systems (BA.)

BAE Systems managed to keep its underlying operating profit steady in 2020, at £2.1bn, writes Nilushi Karunaratne.

The aerospace and defence company saw pandemic-related disruption to supply chains and ship repair activities in its US platforms and services (P & S) business, but this was offset by strong performances in its air and maritime divisions.

Looking to 2021, BAE is guiding that its underlying operating profit will rise by more than a tenth at constant currencies amid a recovery in P & S, and a full year contribution from the Airborne Tactical Radios and Military Global Positioning System businesses acquired from Raytheon last year. The group is anticipating that its revenue will grow by between 5 to 7 per cent, with a £45bn order backlog providing visibility over 80 per cent of expected sales.

Despite the stability afforded by long-term government contracts, investors have been wary of buying into defence stocks over the past year amid concerns that defence budgets will be squeezed post-pandemic. But with countries still facing the same long-term geopolitical threats and tensions in some regions — such as the Asia Pacific — ramping up, there are reasons to believe that military spending will remain robust. Indeed, in response to an increasingly emboldened China, Australia has increased its 10-year investment in its defence capabilities from AU$195bn (£108bn) to AU$270bn — something that bodes well for BAE as Australia’s leading defence contractor.

Closer to home, the UK unveiled a surprise £16.5bn boost to its defence budget in November, although there is still uncertainty over the outcome of the integrated review of the UK’s security, defence, development and foreign policy. We are likely to see a shift from traditional to more modern fighting capabilities, such as space and cyber, which could leave BAE exposed with its focus on expensive platforms such as combat vehicles. Still, the group has sizeable businesses relating to electronic and cyber warfare, and Boris Johnson has promised a “renaissance of British shipbuilding”.

The biggest threat to BAE is perhaps across the Atlantic, where there are worries that Joe Biden could curtail US defence spending. BAE relies on the US for around 45 per cent of its sales but says that its portfolio is “well aligned” with US military priorities and growth areas and doesn’t expect this to change under a new administration. Indeed, this month, the group won a $247m contract to design and manufacture advanced GPS receivers for the US Space Force.

BAE’s net debt (excluding lease liabilities) has swelled from £743m to £2.7bn on the back of a £1bn bond issue to fund its UK pension deficit, as well as £1.7bn spent on the Raytheon acquisitions. Following this pension scheme contribution, free cash flow more than halved to £367m — short of the group’s £800m guidance — although BAE is aiming to produce more than a £1bn of free cash flow this year.

With the 2019 final dividend being reinstated back in July, and the 2020 final payout increasing by 4 per cent to 14.3p per share, BAE has now grown its annual dividend since 2003, and analysts believe that the payout will continue to grow over the next few years.

Jefferies analyst Sandy Morris believes fears over US defence spending have been overdone and “[t]he market just needs to stop looking for trouble, in our view”. Further clarity will come when the US defence budget for 2022 is unveiled later this year. With the shares offering a dividend yield of almost 5 per cent, they’re worth holding on to as an income play. 

Chris Dillow: A coiled spring

The Bank of England’s chief economist Andy Haldane recently said that the economy is like a “coiled spring”, ready to bounce back strongly when the pandemic is over. He’s right — in more ways than one.

Bank of England data next week will show why. They’ll show that the pandemic has strengthened households’ balance sheets, at least in aggregate. They’ll show that consumer debt has fallen and that our bank deposits have swelled by more than ten per cent in the last twelve months, the fastest annual growth since the 90s.

We have, therefore, the cash to spend. And there are obvious places where we’ll do so. When they reopen, pubs and restaurants could see a boom because of the Joni Mitchell effect: you don’t know what you’ve got till it’s gone. Spending on home improvements will be swelled by the simple fact that more people are moving house: mortgage approvals at the end of last year were at their highest level since before the financial crisis. The fear of being quarantined if we go abroad will encourage us to go on staycations. And there are some things we cannot so easily buy on the internet: your correspondent wants a new guitar, but needs to try it in the shop before getting it.

Millions of us have the motive and means to go on a spending spree. We’re just waiting for the opportunity.

But, but, but. There are two drawbacks here.

First, people will lose their jobs in coming months. Just how much unemployment will rise is a matter of huge uncertainty. It depends upon: whether or how far the government extends its job retention scheme; how many migrants return home; and how many of those losing their job just leave the labour market rather than register as unemployed. But the direction of change is clear. This will hold down consumer spending not just by cutting the incomes of the jobless, but also by creating uncertainty among some of those still in work.

Secondly, some of us might have fallen into newer, more frugal habits such as entertaining at home rather than eating out, or not walking around shopping malls each week and so being tempted to spend.

Certainly, there’ll be a jump in spending post-pandemic. But nobody knows for sure how big or long-lasting it will be. And nor does the Bank of England. If it were confident of a big consumer boom, interest rates would not be 0.1 per cent.

But there’s something else. Before the pandemic, trend economic growth was lacklustre, and not just in the UK: industrial output in the euro zone was lower in 2019 than it was in 2007. A big reason for this was that corporate investment was weak — which itself was a big cause of stagnant productivity. There are many reasons for this weakness: lack of monetisable innovations; low profit rates; depressed animal spirits; and so on. And the pandemic has not removed them. After a one-off jump in spending we might therefore return to the pre-existing trend of secular stagnation.

Haldane’s analogy is therefore a good one. The thing about coiled springs is that they jump when they are released, but quickly return to rest.

Chris Dillow is an economics commentator for Investors’ Chronicle