Citigroup Sees Value Case for `Unloved and De-Rated' U.K. Stocks

(Bloomberg) -- Equity bargain hunters can find an ideal playground in the U.K., according to Citigroup Inc. strategists.

Citigroup expects returns in excess of 10 percent from British stocks through the end of the year, barring a Brexit-related or global shock that stifles growth. The FTSE 100 Index trails other major European equity benchmarks this year, down about 9 percent versus the Euro Stoxx 50 Index’s decline of 5 percent.

“Uncertainty, coupled with extended concern over U.K. domestic politics, appears to have oiled the U.K. equity market’s de-rating: we think this presents opportunity,” strategists including Jonathan Stubbs wrote in a note.

Proof that British stocks have become incredibly cheap abounds. A measure of the market’s dividend yield relative to bond yields shows U.K. equities have only been cheaper twice in the last century, and that’s during the two world wars, Citi found. International investors have stayed away, yanking money from U.K. stocks in five out of the past six years, with heavy outflows in the past two, the bank said, citing EPFR Global data.

Citigroup Sees Value Case for `Unloved and De-Rated' U.K. Stocks

Many investors aren’t biting, saying the market is cheap for a reason. Most equity strategists see the relative weakness of U.K. stocks continuing, predicting less upside for the FTSE 100 than for euro-area peers through end-2018, data compiled by Bloomberg show.

Citi sees three ways to take advantage of the low valuations: invest in strong domestic stocks like Ocado Group Plc or Just Eat Plc, small and mid-caps like Dixons Carphone Plc and Pagegroup Plc or attractive consumer stocks such as ITV Plc or Merlin Entertainments Plc. The bank’s list of its “top six” U.K. stocks includes AstraZeneca Plc, Aviva Plc, Ferguson Plc, Rio Tinto Plc, Standard Chartered Plc and WPP Plc.

Citi’s strategists are still lowering their end-2018 FTSE 100 target to 7700, based partly on their projection of annualized profit growth of between 5 and 10 percent.

“Recent price action is posing clear questions of the extension of this cycle; both global growth and UK Plc’s ability to grow dividends,” the strategists wrote. ”We think the cycle extends on both counts, although monitor risks carefully. We see most recent price action as an opportunity for investors to pick up stocks more cheaply.”

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