UK Smalls Update

There's really no price too low

A brief blog update

I hinted earlier this year that I might add a paywall to the site, but have decided not to go down that path. I’m simply not motivated enough and don’t think I have enough excellent ideas to fill a writing schedule. My version of hell is to churn out articles I don’t really believe in and turn investing into a chore.

UK (mostly) smalls

Last November I wrote Noteworthy UK Carnage highlighting a number of UK value stocks that were being pummelled.

I’m happy to report that the beatings have continued as morale hasn’t improved and several of these companies are now in the Superfluous Value portfolio.

Many have highlighted cheapish UK defensives such as Diageo, but that’s not really my area. The link between many of the below companies is exposure to economic weakness, but strong company-level balance sheets. This is the sort of risk I will take all day, as patience is a very achievable edge in this market.

We’re nearly a decade on since the Brexit vote and some of the valuations look like career makers. UK pension fund exposure to domestic equities recently reached an all-time low of 4.9% (from +50% in the 80s) and UK funds have faced a decade of redemptions as the US sucked money from global markets. There simply hasn’t been a buyer for many names.

Churchill China

I went to the effort of opening an account with CMC just so I could buy Churchill (IBKR is quite restricted on the AIM). Of course my reward has been a 25% loss on my purchase and the trend looks well established.

The company is an interesting one. A ceramic tablewares manufacturer established in 1795, Churchill only services professional hospitality so has suffered deeply with the UK economy. Despite this, the company remains solidly profitable and maintains a safe balance sheet with net cash of £5.6m. I estimate earnings of around £4.2m for 2025 for a P/E of 9x depressed profits (5x 2022 peak), with explosive upside to a recovery.

Liquidity is limited, so major shareholders Cannacord and Rathbones selling down their stakes this year has caused relentless pressure on the price. I view it as a gift, but the timeframe remains uncertain.

Barratt Redrow

We continue with another cyclically exposed, but debt-free holding. The UK has a chronic housing shortage that grows annually, despite the efforts of successive governments. As the UK’s largest homebuilder, Barratt is one of only a few companies with the ability to make a dent in the problem. The company is still digesting its £2.5b acquisition of Redrow, but the scale and synergy benefits are evident.

The shares have been weak as affordability has gotten away from buyers in recent years. This has hurt margins, but only temporarily in my view. In the meantime, the company remains very profitable despite a price suggesting the business is worth more dead than alive. The market cap of £5.1b is equivalent to mere net cash and land bank value, while net tangible assets stand at £6.2b. Absurd for a market leader not going anywhere with leverage to the eventual recovery.

Barratt earned 31p/share over FY25 for a P/E of 12x, but once again this was a highly depressed result. Prior to 2024, the company was consistently making 70p/share (5x P/E) and achieving Returns on Capital Employed of circa 30%. The company is buying back shares and pays a well covered dividend of 4.8%.

Ashmore

I have written extensively about Ashmore and continue to believe it is an outstanding opportunity. The company is a fund manager specialising in Emerging Market Debt and a very good one with 80% of its products ahead of their index over the last 5 years.

The company holds 56% of its market cap in net cash and liquid investments and pays a 10% dividend. The opportunity doesn’t screen cheaply with 11.8p/share of FY25 earnings for a 14x P/E, but I have shown analysis in the past of average profits of 21p/share over the last decade. Subtracting cash and investments leaves the company at 4x these average earnings.

A buyback would work wonders here, but likely isn’t forthcoming given management hasn’t acted in the past. Nevertheless, the operating leverage inherent in asset managers should ensure a good return over time. Costs are mostly fixed, so AUM and performance tend to rise together, creating a positive flywheel, resulting in higher fees on a larger base as the cycle turns in their favour. The share price is likely drastically higher whenever they earn +30p/share again and I’m paid very well to wait.

Conduit Re

Another debt-free, conservatively run company with a good dividend. Conduit is a multi-line reinsurer founded in only 2021 to take advantage of the post-Covid, “hard” insurance market. Further, its Bermuda base ensures it pays no taxes.

The company’s stated goal is to stay profitable and average a “mid-teens ROE” across the cycle. After a successful start, these goals have been derailed in the two years, with out-sized losses to the California wildfires and the Ukraine war. Despite this, the investment portfolio remains short-duration and high quality, with operating leverage extremely conservative.

There is a certain amount of faith that needs to be placed in management of an insurer, especially when recent results have been poor. But leadership is now being told to “deliver” by activist investor Richard Berstein who has called for a sale, stating “I think that a sale of the business seems inevitable because it is the cheapest quoted reinsurer in Europe and an attractive target”.

It’s easy to imagine why. On my estimate of current tangible book of 490p/share, a 15% ROE (not a given of course) would produce earnings of 73p for a P/E of 5x. The stock is yielding 7% and buying back shares daily.

S4 Capital

This has been my one major loser this year- here’s my analysis from last November. I’m still trying to work out if S4 is an AI beneficiary or victim, although the market’s vote is clear.

The company is a digital-only advertiser, supposedly founded to be a winner in the new media world. This hasn’t played out and the last few years have seen a major downturn as large tech have directed more of their advertising budgets towards AI capex. The controlling founder, Martin Sorrell, turned down a buyout at +5x the current share price in only 2024, although the company is a serial issuer of shares.

Given the industry uncertainty and a non-trivial debt load I likely won’t add to this one. But at less than 1/4 of book value and clearly worth much more in the hands of a private buyer, I think the potential returns looks strong.

Unite Group

The central idea behind this post and my large overweight is the long-term desirability of the UK as a global hub and London as a cultural and financial capital. If the current malaise is temporary, quality real estate is one of the purist ways to express this theme. I have owned Landsec in the past and looked at many of the REITs and the one I currently find most interesting is Unite Group.

The company is a specialist provider of student accomodation and has recently sold off on uncertainty in the international student market. This was compounded with the negative reaction to their August announcement of plans to acquire peer Empiric Student Property. A deal I view as sensible and reasonably priced.

Post-acquisition, Unite will control 227 buildings and I calculate a NAV of 991p/share. The company trades at a 45% NAV discount and a 7% dividend yield- untenably low in my view.

Harbour Energy

Energy E&Ps are loooking depressed again and a UK-listed independent is a candidate for particular punishment. Harbour is the result of four major acquisitions since its 2017 founding for total expenditure of £14.6b. These included purchases from larger companies wanting them off their books (such as Shell, ConocoPhilips and BASF), the most impactful being the 2024 acquisition of Wintershall Dea’s non-Russian assets for £8.4b.

Harbour’s current Enterprise Value of only £7.1b (market cap £2.9b) is indicative of its undervaluation. A significant discount on top of already cheap, opportunistic deals. The company expects to produce £750m in Free Cash Flow this year despite weaker oil prices, placing it at 4x FCF.

The obvious catalyst is stronger oil prices, but a more friendly regulatory stance from the UK government could unlock significant value. A share buyback in place and 10% dividend suggests strong returns even before any re-rating.

Wizz Air

UK in listing only, the Eastern European, low-cost airline has struggled recently due to a faltering expansion into the Middle East (now being unwound) and major Pratt & Whitney engine issues that have grounded 20% of their fleet and inflated maintenance costs.

The shares look attractive, priced at only 8x earnings and 1/3 of sales. Financials that already incorporate both these challenges and will inevitably be fixed. The company is ruthless with costs and maintains an operational advantage in its markets. I believe Wizz will return to growth over the medium term and an end to the Ukraine War could be a large catalyst.

Like S4, Wizz does carry significant leverage with net debt of 4x 2025 EBITDA. The company’s financial resources and profitability seem adequate to cover this, but it remains a risk if there are furthert disruptions to its network. One of my favourite investing quotes is from Nick Kirrage of Schroders who I’ve heard say “if you don’t have a portfolio company going bankrupt once a year, you don’t own deep enough value to generate outperformance”. It’s probably not something to aim for, but worth considering when analysing leveraged cyclicals.

Have a Happpy Holidays and thanks for reading. Please let me know any other UK bargains you’ve come across.

Guy

I own shares in Churchill China, Barratt Redrow, Ashmore, Conduit Holdings and S4 Capital.

As always, this isn't investment advice. It is me journaling my investing experiences. Please do your own due diligence and seek professional advice if you're unsure about your finances.