Counting on financials to outperform
We are positive on the financials sector overall – valuations have dropped so far that we expect them to outperform in the long run. But we divide general financials into four different subcategories, and our views on each are quite different.
The first is alternative investments. By far the biggest is Man Group – accounting for around a third of the entire general financials sector by market cap. We like Man, and have a Buy recommendation on the stock. Some hedge funds have been hit by the subprime crisis, but Man has been pretty resilient so far. It was the only European financials stock to generate positive returns in 2007.
It also has an international focus, with a growing presence in the Middle East and Asia. And – its individual attractions aside – we think the prospects for this sub-sector are good, with rising demand across the market. However, other investors have spotted its attractions too, and Man now trades at a premium. This is partly justified by its high growth, but nevertheless, the shares are now less attractive overall. Our fair value of 690p is relatively cautious.
The second group of companies in this sector is the interdealer brokers (firms that facilitate trades for other market participants). These have been among the few companies to benefit directly from the recent market turmoil. We expect demand to stay robust, helped by increasing trade in financial derivatives. Effectively, this sub-sector is a play on market volatility.
Interdealers
The two companies in this area are ICAP and Tullett Prebon. We originally held ICAP shares, but after a very strong performance, switched into its smaller competitor Tullett Prebon. This has proved successful. For now, we are still positive on Tullett Prebon, where the attractive outlook is not reflected in the share price, despite mid-range multiples.
Thirdly, there are the conventional asset management firms. Valuations here are pricing in big declines in earnings per share for companies like Schroders and Henderson, reflecting weak financial markets (and hence fee income). For now we think sentiment could remain against these companies.
Finally, we are cautious on both non-standard credit providers in the sector, on account of the macroeconomic outlook and their UK focus. That said, Provident Financial is trading at robust multiples, reflecting the relatively small loan sizes of its home finance lending. The outlook is less positive for Cattles. It is involved with larger sums, has a higher risk profile and there are concerns that the business has been growing too fast.