Moving through 2023, inflation is sticking around longer than some might have expected. We’ve seen central bankers toughen their stance on interest rate rises, meanwhile the threat of recessions in major economies remains very real.
On the face of it, equity markets have stayed relatively resilient, but performance has been buoyed by a handful of US Mega Caps.
It’s an increasingly complicated picture. So, here’s an update on how our five shares to watch fared in the second quarter of 2023, and what could be next.
This article isn’t personal advice. Investments and any income from them can fall as well as rise in value, so you could get back less than you invest. If you’re not sure if an investment is right for you, seek advice. Past performance isn’t a guide to future returns.
Investing in individual companies isn’t right for everyone. Our five shares to watch are for people who understand the increased risks of investing in individual shares. If the company fails, you risk losing your whole investment. You should make sure you understand the companies you’re investing in, their specific risks, and make sure any shares you own are held as part of a diversified portfolio.
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BAE Systems
We’re expecting another steady showing from BAE when first-half results are released. Consensus estimates are forecasting first-half revenues to grow 5.4% to £11.2bn. And in a recent update, BAE’s maintained its full-year underlying operating profit guidance, expecting 4-6% growth on last year’s £2.5bn.
Continued global events and rising tensions have seen the demand for BAE’s products and services increase, helped by the fact that UK, US and European defence budgets are all set to rise over the coming years. Given these three geographies accounted for more than 75% of sales last year, it adds serious weight to BAE’s expectations that once again, orders will exceed sales for the full year.
With that said, we expect to hear the order book’s grown in the first half, up from £59bn at the start of the year. And because these orders are typically delivered over several years, visibility for top-line growth is high. But keep in mind that profitability hinges on estimating future costs.
The long-term nature of many contracts means that the related risks and costs can change over time.
The reasons behind selecting BAE as one to watch are still in place. A strong global presence, a diverse portfolio of products and services, and impressive cash generation are all good qualities.
The three-year buyback programme for up to £1.5bn, which began in July 2022, is ahead of schedule too. The shares trade on a forward price-to-earnings ratio of 14.9, which is slightly above the long-term average. That’s a mark of confidence from the market but increases the risks of ups and downs should any missteps occur.
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British American Tobacco
British American Tobacco is keeping its eye on delivering further growth in 2023, keeping full-year guidance of 3-5% organic revenue growth and a mid-single figure uplift in earnings per share. That’s ignoring the effect of any currency movements.
Meeting these targets will need an improvement across the second half, after a first-half trading update pointed to a disappointing performance for traditional combustible tobacco products in the U.S. - the company’s biggest market. However, BATS has been performing better in other markets, and expects strong New Category revenue growth over the year.
Despite disappointment from some investors at the decision to pause share buybacks earlier in the year, there have been no moves to put them back on the table. But if further progress is made on debt reduction this year, there could be scope for the Board to restart the share buyback programme, given BATS’ valuation is close to ten-year lows.
In the meantime, analyst forecasts suggest this year's dividend payments are in line with the company's 65% target pay-out ratio, giving some comfort that the yield is sustainable. We stress, however, that no dividends are ever guaranteed.
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Bunzl
We’re expecting first-half performance to be strong but nothing to shout about. The small amount of underlying growth seen over the first quarter looks to have reversed over the second, as Bunzl expects half-year underlying revenue to be broadly flat. The new, upgraded, guidance on operating margins points to something slightly lower than the 7.4% delivered last year.
Inflation has been a revenue boost recently, as Bunzl’s been able to push prices up due to the essential nature of its products. The picture is changing as inflation moves lower and those tailwinds ease. We expect that to make organic growth tricky over the year, especially as it’ll also be lapping some strong 2022 numbers.
And so, the pressure’s on the acquisition pipeline to keep things moving. This is a strong area for Bunzl, it’s been able to add value and improve margins through acquisitions for over a decade. A handful of acquisitions this year and a healthy pipeline support continued growth from this avenue.
The reasons we put Bunzl on the list remain very much intact. The resilient portfolio, ability to pass higher costs to consumers and highly cash-generative model are all attractive. There’s no guarantee that will continue, and we’ll be watching closely for any weakness in organic growth as the year progresses.
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PayPal
Ignoring exchange rate movements, PayPal is expecting second-quarter revenue growth to slow from the 10% reported in the first quarter, to between 7.5% and 8%. For the full year, underlying operating margin growth guidance has been trimmed down to 1 percentage point, against the previous steer of about 1.25 points. Nonetheless, full-year underlying earnings per share guidance has been raised slightly to about $4.95.
PayPal's strongest volume growth is currently coming from its unbranded business which allows businesses to put their own name to the payment solution. It also opens the door to provide retailers with added services such as the buy now pay later offering, which we think may see further traction as consumers grapple with a cost-of-living crisis and burn through their savings at a rate of knots.
There are some concerns about the lower transaction margins in the unbranded side of the business. PayPal tells us there's a plan to improve this, but only time will tell how successful this will be.
The price-to-earnings multiple has fallen well below the ten-year average, reflecting the slowdown in growth and pressure on the bottom line. But we think that analyst forecasts of double-digit operating profit growth for this year and the next are still achievable in the absence of any economic shocks - and that's no bad thing. Looking further ahead we continue to see PayPal as well placed to benefit from longer-term structural growth drivers.
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Volvo
Just like the trucks and heavy-duty equipment it makes and services, Volvo is trundling along nicely. Its long-term attractions stay intact in our view. The biggest of these is the very high barriers to entry that puts distance between Volvo and its competitors.
Volvo’s first-quarter financial results showed us that net sales were up 17%, driven by growth in all areas. Higher demand for construction equipment from mining companies has helped, as has continued strong demand from the core trucks business. There’s also been an increase in demand for buses as travel resumes after the pandemic. And we saw underlying operating profits rise by almost SEK6bn to SEK18.4bn.
As ever, nothing’s perfect, and the group is still exposed to higher inflation. The nature of the company means that materials, logistics and labour all rank high up on the list of bills that need paying – and these are all areas affected by rising prices. While we are still mindful of the situation, it does seem that the worst of the problem has been put to bed.
Looking towards the rest of the calendar and financial years, it looks as though transport volumes and infrastructure activity has remained relatively resilient. That bodes well for Volvo. At the same time, these predictions could change at short notice and will depend on the depth of the incoming global economic slowdown. With that risk in mind, debt levels weren’t concerning at the last count.
The group’s price-to-earnings ratio of 10.5 is lower than the ten-year average, which we think could mark an interesting entry point. Keep in mind though that it also highlights the ongoing economic uncertainty.
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This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. Unless otherwise stated estimates are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Investments rise and fall in value so investors could make a loss.
This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.
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