Defenders Assemble: Defensive investing in the FTSE250 – The Armchair Trader
With trouble at home and chaos overseas, the investment world needs a superhero – step forward these five defensive plays from the FTSE250. Defenders Assemble.
It’s not a fun time to be a new investor. Years of Covid-19 restrictions, a volatile geopolitical environment highlighted by the ongoing Russo-Ukraine war and public sector strikes, soaring commodity prices, interest rate hikes, contracting growth… The list of negative news seems quite exhaustive and depressing. Since the beginning of the year many portfolios have taken a pummelling, and some investors are ready to throw the towel in.
All economic news is pointing to a global recession next year and identifying growth in any sector of the economy is becoming a riddle worthy of a sphinx. It’s a natural human instinct to follow the herd and when everyone is clamouring for the lifeboats and throwing their meticulously nurtured portfolios into the sea, the reaction is to join the panic. Fear, anxiety and despair take hold and that drives many investors into selling rashly into a falling market.
However, market crashes and economic downturns are part of life, and like a squall on a sunny day can blow out of nowhere. But past experience has shown that investors that stayed the course and remained invested in hard times came out the other side in great shape. As the adage says: what goes up, must come down, and the reverse is true in that downturns are followed by upturns.
In fact, the coming months may provide a rare opportunity to accumulate good quality companies with excellent long-term prospects when prices are low. These opportunities aren’t available to investors who sell during market downturns, hoping to stem their losses and wait things out on the side-lines.
That said, now is not a time to be reckless. As always, investors need to have enough cash kept on balance to cover real-life eventualities – you shouldn’t be selling stock to pay the gas bill. Moreover, in a downturn some sectors are going to be eroded more than others and investors can protect their portfolio by selecting sectors and companies that will fare better than others in market downturns – hence the term ‘defensive stocks.’
What is defensive investing?
Defensive investing boils down to an analysis of needs versus wants. We may all want the latest flat screen television, or the luxury cruise. But we need to eat every day, keep our lights on, put petrol in the car to get us to work every day and keep a roof over our heads. It’s a bit like the weekly supermarket run, we’re going to need bread, milk, and toilet paper – but don’t necessarily need chocolate, a bottle of wine or smoked salmon.
So, to defensive sectors. Food producers need to keep producing food, especially at the basic end. We need to buy our food from somewhere, so supermarkets are another thing we cannot avoid. Coughs and colds will still affect people regardless of the economic situation, so we still need to buy medicine. We need water for sanitation and drinking, as too electricity, gas and in today’s economy, broadband. And to pay for this people still need a job, so in the service industry, recruitment companies are fairly recession-proof.
The FTSE 250 is a very diverse index. It contains some household names, is somewhat under-regarded in comparison to its larger peers, offers great value plays and the prospect of growth, and boasts strong liquidity. In this market looking for defensive stocks in the FTSE 250 might be a ‘super’ idea. Here are five ideas for FTSE 250 stocks that might make compelling defensive additions to your portfolio.
From its origins as a Newcastle bakery, Greggs has become staple on the high street, offering food-on-the-go, including baked goods, sandwiches and of course sausage rolls. Listing in 1984 it used the proceeds from its IPO to acquire bakeries across the country and establish itself on the high street. Shares peaked at 3,412p on 30th December 2021, before falling back and trading as low as 1,817p on 30th June 2022. Shares closed trading at 1,883.0p on 15th July and the stock has seen a YTD return of -43.57%.
However, Berenberg Bank reissued a “buy” rating and set a price target of 3,600p as recently as the end of March. In preliminary full-year results, the baker saw sales rise 5.5% to GBP 1.23bn compared to pre-pandemic levels. Accordingly, pre-tax profit rose to GBP 145.6m, a massive rebound when compared to its 2020 GBP 13.7m loss and 2019 GBP 108.3m profit.
Greggs is a classic defensive stock. It had a hard time when it had to shutter during the Covid-19 pandemic, and is still vulnerable to regulatory changes, such as the possible imposition of government-led obesity charges. That said, in terms of wants versus needs the public are likely to prioritise a cheap coffee, sticky bun or sausage roll over other expenditures in the coming year.
Pennon Group [LON:PNN]
A water infrastructure company headquartered in Exeter. It owns South West Water and serves around 1.7 million customers in Devon, Cornwall, Dorset and Somerset. It closed trading at 973p on 15th July and has had a YTD return of -16.6%. The company emerged in 1989 out of the privatisation of the water industry.
As with all water companies, it is vulnerable to regulatory risk. There is a limit set by government as to what water companies can charge their customers. Pennon also sold its recycling and waste business to KKR in July 2020 for GBP4.2bn, which although it was a welcome cash injection, did reduce the company’s diversification, leaving it more exposed to specific regulatory risk.
However, water is an essential commodity, and something everyone has no choice but to pay for. Pennon has had a good dividend track record, recently declaring a 26.83p dividend per share. Revenue has grown year-on-year for the past four years and Pennon has recorded consistent profit for the past four years as well. Pennon will benefit from a price rise in water each year in line with inflation and the retail price index here in the UK. As a result, Pennon should see performance and growth increase, unless regulation holes it below the water-line.
Closed trading at 474.6p on 15th July and has swung between 271.4p and 490.4p offering a YTD return of 48.13%. The Stellenbosch-headquartered, South African international private hospital group was founded in 1983 and provides private medical healthcare in in South Africa, Namibia, Switzerland and the United Arab Emirates. It is also listed on the JSE. Mediclinic also holds a 29.9% interest in Spire Healthcare, an LSE listed and UK-based private healthcare group. Obviously, the demand for healthcare during the Covid-19 pandemic – especially in South Africa – did the company no harm, and coronavirus still hasn’t gone away, so Mediclinic is well placed to benefit from further Covid-19 spikes. The downside though is that Mediclinic is about as defensive as you can get, so it has been popular and is possibly reaching the top end of its valuation.
Is another company in the medical sector, however it is a supplier of medical and laboratory equipment. Closing at 218.2p on 15th July, the Reading-based company supplies various medical disposables specifically in advanced wound care, ostomy, incontinence, and infusions. Its share price has been a bit more of a creeper than Mediclinic this year, ranging from 165.30p to 265.00p and offering a YTD return of 12.97%. The market likes it. At the beginning of the month Convatec received an average recommendation of “Hold” from the seven brokerages that are covering the firm, according to MarketBeat. Four out of the seven recommended a “Buy” rating with the average consensus share price target being 241.67p). Convatec isn’t a small fish – it has a market cap of more than GBP4.5bn. It has a fair bit of debt on its balance sheet, (north of GBP1bn as at year end 2021), but it should be able to handle this comfortably, even as interest rates rise. One possible risk is healthcare spending, however, the products it produces are fast turnover disposables which are always in demand to treat various conditions.
Pets at Home [LON:PETS]
A consumer affairs survey of 1,000 millennials taken earlier this year revealed that 57% of 25 to 42-year-olds love their pet more than their siblings. Half the respondents said they prefer their pet to their mum. The millennial generation would – apparently – prefer a dog or cat to having children and if their pet needed life-saving treatment and they couldn’t afford it they would take second jobs and sell their possessions.
Pet-ownership is truly inflation- and recession-proof, that’s why Pets-at-Home, the Handforth-headquartered pet supplies retailer makes a compelling case for investment in uncertain economic climates. Analysts, Peel Hunt and Berenberg Bank both have a “Buy” rating for the group. However, earlier this month RBC Capital Markets cut their rating on the retailer’s stock to “Underperform” from “Sector Perform,” meaning it thought the stock would start to lag behind some of its high street peers. RBC also lowered its price target to 280p per share from 330p.
Boasting more than 450 stores and 300 veterinary and grooming salons nationwide, PETS reported an underlying profit before tax of GBP144.7m for the 53-week period to 31 March representing 61.1% growth on the prior year. There have been some boardroom changes, which has impacted recent share price, but PETS is fairly insulated against inflation in that when pet owners are seeking veterinary or grooming services, they don’t shop around, they just buy what is on offer at the price advertised, and with its large retail footprint PETS is often a first port of call.
Analyst, Liberum said they: “continue to believe risks to Pets at Home should be relatively low in a downturn,” and the shares are supported by a “very healthy balance sheet, 7.2% free cash flow yield, 3.8% dividend yield and a return to double-digit profit growth [expected] in FY24E”.
PETS closed trading at 295.8p on 15th July trading in a range of 266.8p to 524.5p over 52-weeks offering a YTD return of -36.4%.
Staying in the game
It is hard to time the market, and to capture the best returns, it is advised to stay invested for the long-term. Buying the dip helps investors build up their portfolios on a lower cost basis. Having a long-term outlook, and backing companies because of their long-term fundamentals, as opposed to short-term volatility is often a strategy that wins out.
It’s a scary time. But removing emotion, bulking up on cheaper stocks and keeping your nerve will yield benefits when the market swings to recovery. Patience and discipline are the by-words to navigating the next twelve months.