The UK Value All–Stars

10/14/2009 10:58 am EST

Focus: GLOBAL

Peter Shearlock

Editor, Growth Company Investor

The Cable & Wireless telecom group and currency printer De La Rue deliver generous payouts from fundamentally strong businesses, writes Peter Shearlock in The IRS Report.

So far this year, value stocks have taken a back seat as investors have piled into [riskier alternatives]. But this is not a time to lose faith in the value philosophy. Given the prospect of a low-growth, low-inflation era ahead of us, value stocks—inherently more defensive than momentum stocks—should prosper.

So, where is value to be found now? I have picked out four shares I believe show excellent value.

Shares in the telecoms group Cable & Wireless (LSE: CW) sailed through last year’s bear market, but have lagged this year’s rally. They now sell for barely ten times anticipated earnings for 2009-10 and offer a yield of 5.8%. This is despite continuing growth in the international businesses and a move into positive cash in the corporate services business, now called “Worldwide.” C&W has little debt.

The key to the share price lies in the long-mooted plan to split the business in two with separate listings, gear up debt levels, and use the money to buy back shares. One or other of those businesses would then look a likely takeover target.

De La Rue (LSE: DLAR) shares have also gone sideways for much of the past two years. The banknote and identity systems maker recently won a ten-year contract to produce the UK’s new biometric passports and has extended its exclusive deal to print the UK’s paper currency. The company throws off cash at a prodigious rate and is not shy of handing it back to shareholders.

De La Rue, [which] lifted earnings by 37% last year, is one of Britain’s best companies, with good management, little debt, and good earnings visibility.

CD and book retailer HMV (LSE: HMV) has been transformed since Simon Fox took over as chief executive two years ago. He is battling the decline in the company’s markets with new store formats, a move into preplayed games and the wider entertainment market, and a central book hub for Waterstone’s.

The strategy is paying dividends in the UK, but the company’s Canadian operation is still losing sales and is a drag on profits. However, this is all allowed for in the current price. After a recent sell-off, HMV is selling for about eight times anticipated 2009-10 earnings and offers a sustainable yield [of 7.1%].

Legal & General (LSE: LGEN) shares have come up by a half in the past three months but still look undervalued. The life assurer has big holdings of corporate bonds which have rallied well of late. It also has a big exposure to UK commercial property, where prices are probably now bottoming out.

The recent half-year figures [showed] net cash flow to £302m, which compared with £320m for the whole of last year. L&G is writing new business on a very selective basis and being tougher on claims. After rebasing the dividend, the current [3.6% yield] looks positive.

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