More Growth Shares at a Reasonable Price: Part 2


This is the second of a two-part transcript in which's David Kuo chats with fund manager Jane Coffey about GARP investing. Jane, who is head of equities at the Royal London UK Equity Fund, revisits five stock picks for Money Talk listeners from last year that have delivered an average return of more than 20%. Read on for this year's selection of shares from Jane that could also offer "growth at a reasonable price!"

(You can read the first part of this transcript here. You can listen to or download the full podcast here.)

EDITOR'S NOTE: What follows is a lightly edited transcript of The Motley Fool's Money Talks transcript.

David Kuo: Right. Given the record of your success from your last trip here into Money Talk, have you got anything for us this time? I'm all ears by the way, Jane.

Jane Coffey: Well, I do have a few things. I think, as you and I have discussed before, it does depend on your top-down view as to what kind of stocks you'd be looking for at the moment. I believe ...

David: Whilst we're on that topic, can you explain to listeners what exactly is meant by top-down investing, and a top-down view?

Jane: OK, well the top-down view is, what is going on in the economy all around you, so not what's actually happening at that individual company, but what's happening globally in global GDP growth, which areas of the economy are doing the best, whether it's the consumer, whether it's the industrials. Now, as we all know, we're quite a long way into the so-called recovery, which hasn't been a very strong recovery, and in fact --

David: Has there been one?

Jane: There has been one -- there has been growth since the low, but we still aren't back to the same levels of absolutely nominal GDP in the U.K. or in Europe that we had before 2008, so we're still struggling on the recovery, and trend growth is pretty weak. So I expect that to actually continue. The big question now is, will there be some kind of breakup in Europe -- would that drive us back into a serious recession, so not the kind of debt-induced, minus 0.5%, minus 1%, that we're seeing in continental Europe at the moment, but another big leg down.

David: A big catastrophic change, yeah.

Jane: Yes. If that were to be the case, then obviously you want to take a more defensive approach to your equity investments, and you want to look for companies that are protected from the worst excesses of a recession. Now, very few companies actually benefit in absolute terms, but some companies are much more defensive than others, so your utilities, your pharmaceutical companies, food companies, are much less likely to have big earnings shocks during ...

David: Tobacco as well, I suppose, is another one, yes?

Jane: Yes, during recession. On the other hand, if you believed that growth was going to accelerate a lot more than we thought, and say China was going to go back to growing at 8% or 9%, then the cyclical companies are going to be growing much faster than the market is already anticipating, so you'd be much more interested in buying some of the mining companies or the industrial companies.

David: So what is your gut feeling, then?

Jane: My feeling at the moment is that we are continuing to have low growth, but positive growth, and in that environment I'm happy to look for companies that are not totally defensive, but I still want them to preferably have growth that comes from something structural. So all those companies that we spoke about earlier, like Spirent or IMI or IG Group, actually had some story of their own, IMI probably less so than Spirent or IG Group, but it's important that you can sort of see that they're not just related to what happens to the economy.

David: OK, so give me some names, Jane!

Jane: So some of those, in the U.K. at the moment, I think the consumer climate is tricky. I would completely avoid retail and that kind of thing.

David: Even supermarkets?

Jane: Yeah, absolutely supermarkets. The supermarket sector I would avoid, definitely. There's a big price war going on there, and because Tesco is under pressure and has been losing market share, it is going to keep the pressure on, and euphemistically calls it "reinvesting in the brand", but what they're effectively doing is --

David: Cutting prices.

Jane: -- keeping prices low, and that makes it very difficult for everybody else to compete against such a big giant.

David: But will Tescos be able to succeed in doing that, do you think?

Jane: Well, I think the danger is that it just drags down the returns across the whole industry, so I don't think Tescos are going to lose this battle, but I don't think they're going to make money for investors when they win it. But -- going onto the ones that we really want ...

David: OK, so not retailers, not Tescos.

Jane: So, some that I actually like would be BSkyB (ISE: BSY.L) .

David: Really? OK.

Jane: That's slightly controversial, because of all the excitement around the Murdoch holding, and whether they're fit and proper people to be involved in media. I actually believe that, if the Murdochs came out of BSkyB, the valuation of BSkyB would go up, so I don't see that as a huge risk in the long term. In the short term, there might be a bit of an overhang of stock. But assuming that they remain there, and they're just a bit more distant, the fundamentals, the underlying fundamental characteristics behind BSkyB, look attractive at the moment, and very undervalued. You're able to buy this company on 11 times earnings, which is unusual -- it's not normally this cheap (that is next year's earnings, not this year's -- 2013). They've already just done a very big investment programme which absorbed cash, where they were putting out all the HD boxes, the Sky Plus boxes. So the estate, really, of their subscriber base is now quite well invested, and so the cash should be coming back from that in higher ARPUs (average revenue per user), plus they're doing very well on getting broadband, so the triple play, selling telephony to their clients, and that actually makes their clients more sticky, and sort of keeps down churn. So at these levels, you're getting reasonable cash flow growth coming through, and this is, of course, why Murdoch wanted to buy out the minorities last year. You're getting a good dividend yield --

David: But they're not really going to be growing their subscriber base, though? Surely anybody that wants Sky has already got Sky, so there are not going to be new homes in which they can start installing new dishes?

Jane: Absolutely, so it is all about getting ARPU up, and I think that they're doing that through broadband, telephony, 10 pounds for HD, multi-room --

David: Sky Any Room, yeah.

Jane: Yeah, there's all kinds of ways that they can actually get this ARPU up, and they've already done the investment. The other big thing that's coming up though here is, they're having to bid for the football rights, and this something that has hung over the stock as well, because people thought that it's going to be more expensive than their last deal. So in most analysts' earnings' numbers, you have about a 20% uplift in costs of the TV rights. What we've seen recently in the way that the packages have been put together makes it look likely that they could get the rights probably at about the same or only slightly higher price. I don't think there's going to be as much competition for these TV rights as people feared initially.

David: You know, the picture of that customer that you painted was exactly me -- did you know that, Jane? I first of all started with just Sky television, then I got Sky broadband. Now I've actually got Sky television, broadband and the telephone, and the chances of me leaving Sky is probably non-existent. So you're probably right in terms of the type of customer that you are depicting, as far as Sky is concerned.

Jane: Well, I think in this environment that we've been talking about, this top-down environment where it's very difficult to find great growth stories, this is a defensive, cash-generative company that still has a structure of growth, getting a little bit more of your wallet every month.

David: Is there not a danger that, if austerity bites in the U.K. over the next three years, that there will be many customers that say, one thing that has to go is that Sky box?

Jane: Well, history seems to show that not being the case.

David: It's almost as addictive as cigarettes, isn't it?

Jane: Absolutely -- it has been very defensive! I think one of the reasons that Sky has derated, and why I think it's an opportunity, is that there are a lot of people that are looking at the alternative like Netflix, and these kind of things, and saying, people will abandon their Sky, they will trade down. Now, the latest results, there's no evidence that this is happening; in fact, rather the opposite -- their ARPU was pretty strong. So I'm prepared to bet that this is actually quite a defensive investment.

David: And you don't think the competition from Virgin and also from BT is going to hurt Sky that much?

Jane: Not that much -- not as much as is already discounted in the share prices, I would say.

David: OK, I can say I like that one. Next one?

Jane: So two other stocks that would go in that sort of defensive U.K. consumer world, one is Domino's Pizza (ISE: DOM.L) .

David: Really?

Jane: Now, this is a bit tricky on the reasonable price, because its price on a P/E basis is reasonably high -- it's trading on 17 times earnings, but this is a fantastic business model. They still appear to be able to grow capacity in the U.K. It's a franchise model, so there's no capital involved in expansion. They're growing their outlets at 60 outlets a year, which is about 10% on their estate, so that is giving them additional demand for all the things that they provide for their franchisees, so the dough, all the food, all the boxes -- the whole works, and that's where they're getting their additional margin and their additional revenues coming through. So the U.K.'s still got quite a lot of time to grow on their models. They still think that they can get to 1,200 outlets, and there's fierce competition from franchisees for these franchises, so it's certainly something that looks quite reasonable. But the exciting thing is, they've also now moved into Germany, and they've only just started in Germany, and their pilot schemes seem to be going very well. They've got four outlets, and their aim is to get to ten within this year, really test it out. Once it gets going, they can roll out up to the same number as they've got in the U.K. really, assuming it goes well, but if it doesn't go well, then they're not really investing very much at the moment to try this out. It's really not losing them much money. So a very cash-generative model, they return all the cash, extra cash that they get to shareholders, so yet again they're a company that's doing buybacks, got a good yield, and yet is managing to grow at 15% a year.

David: But is there not a danger of cannibalizing their own franchises? Because when you have two franchises that are open so close to each other, there is that danger that one is just going to eat the sales from the other franchise?

Jane: There is, but they feel from all their studies at the moment that there's still an awful lot of space that can take more franchises, and in fact one of the big trends that they have is increasing the like-for-like sales at their individual stores anyway, through more spread of time that it's available, so going for the lunchtime area. They tried breakfast -- breakfast didn't work quite so well! It was mainly the shift workers. But also the other big trend is that, whereas it used to be one person took on a franchise, they were individuals, they had 50 different individuals in an area running the franchises; now each franchisee wants to have an increasing number of stores. So some of their biggest franchisees have got eight, nine, 10 stores, and those franchisees, probably unsurprisingly, because they're more experienced, actually have much higher sales per branch, even though quite often they're in the same area geographically.

David: That's really quite strange, because I would have thought that most of their orders were coming in through the Internet anyway, so that people would be ordering either over their smartphones or on the Internet, rather than to rely on the entrepreneurship of each franchise owner?

Jane: It is, but there is a massive growing trend. Their online sales have gone through the roof, and actually this is another thing that is good for them -- online sales tend to be a higher value than non-online sales, because you can see the other things that are available, and the online app comes back and says, would you like a dessert for only an extra 2 pounds, and we could do this bundle deal for something, so they're actually getting greater sales for any individual order, because it's online, and you can see the menu, and you can get the deals.

David: OK. So we've had BSkyB, which I like; Domino's Pizzas, which I also like. So what is your last and final one, then?

Jane: Is this the last and final one overall, or just for the U.K.?

David: Just for the U.K., yes.

Jane: OK, Cineworld (ISE: CINE.L) .

David: Really?

Jane: Yep -- Cineworld, a small company, the same kind of idea in the sense they're quite recession-tolerant. Going out to the cinema is actually not a luxury -- it's quite a cheap night out relative to lots of the other nights out that you could have. So what you've seen with Cineworld is, they've been updating all their cinemas, so they're giving a much better offering. It's all going digital - that's actually cutting costs for them, and providing a better product. They also have a 3-D thing, which was a bit of a trend, and they got a higher ticket price for 3-D sales, and they also sold glasses and that kind of thing. But what we have seen, this is relatively recently, is that the wet weather, they have been a massive beneficiary of wet weather, and people have been going to the cinema recently over the last two or three months, so that's upped their sales. But there's a really good release schedule through the rest of this year. I'm not a great cinema-goer, but apparently Avengers has been a massive hit, and they've had bigger sales per weekend than almost any of the blockbusters that we've had for the last five years, but for the rest of the year, we've got Spiderman: The Movie, we've got The Hobbit, we've got another Twilight film ...

David: Not another one, surely!

Jane: ... and Skyfall from James Bond. All these are big, popular movies, so it's a good schedule across the summer. Maybe we'll have a little blip around the Olympics or the football, where people don't go, but they've obviously intelligently looked at that schedule and put the kids' films on when the football's on, so the mum can take the kids to the cinema, whilst the dads are having the party with the football. So I think that this is a company that has a good long-term strategy. It's not high growth -- it's kind of mid-single-digit, long-term growth, but it's trading on 10 times, and it's another very cash-generative company, with a bit of short-term spice.

David: Now, I'm one of these people that just sort of waits for them to come on DVD anyway, so I can just sit at home and watch it.

Jane: Or use Sky!

David: Or just wait for the movies to come on Sky -- I can't possibly have Sky and Cineworld in the same portfolio! OK, so what else have you got for me?

Jane: OK, so if we go a bit more international now, and look at not just what's going on in the U.K. domestic consumer, Diageo (NYS: DEO) has been a perfect GARP stock really, over the last few years. This is the leading global drinks maker, so back to what happens in this kind of environment of relatively low growth -- well, food and drinks companies are usually pretty defensive. Diageo has been benefiting very much from emerging-market sales growth. Branded spirits have been great hits across China and the Asian markets.

David: Yeah -- tell me about Johnnie Walker out in Asia -- yes, that's right.

Jane: Absolutely, so as they get richer, they're moving onto those Western brands, and this is a very accessible way of feeling like you're getting a luxury brand, because it's still not that expensive. Similarly, I also think the U.S. consumer is beginning to revive, and the US is still a very big market for them, so a bit of trading up in the U.S. isn't going to go amiss, as far as helping their profit line.

David: So how do the numbers stack up for Diageo, then?

Jane: Diageo at the moment's trading on 14 times prospective earnings, and we're looking for 10%, 11% earnings growth. What I did bring you, which obviously doesn't translate very well on the radio, but I've got some great charts of Diageo's performance so far, and as you can see, what we can see here is that the earnings revisions upwards have been pretty dramatic, and have mirrored what's being going on with the stock price, so therefore really again you're getting into a company that, although it has gone up already, has only really gone up in line with its revisions in earnings expectations.

David: And you don't think that any kind of global slowdown will have any detrimental effect on Diageo at all?

Jane: Well, I think if we were going into a global recession, yes it would, although it actually did pretty well during the 2008 downturn after everything settled down, and we realized that, in fact, there was long term growth coming from emerging markets. So a real recession -- no, this wouldn't be the greatest stock, but actually slow growth, difficult growth, I still think this is a little bit of luxury that people are prepared to pay for.

David: And it does have competitors out there, I mean Pernod Ricard being one. There are lots of competitors for Diageo. It doesn't really have the field all to itself, does it?

Jane:No, but it tends to have the No. 1 or No. 2 brand in each drinks type, so whether it's whisky or vodka or whatever, and it's not that fragmented, this market. I mean, yes, they've got competitors, but there's only two or three major drinks companies in the world, really.

David: OK. Have you got anything else for me, or is that it?

Jane: What else would I have for you?

David: Or am I just being greedy here, Jane?

Jane: Rockhopper (ISE: RKH.L) is my other ...

David: What -- the oil driller?

Jane: Rockhopper is another completely --

David: It doesn't really fit in with the rest of these, does it? I mean, we've got BSkyB, Domino's Pizza, Cineworld, Diageo, and if I ask somebody to guess what the fifth one would be, I don't think Rockhopper would roll off the tongue.

Jane: No, you're absolutely right there, and its share price ...

David: If you had said Shell, BP, or maybe BG Group, I would have said yes, but Rockhopper?

Jane: Well, this is where you can put a bit of spice into the portfolio as far as beta's concerned, but what Rockhopper isn't is dependent on the global economy. Rockhopper is dependent on the oil that it has found at the moment -- is it going to be able to exploit it commercially, and therefore become a full-blown oil producer? So its future is very much tied up with what is going on at Rockhopper, and not what is going on in the global economy, so in that sense, it is recession-proof. Now, it's at a very interesting stage in its development, because it has found oil, and at the end of April it put out the latest competent persons' report, which laid out a very conservative value of number of barrels in the ground in the two fields where the oil has been proven. It's currently in the process of negotiating a farm-in, so some of the big oil companies are looking at all the data that Rockhopper has, and they will actually provide the money to commercialise this field, and at that point we will really see what Rockhopper is worth, because it'll be interesting, what they're prepared to pay. Now, at the moment, the market is valuing it on approximately $3 per barrel of found oil -- that's way below the level that other stocks are trading in the market, and we would expect a farm-in to come in at a much higher price than this. So this is a very speculative recommendation, but it is one that's not dependent on the current economic situation -- it's very much dependent on what happens at the company. We believe that there's a lot of upside for a relatively low risk at the moment.

David: Do you think this one, this company, Rockhopper, will go the same way as Holidaybreak -- the last tip you brought to us? In other words, that it could get taken over?

Jane: It certainly could get taken over, and whilst Rockhopper is currently looking primarily to find a farm-in partner for this, it could be that one of these big oil companies comes and says, "Well we don't want to mess around with being a minority partner. We want to actually buy the entire company, because we think the data's so good." So you could find that we get a bid for the company quite soon.

David: OK, well that's wonderful. You've given me five shares here altogether.

Jane: We have to add another stock to my list here.

David:I'm all ears, Jane.

Jane: An earnings momentum stock. This has been a very poor-performing company recently --Carnival Cruises -- and we obviously had the Costa Concordia problem, which has cut their earnings forecast for last year, and it has also made people worry about whether they'll be able to get people booking cruises going forward, because if there's a safety issue, are people going to be too scared to go on a cruise? Will they choose different types of holidays? So that's all the start of the earnings downgrades. We then saw oil prices actually pretty high, and this is a company that is very sensitive to oil prices, because that's one of their major costs. So earnings forecasts have come down dramatically; the stock price has come down dramatically. Given the sort of weakness that we've seen in the oil price recently, and the fact that people's expectations are pretty poor for bookings of cruises going forward, I think analysts have over-compensated now, and are going to have to start revising up their earnings forecasts. So this is a company that I think, this is something I think opportunistically we'll start seeing a change in earnings momentum, and that will let the company re-rate.

David: OK, that's wonderful. Thank you ever so much for coming in today, Jane, and bringing in these six stocks now. Will you come back in a year's time, so we can actually review these six stocks, and see how they've done?

Jane: I hope so!

David: We'll review those six stocks, and the other five that you brought in a year ago, and we'll just sort of see how this portfolio is performing.

Jane: All right, lovely. I'll look forward to it.

David: I'm sure it'll do very well. Now, I have one more chore to perform, Jane, which is to find a suitable quote to sum up today's podcast, and today's quote comes from a fictional character called Kelvin Throop, who said: "If people behaved like governments, we'd call the police." I agree with his sentiment entirely. This has been Money Talk, I have been David Kuo, and my guest has been Jane Coffey from Royal London Asset Management. If you have a comment about today's show, please let us know on the Money Talk web page, which you can find at, and don't forget you can email any investing questions you may have for our new Ask A Foolish Question podcast to Until next week, happy investing, everyone!

That was the second of a two-part transcript in which's David Kuo chatted with fund manager Jane Coffey about GARP investing. In the first part of the transcript, Jane, who is Head of Equities at the Royal London UK Equity Fund, revisits five stock picks from last year that have delivered an average return of over 20%. Just click here to continue reading.

David Kuo challenged his Motley Fool analysts to pinpoint the attractive sectors of 2012 -- and they delivered! Discover the industries they selected in this new Motley Fool guide -- "Top Sectors for 2012" -- while it's still free!

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