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Investors’ Chronicle: Liontrust, Cranswick, Virgin Money

BUY: Liontrust Asset Management (LIO)

ESG investing has been under the spotlight over the past 12 months but investors still seem interested in the strategy, writes Julian Hofmann.

The past year has not been a happy experience for many asset managers as investors have pulled funds in the face of market declines. However, Liontrust Asset Management seems to have swerved the worst of the market downturn, despite net outflows of £2.2bn for the half.

The company, along with the rest of the sector, seems to have reconciled itself with the market volatility that has characterised the year so far. A decrease in assets under management and administration of 5.5 per cent to £31.7bn illustrated the core of the problem, but there were some signs of improvement.

Difficult market conditions were a factor in impairments, with more than £12mn knocked off the value of two of Liontrust’s acquisitions. Some £4mn of this related to Majedie Asset Management, which Liontrust acquired for £80mn earlier this year. Unforeseen outflows at Majedie meant its goodwill valuation had to be reassessed. It was a similar story at Architas, which incurred a charge of £8.8mn.

Broker Numis said the impairment at Majedie was particularly disappointing given that the deal completed only six months ago. However, it noted that November had seen a modest improvement in inflows: “Clearly, this is a very short time period and too early to extrapolate anything, but nonetheless a welcome respite from the significant net outflows seen this year,” the broker said.

Our analysis that Liontrust’s shares were oversold earlier this year turned out to be correct and the company has remained resilient in difficult market conditions. The forward price/earnings ratio of 10 times Numis’s earnings forecasts for 2023 still represents a significant discount to its long-term average. Throw in a decent dividend yield and the basic case remains intact.

BUY: Cranswick (CWK)

Increasing Chinese swine prices are something to watch in the second half, according to analysts, writes Christopher Akers.

It’s a tough meat market out there. The sector has been dealing with, among other things, labour shortages, soaring feed prices and a challenging avian influenza season. In this context, the chunky sales growth posted across divisions by pork and poultry supplier Cranswick was a good result, as indicated by the 4 per cent mark-up in the shares on results day. But higher costs led to an 88 basis point contraction in the adjusted operating margin, with profits hit by a timing lag in cost recovery and a £3.1mn charge stemming from a product recall and site closure at the company’s cooked poultry facility in Hull.

Recovering costs is essential in this inflationary environment — the company noted that the UK standard pig price jumped from 147p per kg at the beginning of 2022 to 200p per kg at the end of September. The passing through of cost inflation via higher prices drove the revenue uplift, with customer growth and the introduction of new products also helping matters. Convenience sales grew by 13 per cent, fresh pork sales by 6 per cent, gourmet product sales by 20 per cent, and poultry sales by 8 per cent. With like-for-like volumes consistent with last year despite consumer demand pressures, this was a solid top-line performance.

Despite the challenges posed by the pandemic and Brexit, Cranswick also made encouraging noises on its supply chain, saying that “labour constraints seen in the prior year have eased with ongoing investment in our skilled labour pool” (the company has turned to the Philippines for a supply of skilled butchers). It also noted that it is now 40 per cent self-sufficient on the pig farming side of the business after buying a further pig herd, which is no bad thing in this volatile market.

Peel Hunt analysts cut their adjusted pre-tax profit forecast for the company’s 2023 financial year by 2 per cent on the back of these results, but pointed to higher Chinese pig prices as a profit booster, arguing that “ongoing price improvements will make a material difference to profits in [the second half] and help to mitigate the tough environment in the UK”. Cranswick’s shares trade at 15 times the broker’s 2023 earnings forecast, below their five-year average of 19 times per the FactSet consensus. And an improved cash position and increase in the dividend also support the bull case.

HOLD: Virgin Money (VMUK)

The financial services group bumped up shareholder returns as lending balances returned to growth, writes Mark Robinson.

Virgin Money’s statutory profits have been boosted by a combination of rising interest rates and a lower level of impairments. The net interest margin, the difference between loan and savings rates, increased by 23 basis points to 1.85 per cent. Management expects the net interest margin to rise again, pitched at 185-190 basis points for full-year 2023.

The deteriorating circumstances bedevilling the UK economy has yet to impact performance. But management remains cautious over prospects, even though it notes that “credit quality remains robust with low and stable arrears; provision coverage of 62-basis points above pre-pandemic levels”.

Overall lending balances returned to growth, finishing up 1 per cent at £72.6bn, as the group continues to improve the mix of its deposit base, evidenced by a 13 per cent increase in relationship deposits. Operating costs edged up slightly through the year, but inflationary pressures could weigh more heavily on the group’s clientele as the year progresses.

Chief executive David Duffy noted “the potential affordability issues that higher living costs will cause for households and [Virgin] is ready to continue to support customers, as was the case throughout the pandemic”. At least many of the previsions taken against Covid-19 have been unwound.

The CET1 capital of the institution as a percentage of its total risk-weighted assets increased by 10-basis points to 15 per cent and management highlighted the “strong outcomes” from Virgin’s inaugural participation in the Bank of England’s stress testing regime.

On the balance of risks, management felt justified in awarding shareholders with a final dividend of 7.5p per share, together with a £50mn extension to the £75mn share buyback announced in June. However, we remain circumspect given wider macroeconomic challenges.

Hermione Taylor: Should the 2 per cent inflation target be ditched?

Will inflation ever drop back? The Bank of England thinks so. It forecasts a rapid retreat, with inflation returning to the 2 per cent target by the second quarter of 2024. But there is another argument: thanks to reduced globalisation, elevated inflation expectations and changing energy supplies, inflation might become “structurally” (and permanently) higher.

UBS analysts addressed this in a recent briefing, but remain sceptical. They argue that “we believe the inflation trend over five to 10 years is largely controlled by the central bank” meaning that inflation can remain elevated “if, and only if, central banks allow it to move higher”.

Given the steely rhetoric of central banks over the past few weeks, this seems unlikely. The BoE says it is prepared to “respond forcefully” to inflation. The Federal Reserve has made similar statements.

But here’s a radical idea — what if they stopped trying?

As the BoE sets out, the desirability of “low and stable inflation” is well established, but a 2 per cent target is relatively arbitrary. Today’s experience reminds us that high inflation is painful: squeezing real incomes and fuelling fears of a wage-price spiral. But very low inflation is also a problem — it risks tipping into deflation, increasing the real value of debts and encouraging people to delay consumption.

A bit of inflation also helps central banks to avoid the ‘zero lower bound’ of interest rates. If interest rates are at zero but the economy is underperforming, traditional monetary policy is stymied: the central bank can’t provide any further stimulus by cutting rates. If policymakers aim for a higher inflation rate, they can set higher nominal interest rates whilst keeping the same “real rate”. The higher the inflation rate, the more scope central banks have to cut.

This might seem a rather hypothetical problem. Yet if forecasts are correct, the UK could find itself mired in a low growth and low inflation (see chart) environment relatively soon. A higher inflation target would mean more monetary policy “firepower” if the economy stagnates.

This was the argument made by economist Olivier Blanchard and colleagues in a 2010 IMF paper, which raised another important question: why have a 2 per cent target at all? Are the net costs of inflation really any higher at 4 per cent?

This question has consequences for our immediate economic position, too. The BoE’s Huw Pill recently warned that the economy would not face an “immaculate disinflation”, and that returning to target would mean a weaker economy. The Bank expects unemployment to rise to 6.4 per cent by 2024, and for the UK to enter the longest recession in a century. Does pursuing a 2 per cent target mean economic pain for minimal gain?

Howard Davies, former chair of the Financial Services Authority, argued in August that raising the UK’s inflation target “might give policymakers a little more flexibility, and bring about a more stable monetary-policy regime in the longer term”. But he also highlighted a significant problem — raising the inflation target as price increases are running hot is risky. After all, it could untether inflation expectations.

The Bank’s fragile credibility would also be damaged if the move to a higher target gave the impression of giving up the fight against inflation. It would be particularly vulnerable if it moved first among the club of economies with a 2 per cent target, especially the eurozone and the USA.

Given central bankers’ tough talk, it is hard to imagine any of them settling for anything less (well, more) than target. Yet inflation is forecast to drop swiftly and dramatically. Once it is on a downward path, the dialogue will be free to pivot away from the battle against inflation and towards the monetary policy of the future. A higher target could become an increasingly attractive prospect.

Hermione Taylor is an economics reporter for Investors’ Chronicle

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