Reckitt Benckiser – Buy

Please read our recommendation on Reckitt Benckiser, the world’s largest producer of household products which include Vanish, Harpic, Cillit Bang, Air Wick and Dettol amongst others.
This is a defensive stock that we feel is a core holding during the current economic environment. Trading on a prospective 13x P/E multiple, at the bottom end of its ten-year historical P/E range, we believe the current share price of 3191p represents an attractive entry point. Nomura has a 3900p price target. A prospective dividend yield of 3.9% is also an attractive proposition

Aviva – Buy

We feel the company has many catalysts that could see the share price rise substantially over the next twelve months. At just 415p, the stock is cheap trading on a forward P/E multiple of just 6.9x and at a substantial discount to its EEV of 487p per share. In the meantime, investors are rewarded with a well-covered yield of 6.2%. Option traders may want to look at the August 380 or 400 puts, trading at 4p and 9p respectively.

Core Defensive – Pharmaceuticals

With the market at its current level and entering the traditional lacklustre summer months, we are relatively cautious on shares in the short-term and are favouring defensive stocks in general given that:
1) their current outperformance is relatively modest;
2) seasonal trends come into play (defensive stocks tend to outperform in the summer months);
3) defensives remain under-owned;
4) long-term earnings expectations for defensives are at a record low relative to cyclicals;
5) defensives trade at long-term valuation lows versus cyclicals on a variety of valuation metrics;
6) macro newsflow is likely to weigh on risk appetite.
With this in mind, we are advising investors to add some exposure to pharmaceuticals. Post poor long-term performance, the sector offers good value and any USD strength associated with the end of QE2 should offer support.
Our pick of the UK sector is Astrazeneca (see research note attached), trading on a low 2011E p/e multiple of 6.9x and yielding 5.26%. We see Astrazeneca as having a better chance of outperforming expectations than sector peer GlaxoSmithKline where the return to sustainable growth looks factored into the City’s forecasts and the 40% 2012e p/e premium to Astrazeneca.
For those invested in GlaxoSmithKline, we would take advantage of Glaxo’s recent strong performance and use this as an opportunity to switch into a higher yielding and better performing stock. For option traders the Astrazeneca September 2800 puts look good value at 48p (note the stock will go XD in August by a similar amount).

Asian Citrus

Please read our complementary research on AIM listed Asian Citrus. Legendary investor Warren Buffett stresses the need to invest in simple businesses and it doesn’t come any simpler than growing oranges. Asian Citrus won “International Company of the Year” at the 2009 AIM awards by ticking all the right boxes with strong management, no debt, market-leading positions in two growing areas and a good distribution chain. Two directors of the company recently acquired a total of 522,000 shares at an average price of 72.801p, illustrating their confidence in the company.
Despite the risks of investing in a Chinese agricultural business (such as the weather and geopolitics), we believe this is an old economy stock in a growing sector, trading at an attractive price for the more adventurous investor.

Rockhopper Exploration

Rockhopper Exploration (“RKH”) is an AIM listed company involved in the exploration of oil & gas in the Falkland Islands. The company has licences to explore in the North Falklands Basin where it has discovered oil at its 100% owned Sea Lion prospect.

Goldman Sachs has just released a 640p PT valuing the Sea Lions P50 reserves (assuming volumes of 205m barrels and a 60% chance of success) at 360p per share, a 50% premium to the current share price. Thus, on top of this discount to NAV, the risked exploration portion of the portfolio is effectively in the share price for “free”. With potentially substantial exploration/appraisal activities, M&A attractions and the market not fully appreciating the value accretion of pushing Sea Lion to commerciality, Goldman’s view the risk/reward as attractive and have the stock on their Pan-Europe Conviction Buy List.

Dogs of the Dow

Please read a piece of research we have conducted on the well known “Dogs of the Dow” strategy. This has enjoyed a stellar performance since 1973 with an average annual return of 17.7%. Our recommendation from this year’s selection is RSA Insurance Group, currently trading on a sub 10x p/e ratio and yielding 7% (covered 1.8x).

British American Tobacco

Politically correct investors, look away now. Cigarettes are bad for your health, but if you’re a shareholder in British American Tobacco (“BAT”), they’ve certainly not been bad for your wallet. Investing in addiction is a proven way to make money, and a good way to do this is to buy shares in tobacco companies, which boast an enviable track record as reliable performers.

A focus on cost control and the ability to raise prices even in a harsher economic environment has enabled BAT to deliver higher profits in more challenging trading conditions. It’s taking £800m out of the business between now and 2012 by streamlining back office functions, improving buying processes and shutting factories. That suggests it has even more scope to improve its already impressive 32% operating profit margin, nearly double the level of just five years ago. Furthermore, with a large proportion of earnings derived overseas, the tobacco majors are poised to reap the benefit of a weaker sterling.

Over the past five years, BAT has delivered compound growth of 15% in earnings per share and 19% in dividends per share, while rewarding shareholders with a capital return of 97% compared with 3% for the FTSE 100.

And amazingly after all that out-performance, because of the business it’s in, BAT is still cheap. It’s on a forward p/e ratio of just 12.23x, which is a lower rating than the overall market.

Even better, the prospective yield is near 5.5%.The beauty of a mature business such as BAT is that capital spending can be low, so most of the masses of cash generated can be paid straight to shareholders as dividends.

On that basis we rate the stock a strong buy

BG Group

BG Group Plc, the UKs third largest energy giant after BP and Shell, is an attractive investment story on many levels.

In Brazil, it has first mover advantage in the most exciting oil discovery for over forty years, the Santos Basin, which is estimated to contain at least 50 billion barrels of oil. Economical at just $40 per barrel the fields are expected to be a dominant factor in BGs production and cash flow growth for years to come.

It has an industry-leading LNG division, which is successfully building itself a brand new, long-term contracted, southern hemisphere business. Its operations in Australia for example are part of the country’s long-term energy plans, a country set to become the “Middle East of gas”. This helps smooth the group’s revenues because demand for gas there peaks when demand in the northern hemisphere is at its lowest.

It has a first rate management team with the uncanny knack of spotting the next big thing, from Brazilian oil fields to US shale gas.

On top of that the company is a prime takeover target for a super-oil major, such as ExxonMobil, looking for a quick-fix acquisition to remedy their dwindling reserves.

In conclusion, we believe that either the market or a predator is going to wake up to the quality of BG Group’s assets. Citibank and Goldman Sachs have recently reiterated their buy recommendations with price targets of 1500p and 1460p respectively. Trading at 1168p we rate the stock a strong buy.

Carillion

Everyone considers Carillion to be a UK construction business – a sector far from being considered attractive in this economic climate. But the truth is that most of its profits now come from support services – a higher margin business that with it attracts a higher market rating. In fact much of future construction will really be a feeder for its facilities management operations.

With this in mind, the investment case for Carillion is compelling when you look at it’s valuation. Trading on a December 2009 price earnings multiple of just 7.7x, it is not only cheap in absolute terms but also against its support services peers – Serco is trading on a multiple of 18.4x and Capita a multiple of 18.8x.

We believe the market has got the valuation wrong for what is a growing and profitable business. The underlying EPS CAGR over the last 5 years is 14% putting the shares on a PEG ratio of 0.5. Put simply, that means the stock is undervalued and now is a great time to buy before the market wakes up to the Carillion story of a company transforming itself from a construction group into a support services company. And with one of the best yields in the FTSE 350 (4.5%, covered 1.8x) investors can lock in a decent yield as well.

Chesnara

An anagram of Chesnara is “earn cash”, fitting for a company that offers one of the most generous dividend yields on the stock market – over 8%.

Chesnara operates predominantly as a consolidator of life-insurance funds that are not seeking new business, and then runs them down in an orderly way. Chesnara’s overheads are extremely low because it outsources its administrative and investment operations leaving the core payroll at less than 20 employees.

Trading at a discount to embedded value (their broker forecast is 230p per share at year end) the current share price takes no account of any value that management may generate from future acquisitions. With a solid dividend yield supported by a strong solvency ratio Chesnara are a buy not just for yield but also for value and indeed could be a classic bid target for a larger player.