Get ready for some major changes to the UK’s leading stock market benchmark
Thursday 23 Sep 2021 Author: Tom Sieber

The FTSE 100 is poised for some significant changes in the coming 12 months such as the removal of BHP (BHP) from the index and GlaxoSmithKline (GSK) splitting into two businesses.

The importance of sectors like resources, pharmaceuticals and insurance is likely to be reduced with consumer goods and banks potentially enjoying an increased weighting.

Over time structural changes in the economy and different industries are likely to lead to even more dramatic shifts in the index with these short, medium and long-term changes altering the factors which drive the market and how UK stocks are perceived on a global basis.

In this article we look at how the UK’s flagship index has metamorphosed over time, how it is set to change in the next year and what might happen further down the line.

WHY DOES IT MATTER?

The reason changes to the complexion of the FTSE 100 should matter to investors is two-fold. First, the make-up of the index determines which sectors drive it and therefore the performance of the widely held tracker funds and ETFs (exchange-traded funds) which mirror its performance.

Second, it has an impact on how the world views UK stocks. As the chart shows, the FTSE 100 has dramatically underperformed most of its global peers over the past decade and until recently international investors have shunned the UK market.

The Brexit vote in June 2016 didn’t help but UK stocks also have a reputation of being centred around the so-called ‘old economy’ and sectors like oil, mining and banks.

This is unfair, even looking at the current weighting it’s clear that the influence of these industries has diminished significantly over the past decade and this trend is likely to continue in the future.

After all, the FTSE 250, which unlike the FTSE 100 recently attained new record highs, is a more diverse collection of businesses and this is the pool from which the FTSE 100 firms of the future will be drawn.

Oil producer Royal Dutch Shell (RDSB) has two classes of share – A and B – but our table shows their combined weighting. While BHP and its mining peer Rio Tinto (RIO) are among the largest companies by market value, their weight in the index is reduced somewhat by their dual-listed company structure, with only the UK shares counting towards it.



The table showing what the FTSE 100 could look like in 12 months’ time is an indicative example based on currently planned corporate actions and potential new entrants. It does not account for movements in share prices.


The expert’s view

By Simon Gergel, portfolio manager at Merchants Trust (MRCH)

‘The composition of the UK stock market index has always been changing and to some extent mirrors changes in the broader economy.

‘In the 19th century railroad companies were a large part of the market. When I started my career in the 1980s there were still a few large textile companies and many retailers.

‘We are seeing, at this time, quite a rapid shift into asset light, technology and services businesses from typically asset heavy manufacturing and distribution businesses.

‘This is partly due to the polarisation of the UK and other stock markets, which is rewarding higher growth businesses with higher valuations, but also due to numerous takeovers of UK listed companies such as food retailers and aerospace and defence companies (although if these are simply becoming subsidiaries of overseas-listed companies they remain part of another stock market index).

‘At the same time, we are seeing IPOs of technology-oriented companies like THG (THG), which helps brands sell online, and fintechs like Wise (WISE).’

It is worth noting that THG and Wise are big enough to be FTSE 100 stocks, but they don’t qualify for the indices due to have the wrong type of stock market listing (standard versus premium). 


FTSE 100 CHANGE OVER THE YEARS

Like any index, the FTSE 100 has evolved over its lifetime as companies have come and gone. Some members have been acquired by other UK firms and rolled up into a conglomerate, which has then become a constitute of the FTSE 100 itself, but a great many have been acquired by foreign buyers.

A good example of the latter would be Allied-Lyons, an original FTSE member at the launch of the index in 1984, itself the result of a merger between Allied Breweries and J Lyons & Co.

Following a subsequent merger with a Spanish sherry producer in the 1990s, the firm became Allied Domecq, until in 2005 it was bought by a consortium comprising French drinks maker Pernod-Ricard and Fortune Brands of the US.

Yet despite the disappearance of Allied-Lyons and other original FTSE 100 members such as Bass, Northern Foods, Rowntree Mackintosh and United Biscuits, consumer goods still make up 17.9% of the index thanks in part to top-10 weightings for British American Tobacco (BATS), Diageo (DGE) and Unilever (ULVR).

The biggest change in the index since inception has been the rise of the raw materials sector. From less than 5% originally, the sector has exploded to a 10% weighting.

When the FTSE was launched, the only mining stock in the materials sector was Consolidated Gold Fields, with the rest of the sector made up of building materials, chemicals, glass and pulp and paper.

Today, following the explosion in demand for basic materials from China during the first decade of this century, there are some very big names in the FTSE from this sector, namely Anglo American (AAL), BHP, Glencore (GLEN) and Rio Tinto (RIO).

With a new wave of infrastructure spending sweeping the globe, and the US, the UK, Europe and Asia competing for resources, commodity prices are rocketing which simply serves to reinforce the miners’ large position in the index, albeit that will be weakened when BHP leaves the FTSE 100 next year, subject to shareholder vote.

In contrast, the worldwide shift towards alternative energy production in the last decade has seen oil prices fall, and as a result the size of the oil sector has shrunk as part of the FTSE from over 15% at the start of the century to just over 9% today.

FTSE 100 CHANGES COMING SOON

BHP set to leave the FTSE 100… but its shares will still trade on the UK market

Not too long ago mining giant BHP was the largest company in the FTSE 100. Now the company is due to exit the index as it drops its dual-listed company structure, likely in the first half of 2022.

BHP’s dual-listed structure was formed in 2001 when Australia’s BHP and the Anglo-South African Billiton agreed to operate as a combined entity without a formal merger, seemingly due to tax advantages.

Next year, assuming BHP shareholders approve the miner’s plans to change its listing structure, the company will still list its shares on the London Stock Exchange – but importantly, they will no longer qualify for the FTSE indices and therefore it will lose its place in the FTSE 100. The primary listing for the business will be in Austraila.

BHP’s main motivation seems to be making it easier to pursue deals with a share-based element and to restructure other parts of the business as it prepares to exit its oil and gas assets.

Breaking up GlaxoSmithKline

GlaxoSmithKline plans to demerge at least 80% of its consumer healthcare division around the middle of 2022 as it seeks to appease shareholder criticism and unlock the potential to deliver stronger shareholder returns. The firm owns 68% of the division, with joint venture partner Pfizer owning the rest.

The as yet unnamed consumer division is the world’s largest global consumer healthcare company with each of its top 20 power brands generating over £100 million in annual revenues.

Its revenues last year were around £9.5 billion, and it achieved an operating margin of 22%, which implies operating profit of £2.1 billion. Revenues have grown around 10% a year over the last five years.

We can only speculate on the future market cap of the business and given its profitability and growth profile it could attract a market value of between £25 billion and £30 billion, (12 to 14 times operating profit) which would make it roughly the same size as Barclays (BARC).

GlaxoSmithKline is the eighth largest constituent of the FTSE 100 index with a market value of £71.2 billion and a weight of 3.6%. The company’s value accounts for roughly a third of the pharma sector which itself is 11% of the FTSE.

Post demerger, GlaxoSmithKline’s market cap will fall by approximately 40% to £41 billion, reducing the weighting of pharma within the FTSE 100 index. Conversely the demerged consumer healthcare company will boost the weighting of the consumer sector.

Morrisons has just returned to the FTSE 100… but may soon leave for good

Shares in supermarket chain Morrisons (MRW) have been buoyed by a private equity bidding war which has pushed the share price up by 63% since June.

Fellow retailer Sainsbury’s (SBRY) has long been touted as a takeover target and on 23 August the shares jumped 12% on market chatter that it was being lined up for a £7 billion offer from private equity.

If the two grocers were both taken private, it would leave market leader Tesco (TSCO) as the only traditional UK supermarket left on the London Stock Exchange. Asda is privately owned by the Issa Brothers who bought the company from US retail giant Walmart last year.

When we asked Fidelity fund manager Leigh Himsworth about the possible implications for the grocery market, he told Shares that it might be a positive for Tesco because the new owners of Morrisons and Sainsbury’s if it also gets taken over would be temporarily distracted by bedding down the acquisitions.

Himsworth doesn’t think the rationale for buying food retailers stands up from an operating perspective because UK grocery is already efficient. It’s more likely that private equity is interested in the strong cash generation of the sector and asset backing.

Prudential is spinning off its US operations… and they will not be listed on the London Stock Exchange

As Shares went to press, insurer Prudential (PRU)was putting the finishing touches to demerging its long held US annuities business Jackson Life with qualifying Prudential shareholders receiving one new US-listed Jackson share for every 40 Prudential shares they own.

After last year spinning off M&G (MNG), Prudential’s core business going forward will be tied to the fortunes of Asia’s economies with Hong Kong being its largest business, representing 39% of annual net premiums.

With a market cap of £38.7 billion, Prudential weighs in at 2% of the FTSE. The financial sector makes up 18.2% of the index according to Refinitiv and Prudential is the second largest company in the sector. 

Analysts believe that the discount at which Prudential trades compared with peers will narrow once it becomes a pure Asian play.

Fidelity’s Himsworth believes it might even make sense for the company to only be listed in Asia which would reduce the weighting of financials in the FTSE 100 even further.

Who else might leave the FTSE 100 or spin off major assets?

AXA Investment Managers’ large caps expert Jamie Forbes-Wilson says the market has given some consideration to the possibility that Reckitt Benckiser (RKT) could do a deal with GlaxoSmithKline’s soon-to-be demerged consumer healthcare division.

Plumbing and heating products distributor Ferguson (FERG) sold its UK subsidiary to focus on North America and had been a prime candidate to move its listing from London to the US. However, this now looks unlikely given the decision to dual list in New York. This means it will retain its premium listing on the London Stock Exchange and its inclusion in the FTSE 100 index.

Ed Legget, manager of the Artemis UK Select Fund (B2PLJG0), says there’s a wall of money looking to invest in real-returning infrastructure assets with low volatility. ‘That creates an opportunity for companies you might consider to be conglomerates to divest and refocus. There are many companies that own assets that fit into a thematic that people like.’

Activist Elliott is calling for a break-up of utility SSE (SSE), which Legget says ‘could split off its gas infrastructure network business from its renewable energy assets’.

And if it weren’t for the drag of its pension commitments, then BT (BT.A) could ‘easily spin off its Openreach network, which is valued much higher by infrastructure funds than the market values telecoms generally,’ he says.

Glencore (GLEN) has positions in copper, nickel and cobalt, which are all essential for electric vehicles and these mining operations could be worth more if they weren’t part of a broader group that includes a commodities trading arm. ‘Pure copper companies are valued very highly, so splitting this part of the business off from its thermal coal business could also be advantageous,’ says Legget.

He also suggests Flutter Entertainment (FLTR) could list part of its US business, FanDuel, since peers in the US trade on much higher multiples. And perhaps in the medium term, BP (BP.) and Royal Dutch Shell (RDSB) might spin off their renewable energy/charging infrastructure businesses. ‘Oil assets could then be placed in run-off and run for cash,’ he explains.

FTSE 100 PROMOTION CANDIDATES


Wizz Air (WIZZ) £49.09
Market cap: £5.1 billion


Budget airline Wizz Air’s (WIZZ) ambitions were laid bare recently by a slightly cheeky all-share offer for troubled rival EasyJet (EZJ), if rumours are correct that it was the party behind the bid interest.

This approach may have been unceremoniously rebuffed, but the company’s growth trajectory is clear and underpinned by its focus on the Central and Eastern European travel market and helped by an ability to generate significant levels of stable and high margin ancillary revenue. These are the extras like luggage and seat selection fees. A plan to increase the fleet by 65% from the March 2020 level by 2024 should also power the kind of expansion necessary for a move into the FTSE 100.


DarkTrace (DARK) 794p
Market cap: £5.6 billion


A stunning share price performance since its April 2021 debut has seen the market valuation of cyber security firm Darktrace (DARK) more than treble.

While this suggests the stock market listing was priced to get away, with expected valuations slashed at the last minute amid concern over the company’s links to alleged fraudster Mike Lynch, the progress has been underpinned by consistent upward revisions to revenue guidance.

A push to the FTSE 100 looks highly feasible, backed by the group’s position in a fast-growing industry and its innovative approach based on artificial intelligence and machine learning.


Future (FUTR) £36.88
Market cap: £4.5 billion


Since CEO Zillah Byng-Thorne took the helm in April 2014, Future’s (FUTR) market valuation has gone from approximately £300 million to more than £4 billion.

The strategy has been based on acquiring undervalued publishing titles and integrating them on to a centralised platform. This enables Future to monetise the underlying specialist content and brands through a mixture of e-commerce, getting content users to click through to partnered retailers, events and online advertising.

The acquisition of comparison site GoCo in 2020 threw the market a bit of a curveball but any resulting weakness in the shares proved short-lived as Future’s model continued to deliver earnings upgrades.


Softcat (SCT) £22.20
Market cap: £4.4 billion


The appeal of IT expert Softcat (SCT) to customers is clear – it sells third party software to small and medium-sized businesses and public sector organisations along with hardware like PCs and smartphones. It then offers tech support and advice on top.

This removes the hassle for companies in managing several IT service and product relationships, and it’s an offering which is likely to be in greater demand given the digitalisation trend accelerated by Covid-19.

The business has a hard act to follow in the short term given the surge in new work won at the outset of the pandemic. But longer-term we think it is a plausible FTSE 100 candidate.


Spectris (SXS) £39.56
Market cap: £4.4 billion


Industrial controls, testing and analysis kit maker Spectris (SXS) has made significant strategic progress having unveiled a revamp of the business in 2019.

It has sold five non-core businesses, most recently with the August 2021 divestment of process measurement specialist NDC Technologies for £130 million.

Investment bank Berenberg says Spectris is now a higher-margin, less capital intensive and ‘more attractively positioned business’.

The focus is more skewed towards the healthcare sector with a strong balance sheet enabling bolt-on acquisitions. It has £1 billion of firepower without the need for additional financing, and scope for organic growth in margins and revenue.


Games Workshop (GAW) £111.50
Market cap: £3.6 billion


Fantasy miniatures firm Games Workshop (GAW) looks a longer shot for FTSE 100 inclusion but there is a case to be made for the company joining the ranks of the blue chips.

If it is to get there, the driver is likely to be royalty revenue as it commercialises the intellectual property associated with its Warhammer brand through video games as well as TV and films.

Such a revenue stream would be highly prized by the market given the stability and excellent returns associated with royalties. The company also benefits from its in-house manufacturing capability as well as a large and loyal fanbase for its products and invented worlds.

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