Defensives, DS Smith and Ted Baker

Thursday, December 6, 2018 - 09:49

“Investors are back in risk-off mode with markets falling in the UK, mainland Europe and across Asia. Markets are worried by numerous things: global economic growth, rising interest rates and the US/China trade war.

“The latter is certainly centre stage in today’s sell-off after Canadian authorities arrested the finance chief of Chinese tech firm Huawei, who now faces extradition to the US. Investors may fear this will stir up tensions between China and the US,” says Russ Mould, investment director at AJ Bell.

FTSE 100: Defensives in fashion

“The FTSE 100 was down 1.2% to 6,838 in early trading on Thursday with only five stocks showing share price gains: Imperial Brands, British American Tobacco, Diageo, Severn Trent and National Grid.

“All these are considered to be defensive stocks, offering goods and services people would buy regardless of economic conditions. Diageo is perhaps an exception as an alcohol seller yet investors often turn to large, robust business in times of strife. That may also explain why Unilever and Compass declined much less than the broader market.

“The fallers were led by mining stocks which are always sensitive to any fears over the global economy and China. Betting companies GVC and Paddy Power Betfair were also down on news that gambling firms had agreed to stop advertising during live sport broadcasts. Investors are clearly betting that earnings will be hit.”

DS Smith

“On paper, it is hard to find any major faults with DS Smith’s results. There is growth in first half adjusted operating profit, dividends and return on sales. Market demand remains strong for packaging to service the e-commerce boom.

“So why has its share price fallen on the results? There are three potential reasons. The first is that higher polymer prices have hurt profitability in its plastics division, which has now been put up for sale. Second, investors in general seem to be increasingly worried about the pace of global economic growth.

“DS Smith is highly leveraged to global economic activity and any slowdown in spending by consumers and businesses could have negative consequences for packaging demand.

“That leads us on to the third reason. Corrugated box volume growth has actually slowed down in the half-year period, rising by 3.2% versus 5.2% growth reported in its previous full financial year. This may have spooked investors and led them to fear that DS Smith’s purple patch is coming to an end.”

Ted Baker

“Now is not the time for outside distractions, a weak consumer backdrop, depressed high street and the uncertainty created by Brexit – all of which means that management at British brand Ted Baker really need to be focused on the day job.

“Therefore a probe into the conduct of chief executive and founder Ray Kelvin is really the last thing the company needs.

“It also reveals the risks of having one person so central to the fortunes of a business. Mr Kelvin is the creative driving force behind Ted Baker and if he is forced to step down, investors might fear a similar fate to Superdry which has struggled badly since the departure of its own founder Julian Dunkerton.

“A fall in revenue in the third quarter is hardly an encouraging sign and even if trading has improved of late, there is no explicit guidance on the profit outlook and this lack of visibility might spook the market.

“Ted Baker does have some inherent strengths which leave it better placed than some consumer-facing firms would be to face the current challenges.

“It is a strong brand backed by good infrastructure and a smart approach to advertising centred on digital and social media. It also has a good understanding of its customer and the products they want. It might need all of these attributes to get through what is likely to be a turbulent period.”

These articles are for information purposes only and are not a personal recommendation or advice.

The daily market update is written by Russ Mould, AJ Bell’s Investment Director and his team. The article highlights the movement in the main index, winners and losers on the day and any macro-economic announcements.