Lifting the lid – the company with £12bn too much money
Major UK companies are being severely undervalued – great for income
by Doug Brodie
News
As people we know about ‘the law of unintended consequences’, and that rule applies throughout the arithmetic of investment. Some is unintended, some consequences are designed, some are simply natural.
Interest rate rises have a material impact of the income from fixed interest investments and this has had a major impact on the deficits of final salary pension funds. Scheme actuaries calculate a) what income they’ll need in future years to pay out pension income, b) what income returns they can reasonably expect from investments, leaving c) the amount of money that is needed to be paid in now by the employer.
Increased income affects ‘b’, and this is projected over many years, so a small rise in income can have a large effect. Yields going from 0.25% to 4% is, however, a giant increase, which means the maths says that many schemes are awash with money. In turn this means that employers can reduce what they are paying in, thereby increasing their free cashflow. This is good for major UK equities, very good indeed for some.
This table shows that cash benefit to a few companies researched by our chums at JO Hambro, note that on average in the table the value of the reduction of the pension deficit is equal to 38% of the current value of the whole company. In regard to Currys, it saves them £78m per year, and saves ITV £75m per year. These changes are not yet reflected in share prices – but they will be.
Stats
Legal & General, as an insurer, is subject to maintaining minimum solvency, known as the Solvency 2 Ratio. This is a measure of how much extra capital it has over and above its known liabilities. These ratios were tightened for insurers and banks following the credit crunch.
In December last year L&G’s ratio was 187% or required minimum, by the end of this September – partly due to the gain in gilt yields – this had increased to 235%+. The reality of this, as explained by James Lowen of Hambro’s, is that L&G has excess capital of £12.1bn which happens to be the same value as its market capitalisation. This means the share value of L&G is fully underwritten by the value of capital it holds, so no value is given at all to its commercial business, the profits it makes or its free cashflow.
Another little nugget in the Hambro Equity Income fund is Costain: its current market capitalisation is £96.9 million, and the cash it held at the half year in June was £96m. This company generated £34m in cash in the first six months, yet it is being valued solely at its cash deposit.
We’ve all seen individual shares go very wobbly, and sometimes bust – so holding them together in a fund is the prudent way to access those potential benefits – don’t forget that ‘value trap’ is a thing, and even if a stock qualifies as a startling prospect using all metrics, its share price can languish for years (just take a look at Lloyds). The Hambro fund has a yield of 6%, and they have no doubt (not a guarantee) that the dividend will be higher next year.
Observation
It’s a strike day on London trains, and today’s one is known as a Womble strike. (I won’t explain, but email me if you’re stuck).
There’s an awful lot of chatter about how unfair it will be if Jeremy Hunt does X, Y or Z to raise tax, and that state departments all need extra money. Both can’t be equally fixed; more needs to be spent on the NHS, social care, schools etc, and we still need to pay back the free money we borrowed from ourselves to pay for furlough hand-outs, business rates subsidies and all the costs of government support during the pandemic. That Magic Money Tree wasn’t actually real but it seems lots of people appear to have ignored those costs.
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