UK M&A party might just be getting started – River and Mercantile’s Lough

The listed UK equity market could see a further spike in M&A activity this year as international investors swoop to take advantage of depressed valuations now that much of the political uncertainty has been removed, William Lough, portfolio manager at River and Mercantile, has said.

Lough, who runs the ES R&M UK Dynamic Equity fund, said that with the range of outcomes from Brexit now narrower and a business-friendly government, but only a limited corresponding move up for UK equity valuations, the country represents a fertile hunting ground for foreign corporates.

“We should expect UK corporates to remain acquisition targets for overseas businesses and private equity buyers alike, particularly if valuations do not move higher. In this regard, the M&A party seen in 2019 may just be getting started,” he said.

Lough said both international and domestic-focused stocks look attractive versus other markets globally.

“The UK equity market as a whole looks attractive in a global context. The valuation discount to developed market peers is still as wide as at any point since the late 80s or early 90s and many overseas investors have been running underweights,” Lough said.

“There are plenty of UK-listed but highly international companies trading on material discounts to lookalike overseas peers, but the discount is particularly acute in domestics which, despite outperforming by 17% since bottoming in August 2019, still trade close to a relative low P/E versus international earners, compared to a 10-year history.”

In general, these companies will see the largest benefits from improved confidence of consumers and business leaders alike, Lough said. This manifests itself in areas such as demand boosts for construction and building products companies as delayed projects get the go-ahead or improving loan volumes for banks both to small businesses, which have typically borne the brunt of uncertainty, and housing-related consumer lending.

“We have invested in companies which have managed to use the challenging conditions to increase market dominance,” he said.

“What it means broadly in the UK is that there is an opportunity now to selectively buy higher quality cyclical franchises at attractive prices, which may have been punished for an earnings miss or forecast cut which has more to do with the difficult macro environment than any company-specific issues.”

He said the opportunity for long-term investors was especially attractive because, as a favourable developed jurisdiction with political certainty for the next five years, it ticked a lot of boxes for investors.