Wondering What UK Sector is Your Safest Bet in 2016?

Published on 03 Jun, 2016

UK Sector 2016

With global equity markets still adjusting to 2015’s turbulence, sectors such as housing as well as travel and tourism look like they’ll weather the storm to come out on top in the long run.


Global Markets Overview 2015

The year 2015 was a fairly mixed one for global equity markets.

While they followed an uptrend in the first half of the year, a series of upheavals in oil and commodity prices, coupled with China’s lowest GDP growth in 25 years, impacted investor sentiment significantly —resulting in a volatile second half.

On the other hand, the Eurozone witnessed modest growth due to fragile international trade, low domestic demand, and slower growth in emerging economies.

Confidence in the US economy surged as well as the much anticipated Fed rate hike finally materialized toward the end of 2015.

Here’s a recap of how the major indices in 2015 performed:

Index
Country
Return (YoY %)

S&P 500

USA

-0.7

FTSE 100

UK

-4.9

SSE

China

9.4

NIKKEI 225

Japan

9.0

DAX

Germany

9.5


The S&P 500 declined 0.7% for the year, its worst performance since the financial crisis in 2008 when it dropped nearly 40%. The Shanghai Composite advanced 9.4% after a year of tumultuous swings, while Japan’s Nikkei 225 rose 9.0% due to a stable Yen.

The year 2015 was a difficult one for FTSE 100, with the index losing 4.9%, marking its worst performance since 2011.

Here are the top five performing sectors of 2015, arranged in order of their weight:

FTSE 100 Performance Overview

Sector
Weight
Return (YoY %)
Oil & Gas Producers 12.7 -20.6
Banks 11.9 -12.7
Pharmaceuticals and Biotechnology 9.7 1.4
Tobacco 7.0 13.3
Insurance 6.4 3.7

The year 2015 saw major heavyweights in the index registering losses, with Oil & Gas losing the most.

Tobacco was the only one to generate healthy returns.


2016 — A Difficult Year Ahead?

The outlook for oil and commodity prices remains gloomy in 2016.

As per a recent World Bank report

, oil prices would average US$37 per barrel in 2016.

It also reduced the forecast of 37 out of the 46 commodities it monitored.

Iran entering the marketplace following the lifting of oil sanctions would result in a supply glut and more pressure on oil prices.

Moreover, weakening demand from China, one of the largest consumers of gas and all major commodities, would burden commodity prices.

The basic resource sector does not look promising in 2016.

The US Fed’s decision to increase its benchmark rates in December was initially well received, with major indices registering upswings after the news. The global economy had other plans though, and a series of fluxes and a general slowdown did not bode well with the Fed’s decision.

The US GDP grew slower than expected at 0.7% in Q4 2015 vis-à-vis the 2.0% growth recorded in Q3 2015.
The slowdown was not restricted to just the US either.

Asia’s powerhouses — China and Japan — had a terrible start to the New Year

China’s momentum in the manufacturing sector is still declining, with its official PMI displaying a contraction for 11 consecutive months.

Japan on the other hand continues to grapple with low inflation, with the Bank of Japan making an effort to curtail it through a policy of negative interest rates. Japan’s GDP contracted 1.4% in Q4 2015 after increasing 1.3% in Q3 2015, while the economy expanded a mere 0.4% in FY 2015.

The Eurozone is feeling a chill from the global slowdown as well. The European Central Bank has had to intervene with additional stimulus to boost the economy time and again. In addition, the European Central Bank (ECB) continues to struggle with low inflation.

While 2016 doesn’t look like a good year for economies across the globe, the UK is likely to fare better than other economies.

Although the British economy didn’t come out of 2015 unscathed, the growth in domestic demand remains strong due to low oil prices. The services sector continues to drive the country’s economy as well, contributing 79% to its total GDP.

Consumer spending in the UK has grown about 2.5% over the last three years, mainly due to a rise in jobs growth and a drop in the savings rate. This was further bolstered by an increase in consumer confidence and borrowing. We expect the trend to continue, helped by near zero inflation rates, which would boost income growth and help maintain low mortgage rates.

Business sentiment is likely to remain strong in 2016 as well, boosted by cuts in corporation tax rates. Although growth will likely be sluggish as compared to previous years on account of risks related to China and other emerging markets (and continuing uncertainties in Greece and the Middle East) it is expected to follow a slow and steady pace in 2016.

Amidst the prevalent volatile conditions, dividend yielding stocks are your best bet for stability and steady revenue.

Firms with long track records of paying dividends tend to have share prices that are less volatile than others in challenging trading situations. In general, most companies that pay high dividends are quite mature, with substantial cash flows and good prospects. In addition, dividend yielding stocks help narrow losses on investments, as a portion of it is covered by dividends.

With this background and framework in mind, here are our picks of sectors that are expected to perform well in the UK over 2016.


Home Construction

The house building & construction sector is currently booming in the UK.

The sector is well supported by several government initiatives, including Help to Buy and Starters Home.

The ‘Help to Buy’ scheme allows purchasers to borrow up to 20% of their purchase price — interest free — for the initial years, with a minimum deposit of 5%. The ‘Starters Home’ initiative aims to make 100,000 newly built homes available for first-time buyers under the age of 40, with a discount of at least 20% on the property’s value. Britain's Chancellor George Osborne also announced an investment of £7bn for house building, with the ultimate aim of creating 400,000 new homes.

Rising disposable income among UK households is another positive for the sector.

Moreover, mortgage rates are currently at record lows, and they’re expected to hold steady in 2016, with a hike in interest rates unlikely.

Here are the top five FTSE 100 constituents in this sector, arranged in order of dividend yields:

Stocks
Dividend Yield
P/E
Taylor Wimpey 5.8 11.7

Barratt Developments

5.4 10.5

Berkeley Group Holdings

5.1 9.4

Persimmon

5.0 11.7

Reckitt Benckiser

2.1 24.3

Among the above stocks, the best pick is Taylor Wimpey, which has the highest dividend yield of 5.8 and lower P/E than the average P/E of 13.5 of the group.


Taylor Wimpey

Taylor Wimpey is one of the largest UK-based house building companies. The company has a market cap of £6.1bn and posted revenues of £2.7bn in FY 2014.

As per the latest trading updates, Taylor Wimpey delivered strong performance in FY 2015, led by a rise in house completions and an increase in average selling prices. The company expects its operating margin to be more than 20% (2014: 17.9%) and return on operating assets to be over 25% (2014: 22.5%).

Taylor boasts of a healthy balance sheet, with £225m in cash as on 31 December 2015. The company began 2016 with a record order book of £1,779m.

We believe Taylor Wimpey would generate lucrative returns in the long run, well aided by the improving macro-economic conditions and supportive government schemes.


Barratt Developments

Another top pick in the segment is Barratt Developments, which has a market cap of £5.9bn and generated revenues of £3.8bn as of 30th June 2015.

The company displayed drastic improvement in the six months leading up to December 2015, with a 20% y-o-y increase in forward sales and a 9.4% rise in total completions.

Barratt Developments has set a target to achieve a minimum gross margin of 20% and minimum return on capital employed of 25% by FY17 vis-à-vis 19% and 23.9% in FY15, respectively.

Additionally, the company remains committed to shareholders and plans to return £667m to them by November 2017.

The company’s performance is certainly indicative of its bright prospects.


Travel & Leisure

2015’s slump in oil prices was a boon to the airline and travel industry.

Cheaper fuel allowed airlines to increase their coverage, and the low prices are expected to hold true throughout 2016, which also bodes well for these firms.

In addition, unemployment in the UK for the three months leading up to November 2015 stood at 5.1% — its lowest since October 2005.

With wages rising in the UK, the introduction of a National Living Wage scheme in April 2016 would only be a shot in the arm for consumer spending.

Interest rates are also at record lows, and they’re unlikely to increase given the low inflation scenario and current global slowdown. In addition, the consumer price index (CPI) is currently hovering around the 0% mark.

All these factors are likely to stimulate consumer spending.

Here are the top five FTSE 100 stocks in this sector, arranged in order of their dividend yields:

Stocks
Dividend Yield
P/E
EasyJet 3.7 10.2
International Consolidated Airlines 2.9 8.6
Compass Group 2.7 19.2
Intercontinental Hotels 2.3 20.6
Whitbread 2.3 16.9
Carnival 2.2 14.7
Merlin Entertainments 1.6 22.2


EasyJet

The UK’s largest airline (in terms of passengers carried) is your best bet.
It has the highest dividend yield and a lower P/E than most of its peers.

The company has consistently delivered solid performance in 2015, with a record number of passengers and load factors for the month of August 2015. EasyJet has a clear strategy of easy and affordable travel at lowest prices. The company delivered strong performance last year, with improved revenues and higher margins.

EasyJet’s solid cash position paved way for a 21.6% higher dividend last year, amounting to £219m.

The airline has leveraged the low oil price environment by launching strategic routes, including Vienna and Basel, which would result in a higher number of passengers carried annually.

If the company’s progress in 2015 is anything to go by, we expect it to continue its strong performance in 2016, augmented by positive macro-economic conditions.


International Consolidated Airlines (IAG)

Another pick from this segment is International Consolidated Airlines (IAG), the third largest airline in Europe in terms of revenue.

The company was formed in January of 2011 following the merger of British Airways and Iberia, the flag carrier airlines of the UK and Spain, respectively. Since then, IAG has made a series of acquisitions to expand its fleet size and presence across geographies. Its most recent acquisition was the Aer Lingus Group, which contributed €45m to IAG’s operating profits since its merger.

The company consistently reported an increase in passenger unit revenue and load factors over 2015.

As per the recently declared results for the first nine months of 2015, IAG recorded a jump in revenues and pre-tax profits. The company remains well supported by persistently low oil prices, which have boosted IAG’s operating margins and free cash flow. Capitalising on its healthy balance sheet and strong performance in the first nine months of 2015, IAG announced the first dividend payment to its shareholders this year.

Going forward, IAG plans to add eight Airbus Group SE A350 long-range jets to Iberia in order to augment an aging fleet. They’re also slated to add five A330 wide-bodied aircraft to increase the capacity of the Spanish carrier. In view of the positive prospects, the management made a material upgrade to its long-term (2016–20) financial targets as well.

IAG is well placed to maintain its earnings growth momentum, benefiting from the positive demand scenario and acquisition synergies. It’s a definite Buy.


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