Value veteran on banks, defence, and an undervalued sector

Sam Benstead sits down with Ben Whitmore of Brickwood Asset Management. The veteran value investor recently left Jupiter Asset Management to set up his own fund manager to run two value funds: TM Brickwood UK Value and TM Brickwood Global Value.

Whitmore gives his view on the banking and defence sectors after a very strong run for shares, and reveals which sector he believes is now very cheap.

He also speaks about the impact of takeovers in the UK market, as well as what a high dividend yield tells us about a stock.

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Sam Benstead, fixed income lead, interactive investor: Hello and welcome to the latest Insider Interview. Our guest today is Ben Whitmore, manager of the TM Brickwood UK Value and TM Brickwood Global Value funds. Ben, thank you very much for coming to the studio.

Ben Whitmore, manager of the TM Brickwood UK Value and TM Brickwood Global Value funds: Sam, thank you very much for having me.

Sam Benstead: In the Brickwood global fund, UK shares are the largest country allocation. Why is this?

Ben Whitmore: I think it comes back to starting valuations for us. That's very important. And, really, ever since 2016 and the vote to leave the European Union, the valuations applied to UK assets have got a lot cheaper.

Now, I think there are other factors at work as well, maybe. But the key thing is that UK-listed shares look lowly valued, they are objectively lowly valued and therefore that's a good hunting ground.

Sam Benstead: Which UK shares are you really excited about at the moment?

Ben Whitmore: There's a range of shares that are out of favour in the UK. That might be something like our Travis Perkins (LSE:TPK), that's a building materials merchant that hasn't been run particularly well in the past, it's changed its management. Those shares at the start of this year were available at below tangible book value, so there the stock market is being very, very cautious on the prospects there.

I think that's partly due to the fact that it hasn't been run that well in the past, but also there's quite a lot of concerns about the UK economy, [which] also leads to low valuations when people are worried about things.

So, a culmination of stock-specific worries and general macroeconomic worries gives you the opportunity to buy some very attractively valued assets.

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Sam Benstead: We've seen lots of takeover attempts of UK businesses recently. Is this a good or a bad thing for you as a UK equity manager?

Ben Whitmore: I think there's clearly a temptation in the short run to think that it's a good thing because let's say the share that you had that was worth 100 is then valued at 130 the next day. But I think medium to longer term, you might be selling out too cheaply when you think about the compounding effect over time of equity returns.

Second, for a vibrant capital market, you need to have new companies replacing companies taken out, so that there's a wide range of companies across a wide range of sectors and so that it's not shrinking and shrinking and shrinking.

So, any takeover while in the short run it might be appealing, there's a risk in the medium term that it's not as good as you think it is.

Sam Benstead: Some sectors that have done really well in the UK are banks and defence, are they now overbought? Has the run-up been too strong for these types of sectors?

Ben Whitmore: So, let me take both of those in turn. So banks, the leading banks in the UK, the NatWests, the Lloyds, are valued at about one and a half times tangible book value. I think there's now a fair valuation applied to those. They don't look as though there's huge amounts of tension on the valuation. Now, they might still provide an attractive return from here given the returns on equity, which are in the high teens. But there does seem to be a much fairer valuation applied to them now, so there doesn't look like there's huge amounts of tension to look for there.

In the defence stocks, we hold Babcock International Group (LSE:BAB), which is a UK defence supplier with a very strong position in submarines. Those shares have performed very well in anticipation of higher spending by the UK and Europe.

I think that it's a harder judgement there, but any share that has a very high valuation attached to it in anticipation of strong profit growth in the future, for us that means the upside and the downside is much more symmetrical, and what we're looking for are investments where there's a greater asymmetry, so where we think the downside is limited and there's plenty of upside. So, now in defence it's much more symmetrical. They're on high valuations and I think it's unlikely to be an area where we'd look now.

Sam Benstead: The UK fund yields nearly 5%, which is ahead of the benchmark index. Does yield indicate good value to you?

Ben Whitmore: Yes, for us, it's like a secondary indicator. It's a sort of byproduct. We concentrate on shares that look lowly valued on their profits and backed up by cash. So, for us that's more an output based off the ones that we found.

You tend to find lowly valued shares tend to either have a high yield because the stock market is sceptical about the profit growth of the business, or if they've got a bit more stress, they tend to have no yield.

For example, we talked earlier about NatWest Group (LSE:NWG). NatWest is paying a big dividend now, but actually a few years ago it had no yield. So, there are two characteristics and what we tend to consider is the value of the firm. We don't look first at the yield, that's a by-product.

But value investing as we do it tends to attract at the portfolio [level], a higher than average yield because lowly valued shares either have a high yield or no yield in some cases.

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Sam Benstead: Are there any companies with high yields that you think could also be strong capital growers?

Ben Whitmore: You very much want to believe that any company you're investing in can grow its profits over the medium term, both its sales and profits, and therefore that will turn into an ability to grow dividends.

Now, there might be some cases where you think the yield is too high and you're expecting a cut, but we would always invest on the basis that we think the business can grow fundamentally its sales of profits over time, yes.

Sam Benstead: Which sectors in the UK and around the world do you think are overvalued and undervalued right now?

Ben Whitmore: I think one area that is quite lowly valued at the moment is consumer-facing shares.

If I give you an example from the Global Value fund, we have an investment in a company called Mohawk Industries Inc (NYSE:MHK). Now Mohawk is the world number one in flooring. So, this is tiles, laminate, rugs, carpets, whatever you like on the floor for both residential and a bit in commercial.

Now because of high interest rates and difficulties in housing markets around the Western world, those shares have done pretty poorly as consumers have deferred expenditure. So, [firms] in that area tend to be quite lowly valued at the moment. That looks particularly lowly valued, so we've got a holding in that.

Those shares, we think, are in a cyclical downturn, but at some point consumers will spend more on flooring, which is all related to housing transactions and housing markets across the US and Europe.

Sam Benstead: In the UK, two consumer shares that have been suffering recently are Diageo and Unilever. Typically, they've been quite expensive. Are they looking cheaper to you now?

Ben Whitmore: As I said earlier, we have a screening process based off the CAPE yield. This is the average earnings of a company divided into its share price, and then we express that as a yield. On that measure, for the first time in a while, Diageo (LSE:DGE) is showing as attractive. So, on our screens, that is now showing up as attractive. Unilever (LSE:ULVR) is not quite so attractive, but definitely for the first time in a while, Diageo is, yes.

Sam Benstead: How do you know when to sell a share that's performed well for you? And how do you know when to buy more of a share that isn't doing so well?

Ben Whitmore: Value investing is about having patience and waiting for the valuation applied to the security you've purchased to become more fairly valued. That valuation change is what drives the performance. Now, in successful incidences, your security goes from 70 to 120, and then you reinvest those proceeds in other shares which are materially lowly valued.

So, there's like a competition for capital, and you're redeploying that capital into new, lowly valued securities. Over the very long run, we've got 60% right and 40% wrong. There's always an issue faced with securities where they haven't done as well as you expected. The key for us is not to ignore those securities, but with a fresh pair of eyes, look at it and either buy more or accept that you made a mistake in that one and sell it and move on.

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Sam Benstead: Can you give some examples of companies that you sold after a period of strong performance and bought more after periods of underperformance?

Ben Whitmore: When we're talking about the Brickwood UK Value fund, we only launched that in February this year. So, there's not that long a time period to really think about. But we have taken money out of Babcock, the UK defence company, which is highly valued now, and we have bought more of - I mentioned it earlier - Hammerson (LSE:HMSO).

We've also bought some more of WPP (LSE:WPP), an advertising company where the shares are very lowly valued because of fears over the economy and also some fears over artificial intelligence (AI) and what might happen there.

Sam Benstead: Artificial intelligence is one of the big investing themes at the moment. For you as a value investor, does it look like a bubble?

Ben Whitmore: So, you probably won't be surprised [to hear me say that] I'm not sure. If you look back in the late 90s with the internet, people got very excited there. But probably the change was more profound than people actually realised at the time on how businesses have changed and industries have been structured.

I'm sure there will be a lot of change that AI causes in the same way when electricity came along or various other key things in industrialisation.

But we're also very aware of what we do try and do and what we don't try and do. So, we don't try and predict trends that may or might not happen in five, 10, 15 years' time.

We're very focused on the individual companies and looking at why it's lowly valued, [and asking] what are the issues, what are the risks and trying to form a judgement there.

At the same time, we're trying to make sure that the asymmetry when we invest in it is very attractive. So that if we're wrong in our thesis, the downside's not that much, and if we're right, we make a significant amount of money.

We're not trying to understand all parts of the economy. It's too difficult. We focus and concentrate on individual companies.

Sam Benstead: And finally, the question we ask all our guests, do you personally invest in your funds?

Ben Whitmore: Yes, so I'm personally invested in both those funds, and without a shadow of a doubt, that is my most material equity exposure.

Sam Benstead: Ben, thanks for coming into the studio.

Ben Whitmore: Thanks very much indeed.

Sam Benstead: And that's all we've got time for today. You can check out more Insider Interviews on our YouTube channel where you can like, comment, and subscribe. See you next time.