Some forecasts for the coming year: the oil price will not recover and it could subside further if production from Iran is higher than thought. There will be no respite for the mining groups and the fall of dividend income from that source will weigh on the market.
As, too, will a continuing weakness in corporate earnings, particularly from UK companies with exposure to global markets. Consumer spending will not be the tonic some have expected, though well-placed businesses in the right markets will do well enough. January will bring a series of warnings from retailers over Christmas trading.
Oh, and two or three things will happen that we don’t know about yet, which will either send the markets up or down.
One specific prediction: Royal Dutch Shell will succeed in acquiring BG Group and it will maintain its dividend. Which leads us on to my first recommendation of 2016: buy BG as a cheap way into Shell. The terms of the deal value each BG share at £10.70. The shares closed end of the year at 985p. That’s getting on for a quid’s worth of uplift. That assumes Shell shares maintain their value. If the dividend is maintained, the 8 per cent yield should provide some support. If the deal fails, all bets are off. The next chief executive will have free rein to cut the dividend. That’s the downside.
If you believe the market is in for a choppy year, it makes sense to opt for safer stocks. So, excepting the above, no oil and gas or miners. There are bargains to be had there, but the downside is far greater.
I want some exposure to British consumer spending. Among retailers, shares in Home Retail Group, owner of Argos and Homebase, have more than halved over the past year. On little more than ten times earnings, they look a good two-way bet. There has been speculation that this tycoon or that private equity firm is poised to swoop. If the price goes much lower, this could happen. Beware possible reports of bad trading at Argos this month, though.
Greene King has been my pick among the pub operators because of the good deal it got when the company bought Spirit Pub Company. The shares performed well last year, and I advised taking some profits. The shares have slipped but on the assumption that Spirit provides the extra growth its rivals will struggle to achieve, they should be ahead by the year end.
Shares in Whitbread were looking pricey in the spring, at above £54. They have come back a lot and sell on a more reasonable 18 times’ earnings. This is the ultimate defensive play with Premier Inns and the Costa Coffee chain enjoying strong positions in their markets and set for growth, particularly overseas. Alison Brittain is just taking over as chief executive. Again, there has been talk of a possible sale of part of the business, such as pub restaurants. Less likely but, again, a good two-way bet.
Dairy Crest Group could be seen as another play on the British consumer, except that it has cut its exposure to the UK by selling its dairies side, retaining Cathedral City cheese and other consumer brands. The interest here is a new venture selling the by-products of cheese production at its Davidstow plant in Cornwall. These are to go into baby milk formula and there is a global partner, Fonterra of New Zealand, to handle the sales. Of particular interest is the Chinese market. It is impossible to value this venture now and, at close to 20 times earnings, Dairy Crest shares are not cheap, but those prospects should become clearer as the year progresses.
Another solid defensive stock is DS Smith. It sells on an earnings multiple of about 15, which is not unreasonable for the packaging sector. The company has an extraordinary record of growing by acquisitions and has set itself some difficult performance targets, and then beaten them.
DS Smith makes most of its sales in the eurozone, which held back the reported figures last year. This effect will wash through the numbers in due course — on the assumption that the single currency does not deteriorate further. The main point for buying the shares is that the record suggests the string of deals, and the gains that can be wrested from them, will continue.
There has been concern in the market over Babcock International. It bought Avincis, the helicopter operator, in 2014, before the abrupt fall in the oil price — the business gets much of its work flying in and out of oil and gas installations. However Babcock is still building up its bulging order book and will do well enough out of November’s defence spending review, which should reassure doubters. On 14 times earnings the shares should make further progress.
Connect Group is the former Smiths News, now expanding its work outside the delivery of newspapers and magazines and into other, often unproven areas, such as the delivery of awkward-shaped parcels. This is a difficult market and analysts have their doubts. If the diversification succeeds, the shares should go ahead, selling on a relatively low multiple of below ten, while investors will be well enough paid to wait, with a dividend yield of approaching 6 per cent.
Breedon Aggregates has been building its position as a player in the UK construction materials market by a series of deals but in November kicked itself into the big league with the £336 million purchase of assets from Mittal Investments. The secret in this market is wide geographic coverage because such materials do not necessarily travel well. Breedon has been expanding that coverage at the same time that the UK construction industry has been moving out of the doldrums. I am not convinced the market has quite appreciated the Breedon story. It has overshot City forecasts, while the benefits of the latest transaction should become apparent this year.
Finally, investors in Nat Rothschild’s last quoted adventure, Bumi, the Indonesian coal miner that came unstuck, will have qualms over his assumption of the leadership of Volex, an electrical goods company with a chequered history. The financier has every reason to make this one come good as he owns more than a quarter of the company. This is a speculative one and does not meet my criterion of a defensive investment but, if it comes good, the upside is considerable.
As ever, don’t bet the farm, don’t think you need to buy them all, and don’t expect all to come good. It could be a rough year.
