Stockwatch review of 2020: part 2

Having had success in 2020, our shares expert reassesses his tips for BT, M&S and Saga. 

To what extent is it worth taking profits after many stocks are riding high on hope for Covid-19 vaccines? 

Two inflection points have dominated stock-market events during 2020: the strong rebound from March lows after central banks and governments declared stimulus measures, then last November’s rally on the back of much better-than-expected news for vaccines. 

While stock-specific factors have to some extent aided or mitigated recoveries, these macro swings have been more influential. 

In this second piece examining key stocks I have favoured over the past 12 months, I want to re-consider a clutch from November after share prices jumped and changes of stance may be justified.  

• Stockwatch review of 2020: part 1

BT (BT.A) – ‘buy’ at 102p, 3 November

A re-rating to near 140p, currently 133p, was significantly driven by perception that a 7.5% prospective yield was too high, with the stock priced at a chart low of around 100p. The interim results published on 29 October promised a 7.7p progressive dividend policy from the next financial year to March 2022, although be aware that this assumes full benefits from a restructuring and cost-cutting.  

Initially, the market took little notice – so much for “market efficiency” even in FTSE 100 stocks, when the mood is jaundiced like it was last autumn. But as vaccine news unrolled, BT (LSE:BT.A) was among prime beneficiaries of re-allocating cash back to equities. 

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A series of news from Ofcom (which did not appear under BT’s regulatory news flow) improved long-term prospects. On 19 November, the regulator praised progress Openreach had made to become a legally separate company from BT. This contrasted with 2016 when Ofcom criticised how Openreach “had an incentive to make decisions in the interests of BT than its competitors, which can lead to competition problems”. It had also said BT failed to sufficiently consult rival internet service providers. It all seemed like an overhang of regulatory risk. 

Then, on 3 December, Ofcom signalled its support for BT’s £12 billion upgrade of the national broadband network, and said it would not introduce price controls to full fibre services for 11 years. “Ofcom does not want to discourage investment,” it said.

Its next step will be a March 2021 review of the sector, which will set ground rules for the next five years. This will be significant to what rate of return BT can make on its investment. TalkTalk criticised the decision, saying BT had been handed “almost total pricing freedom for a decade or more… a multibillion-pound giveaway” and one analyst said: “This is about as good as it gets for BT”.  

The Ofcom news was unexpected and bolsters the long-term investment case, however, the market is overlooking an imminent strike I drew attention to in the 3 November article. Subsequently, an indicative ballot by the Communication Workers Union (CWU) of 74% of BT employees achieved 98% support, hence industrial action looks inevitable. Operations’ disruption might just be short term, but the key question is whether (serial) strikes limit cuts in jobs and offices that are essential to the quest for £2 billion cost savings.    

BT has brought this dilemma on itself, proclaiming a 7.7p progressive dividend policy instead of waiting until it had more proof of financial delivery. It counted its chickens before they had hatched, and flagging the dividend may have inflamed already poor industrial relations. 

The market tends to be far less interested in industrial relations until strikes compromise a company’s financial planning, but I would beware scope for it to weigh on the stock, so for now I downgrade BT to Hold. If you are more risk-averse, then consider taking some profits. Unless industrial relations go from bad to worse, the long-term investment case remains.  

Marks & Spencer Group (MKS) – ‘buy’ at 96p, 6 November 

I originally drew attention as a ‘buy’ at 88p last May, given a 38% discount to net tangible assets plus last September’s prospect of Ocado (LSE:OCDO) substituting its Waitrose partnership with Marks & Spencer (LSE:MKS). I reiterated this after the 4 November interim results. 

The second national lockdown in November conflated with positive vaccine news, emphasising the Ocado tie-up as timely and with potential to habitualise ordering a wide range of M&S food online. With the majority of the UK now effectively in a lockdown possibly until spring, this Ocado partnership should further benefit, assuming it has capacity to.  

The stock tested 143p by early December, settling back around 136p. Quite similarly, as with BT, you can rationalise this simply in terms of dividend prospects and their risk.  

M&S has historically shown very strong cash flow numbers, enabling a near-18p dividend to be paid consistently up to 2018, and it was well-covered too. So, even though consensus is for a modest 5p dividend in respect of the year to March 2022, if management can transition more business online, then a 10p dividend restoration could, in due course, become possible.

This explains my argument about how the stock offered potential to lock in a double-digit yield, plus likelihood the price would rise once confidence improved in a sustainable payout. 

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A second key commercial challenge is how well the clothing side can recover, given M&S has yet to excel in leisure wear and believes sales of formal clothing will revive. The more lockdown we endure, the longer that will take. 

The third-quarter Christmas period trading update, due 8 January, will be influential on the stock’s near-term status. Meanwhile, I downgrade to Hold until we have more evidence about how Ocado is coping and the likely negative effect on demand for formal clothes that remains a chief aspect of M&S’s marketing. 

Saga (SAGA) – ‘buy’ at 183p, 13 November 

This travel and insurance group targeting the over 50s is well positioned once travel restrictions ease. Saga's (LSE:SAGA) new cruise ships offer a “boutique” experience versus liners for the masses, each room having its own balcony. Forward bookings affirm a sense of pent-up demand. Saga could therefore capitalise well in years ahead, assuming vaccines enable a return to life as reasonably normal. Meanwhile, its insurance operations also contribute useful cash flow, which improves the odds of long-term dividend restoration. 

Mind how there has been circa 68% dilution from last October's rescue share offer to raise £140 million, otherwise Saga might not comply with debt covenants in 2021. Also, how £556 million net assets constitute 129% by goodwill. 

The stock soared near 300p, consolidating at around 230p currently – a prime example of how November’s rally was an inflection point that went from one near-term extreme to another. 

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I suspect there is quite some sentiment-driven money now holding Saga, hence vaccination success and the government allowing resumption of cruising will be essential. Many people are assuming “life returns to normal” by spring-summer. The latest statements of those behind the University of Oxford/AstraZeneca (LSE:AZN) vaccine quite support this, although England’s deputy chief medical officer Jonathan Van-Tam struck a note of reality at the last Downing Street press conference when he said that there is no guarantee the vaccine reduces transmissibility. So, the stock is liable to drop again if hopes get even moderately dashed.  

Saga’s exposure to the cruise industry makes it inherently more volatile than BT or M&S, also its balance sheet had £687 million financial liabilities, hence the £140 million capital-raise did not transform it, just staved off covenant breach risk. 

I therefore downgrade to Hold and urge vigilance. Saga appears a good example of how the consensus on stocks became over-optimistic by early December, viewing this stock as relatively safe tuck-away for capital growth and dividends. 

Should you just sit things out?

The emergence of a freshly disruptive Covid-19 variant shows we must keep re-appraising each case behind stocks. 

Investors could take refuge, of sorts, in the notion that the planet now has a panoply of vaccines, hence beating Covid-19 is only a matter of timing. For this positive scenario, bulls argue that there is nowhere else for cash to go; you should sit things out rather than sell and potentially fail to buy back before the next inevitable surge in confidence. A lot of money now in circulation from stimulus measures will meet V-shaped industrial and consumer demand.  

Unless you want to avoid a complicated capital gains tax return, you could, of course, manage risk with partial sales.  

Call me ultra-cautious, but we have to be sure that this virus will not accelerate out of control before vaccines have a checking effect, and that they will cope with variants and reduce transmissibility. Getting Covid-19 under control is a global challenge, which must be achieved before citizens in developed nations can breathe easy again.  

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.