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BUY: Hollywood Bowl (BOWL)

Hollywood Bowl shored up its balance sheet with a £10.9m placing post period end, and has also secured additional headroom with lenders, writes Alex Janiaud.

With a March 31 period-end, Hollywood Bowl’s half-year figures do not reflect the worst effects of the lockdown. Excluding the fortnight commencing March 16, which was impacted by the roll-out of social distancing protocols, like-for-like turnover rose by 8.6 per cent, against a growth rate of 4.4 per cent for the corresponding period in 2019. 

Given the level of lease liabilities, it is reassuring that the leisure group has secured some relief from its landlords, which means that second quarter rent will be reduced significantly. Free cash flow nearly halved to £5.2m, largely due to the inclusion of £3.7m in lease interest payments, while the continued roll out of its new “Pins on Strings” scoring system pushed capital expenditure up by 24 per cent to £10.7m.

While they won't be forced to wear a hazmat suit, returning customers can expect social distancing measures including alternate lanes and pre-booking for peak periods. The costs of reopening sites under these conditions, which include covering screens and globes, will probably come to around £150,000.

Peel Hunt forecasts full-year 2020 adjusted pre-tax profits and earnings per share of £8.1m and 4.3p respectively, rising to £18.4m and 9.5p in 2021.

With a monthly cash burn of £1.2m versus estimated liquidity of around £35m, Peel Hunt analysts reckon the company has sufficient liquidity to survive the closure period into late 2021. But the bottom line is whether punters will be rolling in the aisles once trading resumes (hopefully in the third quarter of 2020). Some customers may be apprehensive about mingling in public, but we envisage that demographic factors will work in the company's favour. A forward price/earnings multiple of 12 is not extravagant given the underlying performance.

SELL: Ted Baker (TED)

Ted Baker’s turnaround programme will seek to rein in operational costs and slash inventory levels, writes Alex Janiaud.

The clothing retailer will raise as much as £105m via a share placing and an offer for subscription, as new management bids to revive the ailing fashion retailer after a torrid year that included a £58m overstatement of its inventory and the departure of former chief executive Ray Kelvin over allegations of impropriety.

Ted Baker was buffeted by a weak consumer environment, underperforming in key selling periods, including Black Friday. Retail turnover declined 5.4 per cent on a constant currency basis to £440m. Expensive store expansion and weak sales ate into the underlying gross margin, down to 55.6 per cent from 59.8 per cent a year earlier.

The company concedes that inefficient inventory management and lengthy stock cycles have resulted in capital being locked in for excessive periods, though there is evidence of progress, as underlying working capital as a proportion of sales contracted from 27.8 per cent to 15.8 per cent. Towards the close of the year, Ted suspended its dividend and slashed capital expenditure in order to alleviate cash flow pressures, which had been exacerbated by a failure to control costs.

In keeping with peers, Ted is putting its faith in e-commerce and is making it a core investment priority. Online volumes were weak before the onset of coronavirus, with sales down 2.5 per cent over the period, while the pandemic continues to depress volumes.

Peel Hunt forecasts full year 2021 adjusted pre-tax profits and earnings per share of £12.8m and 21.6p, respectively, rising to £17.5m and 29.4p in full-year 2022.

HOLD: HSBC (HSBA)

With the income case now removed, investors are now fast re-evaluating the premium the lender’s shares have historically commanded over UK peers, writes Alex Newman.

When the Hongkong and Shanghai Bank was founded in 1865, a financial bridge for the growing trade between Asia and Europe was built. Since then, the bank we now know as HSBC has retained its role as a global lender, in large part thanks to the special status afforded to the former British colony in which it was incorporated.

This vaunted position is under sudden strain. On May 28, China approved sweeping new national security legislation banning “subversion, secession and foreign interference” in Hong Kong. The move has been widely interpreted as a step to curtail freedoms in the administrative region, with enormous ramifications for both business and civil society. Even before Beijing signed the legislation, US Secretary of State Mike Pompeo warned the financial centre could no longer be considered autonomous from China.

It increasingly appears HSBC, and to a lesser extent FTSE 100 peers Prudential and Standard Chartered, are caught in an impossible and rather helpless position.

Already, the bank has been called out for failing publicly to support the measures. According to a Bloomberg report, former Hong Kong chief executive Leung Chun-ying last week took to Facebook to warn that “HSBC’s China business can be replaced by banks from China or other countries overnight”. Mr Chun-ying currently serves as a senior member of the CPPCC, a top Chinese political advisory body.

Given its history, HSBC is intimately familiar with the geopolitical balancing act between China and the West. Recently, its “apolitical stance” towards Hong Kong’s machinations was put to the test during the civil unrest sparked by a controversial extradition bill last year. At the time, the group took out a series of full-page advertisements in local newspapers to call for a peaceful resolution to the protests. “Hong Kong has thrived as a result of its stability and resilience,” ran the message. “Maintaining its rule of law is essential to Hong Kong’s unique status as an international financial centre.”

Now, amid the threat to that other pillar of Hong Kong rule – the principle of “one country, two systems” enshrined in the declaration preceding British handover in 1997 – HSBC finds itself stuck between increasingly partisan political interests. For investors, this means a direct threat to the shares’ historically low-risk premium.

Chris Dillow: In praise of defensives

UK equities have risen since the autumn — if you look only at defensive stocks.

My portfolio of low-risk stocks is now almost 10 per cent higher than it was in early September and is up by a similar amount over the past 12 months, even ignoring dividends. This is not a quirk of how I formed the portfolio: it comprises the 20 shares with a market capitalisation over £500m with the lowest betas over the last five years. Low-risk sectors such as tobacco, food retailing and utilities are also now higher than they were in the autumn.

This is not what conventional theory predicts. My defensive portfolio has had a beta of 0.9 in the last 12 months. That means it should have fallen only slightly less than the market. But in fact in the last 12 months it has risen almost 10 per cent while the FTSE 350 has fallen almost 15 per cent. Low-risk stocks have therefore delivered a positive alpha, at least if we control only for market risk.

Why? In retrospect, it seems that low-risk stocks were unduly cheap a year ago as a result of their underperformance in 2018-19.

But this is only part of the story. Defensive stocks have done well for years. In the last 10 years, my defensive portfolio has risen 69 per cent while the FTSE 350 has risen only 25 per cent.

Why do defensives do so well?

One theory, proposed by AQR economists, attributes it to borrowing constraints. In theory, bullish investors should borrow to buy shares generally. In practice, though, many cannot borrow either because banks won’t lend to them or because their mandates forbid it. They therefore express their bullishness by buying high-beta stocks – ones they think will be a geared play on a rising market. This causes high-beta shares to be overpriced and low beta ones to be underpriced.

This theory has a testable prediction. It implies that low-beta stocks should do especially well when borrowing constraints are most binding. One of these circumstances is when prices have fallen a lot, because that is when collateral is low. Sure, enough, low-beta stocks have indeed beaten the market since March. (Consistent with this theory, they also delivered a high alpha in 2009.)

Recently, however, Josef Zechner at Vienna University has proposed another theory. He shows that investors are happy to pay high prices for shares with positive coskewness – that is, ones that do especially well when the market does exceptionally well.

Exactly why they have this preference is unclear. It could be for the same reason that they pay too much for small speculative stocks; they like the small chance of large, quick gains and need compensation for stocks that offer slower steadier profits instead.

This explanation, though, runs into a problem: why haven’t smarter investors by now wised up to this error and so piled into defensives, thereby eliminating their under-pricing.

It could be because, for fund managers, “low-risk” are misnamed. They carry the danger of underperforming in bull markets – as indeed they did between 2015 and early 2019. Because fund managers are judged on relative performance, holding defensives exposes them to the risk of losing bonuses and even their jobs, and it means risking being left off financial advisors’ best buy lists and thus being ignored by investors.

If this explanation is right, it is doubly good news for retail investors. If “low-risk” shares do well because they are in fact risky for many investors, then we have a strong reason to suspect they’ll continue to do well on average as they should carry a risk premium. And it means that if we hold defensives, we’ll be compensated for taking on a risk that shouldn’t trouble us. We’ll get something for nothing. There is such a thing as a free lunch.

Of course, this doesn’t mean they’ll outperform month in, month out. Even the best strategies underperform sometimes — and defensives might well do so if the market rises further. What it does mean, though, is that if you must bet against the efficient markets hypothesis by being an active stockpicker then investing in defensive stocks is the best-evidenced means of doing so.

Chris Dillow is an economics commentator for Investors Chronicle

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