Domestic UK stocks likely to lag cheaper international peers

Fri Apr 11, 2014 7:51am EDT

* Share rally in domestically focused UK companies to fade

* Global companies offer better value after missing out on rally

* Resources stocks expected to get dividend boost

By Atul Prakash

LONDON, April 11 (Reuters) - A year-long outperformance by domestically focused British stocks is likely to evaporate this year as investors switch to cheaper shares with more international exposure.

Shares in some companies that get most of their revenues in the domestic market have gained anywhere from 30 to 60 percent in the past 12 months. By comparison, the FTSE 100 index overall is only up about 5 percent.

Consequently, a basket of about 70 domestically focused UK companies now trade at 19 times 12-month forward earnings, against a 10-year average of 14 times earnings, according to Thomson Reuters Datastream.

Capita is trading at 17 times forward earnings, for example, compared with a long-term average of 15 times earnings. Marks & Spencer is at 13.2 times 12-month forward earnings; its long-term average is 11.5 times earnings. link.reuters.com/dux28v

"The UK domestic trade, which is focused on ways to exploit the UK consumption angle, has travelled a long way and the valuation support for the strategy has diminished," said Ian Richards, global head of equities strategy at Exane BNP Paribas. "We feel investors now need to employ alternative strategies."

Analysts said that investors who want to keep their money in London-listed stocks should switch to internationally focused companies. Overlooked during the domestic rally, they are now cheaper and offer higher dividend yield, which compares the size of the most recent payout with the share price.

Among them are defence contractor BAE Systems, food ingredients firm Tate & Lyle and mobile operator Vodafone, which generate 80 to 99 percent of their revenues outside Britain. They offer dividend yields of 4.1 to 5.0 percent compared with 3.6 percent for the FTSE 100.

"A broader search for value has been prompting investors to look at some internationally focused companies having better valuations and dividend yields compared to the domestic ones," said Keith Bowman, an equity analyst at Hargreaves Lansdown.

Resource companies are one internationally exposed sector with attractive valuations and potentially higher yields. With demand for commodities weakening, shareholders are pressuring them to cut back on capital spending and focus on returning cash to investors, analysts said.

Such companies include BP, which gets about 34 percent of its revenue from the United States. It raised its dividend by 5.6 percent after trimming capital spending plans. Royal Dutch Shell has promised to lower its spending as well. Each had spent an amount equal to about a third of its market capitalisation in 2013.

"Energy and materials are value opportunities. We do need a catalyst, but we believe we have one, with companies in the sectors starting to focus on better free cash flow and improving returns to shareholders," said Robert Parkes, an equity strategist at HSBC Securities.

"Domestically focused UK companies have had a strong run alongside the improving UK growth numbers. We expect the pace of gains to moderate going forward." (Graphics by Vikram Subhedar; Editing by Larry King)