With both prices and taxes rising, it’s more important than ever to make our savings and investments work harder. ISAs can help: you can use a Stocks and Shares ISA to shelter up to £20,000 from UK income and capital gains tax.
Bond yields and interest rates are considerably higher than in recent years. This means equities are facing more competition. But over the long term, stocks have tended to outperform other asset classes. Although past performance is no guarantee of future performance.
Please remember investing in individual shares isn’t right for everyone. That's because it's higher risk, your investment depends on the fate of that company. If that company fails, you risk losing your whole investment. If you cannot afford to lose your investment, investing in a single company might not be right for you. You should make sure you understand the companies you're investing in and their specific risks. Make sure any new investment forms part of a diversified portfolio.
This isn’t personal advice or a recommendation to buy, sell, or hold any investment. Share prices can go down as well as up in value and there’s always a risk you could get back less than you invest. Yields are variable and income is not guaranteed. If you’re not sure what to do, please seek advice.
Information correct as at 27 February 2023 unless otherwise stated.
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ASML - Feeding the world with chips
Netherlands based ASML is a market leader in lithography machines used to make semiconductor chips. Without these, you wouldn’t have the chips that power the latest phones, computers or even cars.
ASML is the sole producer of the most advanced type of lithography machines, called Extreme Ultraviolet (EUV) lithography. It took over two decades to research, develop and commercialise the technology involved in EUV – which is now a very deep moat for any competitor to try and breach.
Whilst the global semiconductor market is forecast to double by 2029, it’s going through a rough patch currently. That’s why being the sole supplier of EUV machines has its perks. A €40.4bn sales backlog far exceeds its 2022 revenue of €21.2bn. Management expect 2023 sales to grow by more than 25% because of this, providing a high degree of revenue visibility which helps prop up prices and margins, allowing the company to focus on innovation.
Global Semiconductor Market Size
There’s also the services side of things, a recurring revenue stream which makes up around 25% of annual sales. This includes upgrading or fixing machines. The more machines sold, the more recurring revenue stream ASML receives, making that portion of revenue extremely robust.
But it’s not all blue skies. Potential stumbling blocks lie in the sheer logistical task it takes to assemble an EUV machine, which comprises of over 100,000 different parts. The lack of just one part could cause bottlenecks in the manufacturing process, hampering timelines and potentially hurting profits.
Overall, we think ASML’s market position and order book makes its earning power extremely robust, even in the face of a recession. But this is accounted for with the group trading well above its long-term average. While the price is likely be justified if targets are hit, there’s a lot of expectation on its shoulders. Failing to deliver could punish the valuation.
British American Tobacco - Cash king
Cigarette volumes have been in decline for over a decade. As consumers become more health conscious, that’s likely to continue. British American Tobacco is proving to be adept at navigating a tricky environment. Strong branding and a firm handle on costs is behind impressive stability in revenues and profits.But it’s cash flow that really pays for things, and BATS has that in abundance. BATS has been a consistently high cash generator for years with cash flows from operations actually exceeding underlying operating profit for the last four years. That’s helped by the company’s disciplined approach to pricing, which has kept underlying operating margins in the mid-forties.Paying down the debt pile is becoming a bigger priority at Board level. That's behind the decision to pause the share buyback programme. BATS' cash flows still leave room for dividends, and the track record here is formidable. It paid out nearly £5bn in dividends last year and analysts are expecting a modest increase in 2023. Remember though, no returns are ever guaranteed.New products are the main future growth prospects. BATS has 3 global, market leading, brands in categories like e-vapour and heated tobacco. The division is loss making, but profits are expected to start in 2025.
Revenue from non-combustible products
There are social risks associated with investing in tobacco, not least that the sector is excluded from some institutional products. That restricts the number of funds that can invest in the shares, which can put downward pressure on the valuation. The risk of regulators cracking down on new products is also worth being aware of.
BATS trades on a valuation some way below its longer-term average. A re-rate looks unlikely given the declining volumes in traditional tobacco – still the core performance driver. Instead, the investment case lies on strong cash generation and an attractive prospective dividend yield of 7.8% (variable and not a reliable indicator of future income).
A member of the Share Research Team holds shares in British American Tobacco plc.
Bunzl - Acquisition machine
Bunzl’s unlikely to make any headlines, in fact you may have never heard the name. It’s essentially a mashup of distribution businesses, around 150 in fact, which source and deliver a range of essential products. There’s nothing fancy about the products on offer, think food packaging and safety equipment. But that’s what we like about the business. These are products businesses can’t go without.
Part of the models’ attraction is it allows each business to use local knowledge of customers and suppliers to offer bespoke services.
Growth won’t shoot the lights out, but it’s been consistent for a long time. Both revenue and underlying operating profit have grown at an annualised rate of 9% going back to 2004. Of course, there’s no guarantee that continues.
Organic growth in recent times has been driven largely by higher prices, and that’s expected to keep operating margins within the longer-term trend of mid-high single digits – no mean feat in the current environment.
Bunzl is a merger and acquisitions (M&A) machine. Two thirds of the revenue growth over the last 10 years has been a result of acquisitions, with the group bringing on 12 new businesses over 2022 for a total cost of £322m.
M&A-led strategies have their drawbacks. If the pool of target companies dries up or a business needs to raise external cash to fund acquisitions, then it’s not usually sustainable. Bunzl’s got the latter covered though. Acquisitions have been backed up by operating cash flow and the balance sheet’s in a strong position too.
Cash Generation and Spend (£ millions)
A track record of doing well during tough times and steady growth are attractive qualities as economic uncertainty lingers. That hasn’t gone unnoticed though, with the group trading on a valuation that’s ahead of the wider sector.
Caterpillar - Helping build the future
Caterpillar is a juggernaut in the world of heavy machinery and vehicles, with 2022 revenue up 17% at $59.4bn. Three key pillars underpin the business model: Construction Industries, Resource Industries and Energy & Transportation.
The first two are what you’d expect, machinery to help build infrastructure projects and aid miners in digging things out of the ground. The final segment helps support businesses with their energy needs, ranging from diesel engines to solar power units.
We can find positives in all three. Infrastructure spend has several tailwinds, from government-related investment in the US to the potential for a Chinese reopening to stoke Asian demand. For mining equipment, commodity prices have come down, but remain high enough for continued investment. Longer term, we see increased demand for materials that help support the global energy transition.
In Energy & Transportation, demand for oil & gas related products is likely to slow but orders have remained robust. It’s in the more environmentally friendly offerings that we see potential, innovations like green hydrogen generators can help end customers meet their climate related objectives.
Running across all three segments is the services offering, where Caterpillar offers repairs and upgrades throughout its products’ life cycles. This helps support revenue streams and is an offering that’s going from strength to strength.
Services Revenue ($bn)
The capital structure is heavy on debt, which adds risk. But it’s been consistent, which is typically a good sign. Not to mention, free cash flow came in at $5.8bn from the major units last year and operating profit covered interest by 9.8 times. So, there’s no immediate concern. Another thing to keep in mind is that the valuation has had a 28% uplift in the last 12 months so the market has set a high bar.
All in, Caterpillar offers indirect exposure to a range of end markets where we see several growth drivers and the valuation sits a little below the longer-term average. But investors should remember, the group would be exposed to an unexpectedly bad economic downturn.
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LVMH - Luxury margins on offer
LVMH is the result of a merger between Louis Vuitton and Moet Hennessy in 1987. It wasn’t just hair that was big in those days, so was Bernard Arnault’s vision for the group. He owns 48% of LVMH and has been CEO for the best part of five decades. He’s overseen LVMH’s ascent to the top of the luxury pile. Other brands within the LVMH umbrella include Christian Dior, Celine, Tiffany & Co, Bvlgari and about 70 others across five business divisions.
LVMH organic revenue growth by business area 2022
LVMH lives by the motto “passionate about creativity”. But we think the shares deserve consideration for a place in an ISA because of a different passion. Margins. At around 27%, operating margins are very comfortable. That leaves room for the group to stomach ups and downs and feeds into a healthy free cash flow - expected to reach EUR16.0bn this year.
LVMH’s revenue and profits are more reliable than other businesses because of its customer base. High net worth individuals aren’t as sensitive to economic difficulties. And a best-in-class creative team means LVMH can continue putting eye-watering price tags on its items.
Looking to the long-term, which is a sensible way to approach investing in an ISA, we think LVMH’s stable of brands and adept management gives it the ability to perform. The reopening of China also bodes well as a growth lever at the group’s disposal. Not only from spending within Asia, but from tourists who travel and spend in Europe.
The shares trade on a forward price to earnings ratio of 24.9, which is slightly above the long-term average. That is a mark of confidence from the market but increases the risks of ups and downs should any missteps occur.
It’s possible to hold these shares in our Stocks and Shares ISA, as well as our Lifetime ISA and Junior ISA.