In today’s Exponential Investor…
- US private equity firms: what are they buying – at a (nearly) record rate?
- Oil price hits a three-year high: what’s next?
- UK retail: how and why are we changing the way that we shop?
Tuesday’s edition of Exponential Investor looked at the question of who is actually at their desks and working at a time that many people in Europe and North America are (thinking about being) at the beach….
…and it ended with a note about private equity (PE) investors.
This edition also focuses on work, rather than play, and starts with a note about PE investors.
- US PE: buys UK…
From time to time, private equity (PE) firms have a major impact on stock markets.
Now is such a time.
PE investors buy companies that are listed or unlisted, with the view to making changes/improvements to those companies.
They then hope to make substantial profits by relisting the changed/improved companies, usually by way of an Initial Public Offering (IPO) on a major stock market.
What is happening now is that US private equity (PE) firms are literally buying up UK companies by the dozen.
In fact, so far this year 366 groups have bought or announced bids on UK companies – the highest rate in nearly 40 years.
You’ll likely be familiar with the latest company to be acquired: this week, Morrisons, the supermarket chain, has accepted a $6.3 billion takeover bid US PE firm Fortress.
So, what’s fuelling the current feeding frenzy?
Why are UK companies such appealing targets?
The pandemic has done great things to the US stock market.
Despite a brutal recession, the valuations of many US companies are at an all-time high as investors pile into listed stocks.
Performance of NASDAQ 100 vs. FTSE 100, debased to 100
Data source: Koyfin
The same can’t be said of the UK stock market, whose performance looks anaemic in comparison.
Even now, 16 months on from its lows in March 2020, the FTSE 100 remains nearly 7% below its pre-pandemic highs.
And, by many metrics, UK shares are trading at far lower valuations than their US cousins, which is another way of saying that the former are “cheaper”.
Take the price-to-earnings (PE) ratio for example: this is a widely used yardstick which shows how many years of after-tax earnings (at current rates) would be needed to “pay” for the company.
The FTSE 100 trades at an average PE ratio of around 13, while the NASDAQ exchange trades at a ratio of around 38.
In other words, this means that the current stock market valuation of the average FTSE 100 company is equivalent to just 13 years of profits, compared to 38 years for the NASDAQ.
There are a few reasons why the UK stock market looks relatively cheap: Brexit, whether you love it or hate it, led to uncertainty which scared off investors; oil and mining companies, which make up a hefty share of the FTSE100, have been tanked by the pandemic, and the UK’s lack of big-name growth stocks, like Amazon and Tesla, means it lacks the allure of its American counterparts.
Either way, US PE firms are having a field day…
…and not everyone is happy about it.
A fund manager at Janus Henderson, a global asset manager, told the Financial Times that the takeovers amount to a “private equity raid”, while Legal & General have criticised the Morrisons takeover bid, arguing that it could reduce its tax bill and load the company up with debt – a fairly transparent attack on what PE investors often do.
Really, the criticisms boil down to this: decent UK companies are being bought up on the cheap.
Whether these deals are the result of a functioning free market or “predatory” action from PE firms (in the words of the Daily Mail) depends on your philosophy.
What really matters is that a very sophisticated community of investors – the US PE funds – see substantial opportunities on this side of the Atlantic Ocean.
- The price of oil: set to rise further
After a brutal run on the oil price in 2020, in which the price briefly dipped into negative territory, the price of “black gold” has climbed to its highest price in three years.
Check out the graph below: it shows the price per barrel of Brent crude oil, which serves as an international benchmark, in US dollars since 2016. Over the past week, the price has climbed above $77 per barrel – a three year high.
So what’s going on?
And why does it matter for investors?
Brent crude oil prices over the past five years
There are two big factors at play here.
The first is the collapse of OPEC+ talks.
Founded in 1965, the Organisation of Petroleum Exporting Countries (OPEC) is made up of 13 oil producing countries that, at the time, produced the vast majority of the world’s oil.
Together, the organisation aims to reach agreements on their oil output, in order to support the price and prevent a “race to the bottom”.
Over the past few decades, however, OPEC’s share of global oil production has declined and other, non-OPEC, countries have increased their share of production.
This has forced the organisation to cooperate with a new group of countries – which includes Russia, Mexico and Malaysia – in order to control the oil price.
Together, OPEC and the new group of countries are referred to as OPEC+.
But of course, bigger families aren’t always happier families.
So, it’s perhaps no surprise that this week discussions amongst OPEC+ members collapsed after the group failed to reach an agreement on increasing production.
The United Arab Emirates (UAE), in particular, felt that it should have been allocated a higher degree of production than it was actually awarded.
This has created uncertainty over future production, and has nudged the oil price further upwards.
But the oil prices were already on the up, climbing 45% over the first half of this year.
Which brings us to the second reason behind the rise in price: the end of the pandemic.
Countries are bringing an end to lockdown: consumers are splashing the cash that they have saved, and governments of all political persuasions are funnelling money into hefty new infrastructure projects.
All of this is consistent with greater demand for oil.
That’s why analysts are throwing around all kinds of predictions.
Big US banks JP Morgan and Goldman Sachs expect the price to break above $80/barrel by the end of this year.
Meanwhile, Bank of America is predicting a rise into triple digit figures in 2022 – which would mark the first time the price has broken $100/ barrel in eight years.
So, is there anything that could slam the break on the oil price?
Perhaps the economic recovery that we’re seeing talked up in the press may be far more underwhelming than expected, sapping demand for oil.
Or, we could see a repeat of 2014. Back then, oil prices started to tumble as rising US production met weaker than expected demand.
That was bad news for the oil price, but not the end of the world for the global economy.
Importantly, OPEC was at that time divided on how to respond.
Smaller, cash-strapped countries wanted the group to scale back production and prop up the price of their most important export.
Others – and particularly Saudi Arabia, the biggest oil producer in the organisation – was happy to keep production levels untouched, as this would kill off an emerging US shale industry.
The result was the oil price falling from around $115 per barrel to around $50.
This was another example of how row between members of OPEC has international, and often unexpected, implications.
What is most important, though, is that Paris-based energy think-tank, the International Energy Agency (IEA) is looking for global oil demand to rise above 100 million barrels per day – a new record high – in 2023.
As was explained in Tuesday’s edition of Exponential Investor, this landmark could be hit as soon as next year.
- After Covid-19: back to the shops in the high street, or not…
Has the pandemic changed the way we shop “for good”?
That’s what the CEO of Ocado, the online grocery delivery company, told investors this week as the company released promising sales figures from H1 2021.
One of the best performing UK shares during the pandemic, Ocado shares more than doubled in value last year as the country entered multiple lockdowns.
The company has grown its customer base by around 22% over the 2020 financial year, and sales have grown by over 20%, and is investing heavily in new warehouses and robotics to expand its delivery capacity.
Of course, any boss of an online retailer in their right mind would say that the shift to internet shopping is permanent – but is there any truth in it?
It’s certainly true that the share of groceries sold online has grown during the pandemic, but it still makes up a far smaller proportion than you might expect: although online grocery purchases have nearly doubled year-on-year, they make up only 14% of all sales in the UK.
Since shops have began to reopen, unsurprisingly instore shopping is on the up once again.
But, according to the Office for National Statistics, a “far higher proportion remains online than before the crisis”.
After a year and a half of being trapped indoors, the majority of people were keen to head back to the high street.
According to research from Sensormatic, a data platform, 66% of people said they missed the high street and 74% said it would be liberating to buy in store rather than through a computer.
So here’s a better way to look at it: the pandemic hasn’t changed the way we shop – it was changing anyway.
But it has certainly given online shopping a push in the right direction.
That’s all from me today. Is there a topic you want us to explore at Exponential Investor?
If so, then drop me a line here.
Until next time,
Research Analyst, Southbank Investment Research
It’s often said private equity firms have a leg up on the ‘everyday investor’. They get access to deals on the private market that ‘retail’ investors aren’t privy to. But there’s one market where that dynamic is flipped on its head…
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You’ll notice I said: “for now.”
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