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Woodford: Why I’m backing UK banks and embattled AstraZeneca

14 November 2017

Despite a long-term aversion to banks, Neil Woodford has come out in support of the sector and is also sticking with top holding AstraZeneca despite a wobble earlier this year.

By Jonathan Jones,

Reporter, FE Trustnet

Opportunities lie in unloved domestic UK stocks, according to FE Alpha Manager Neil Woodford, who has continued to add banks to his funds despite the ongoing challenges for the sector. 

The manager of the five FE Crown-rated CF Woodford Equity Income fund made an initial foray into the sector by adding Lloyds earlier this year and noted at the AJ Bell investor conference last week that he has also added positions in Royal Bank of Scotland (RBS) and Barclays in other mandates he runs.

“I have said consistently since the financial crisis: do not listen to what banks are telling you about how healthy their balance sheets are,” the manager said.

“Do not believe that people don’t want to borrow money. The reason they are not lending is because they can’t lend and the reason they can’t lend is because they don’t have enough capital.”

Banks have been one of the worst performing sectors over the last decade after struggling to overcome the fallout of the global financial crisis in 2008. Lower interest rates have squeezed profits, while more stringent regulations have made the operating environment more difficult.

Performance of indices over 10yrs

 

Source: FE Analytics

However, Woodford said he has started to buy banks now because he believes their balance sheets are finally repaired.

After many years avoiding the sector, his confidence in balance sheet strength stems from the amount of capital that banks have built up over the past decade.

“My view about the banks is that now that their balance sheets are repaired and now they have sufficient capital they will start to lend to the economy,” he said.

As previously reported, Woodford remains sanguine on the prospects for the UK economy. But he said there was another reason for his positive outlook.

The manager said the renewal of credit is now beginning to flow into the economy at an “acceptable rate of interest”.

“Banks are lending at very low interest rates and this is a sign of health returning to the financial system – finally,” he noted.

Additionally, while they have built up a large amount of capital, they have also paid and agreed settlements for their misdeeds of the past, he said.

“The fines that I was also worried about that would extend the period of rehabilitation, those fines are largely behind us,” the manager said.



He noted however that there are one or two big issues to go with RBS still needing to settle a deal with the US Department of Justice over the mis-selling of mortgage-backed bonds, having already agreed a £4.2bn fee with Federal Housing Finance Agency.

But with the bulk of these issues behind them, banks that have piled large cash reserves to pay for these fines can now use the extra capital for one of two things: lending to customers or return it to shareholders.

“Of course, the surpluses that they have generated for some time – which have been deployed to build capital and pay fines – now that is done, those surpluses can come to shareholders,” Woodford said.

“Now the surplus capital that the likes of Lloyds [have been] generating will now be returned to shareholders as dividends or share buybacks.

“So, they are cheap. They are rated too low in my view – not least because of course they are liquid vehicles exposed to the UK economy – and you don’t need to go too far to understand why they are out of favour. But my view is [that] they are far too cheap and Lloyds is one of the most attractive bets in the UK.”

While the stance on some of the banks reflect a new position, Woodford has also defended his long-term position in pharmaceutical company AstraZeneca – the largest holding in the £8.5bn CF Woodford Equity Income fund.

“It is a company that the media love to hate and they talk about its well-publicised issues but, frankly, I think AstraZeneca’s issues look to me to be [behind it],” Woodford said.

“When I think of Astra’s issues I think most global pharma companies would give their eye-teeth for what Astra now has. I think it has the best pipeline of any pharma company globally.”

Earlier this year, the stock suffered a sharp fall on the day that it announced the unsuccessful results of its Mystic lung cancer trial.

Performance of indices over YTD

 

Source: FE Analytics

The study was seen as transformational for the stock, with much of its success already priced into its share price, but the results showed it did not reach its endpoints.

“Of course the stock market had a bit of a hissy fit when the Mystic trial was not positive in June and the stock fell 15 per cent in a day,” Woodford said.

At the time, chief medical officer Sean Bohen described the results as “disappointing” but noted that the results of the overall survival, due next year, are more important.



Woodford added: “We remain confident that Mystic will work in overall survival and that data will come out probably in the first half of 2018.”

He said the main reason for his optimism is the pipeline of other drugs – something he said should “drive the Astra story for years to come – to 2023 and beyond”.

This is the reason he argued against the proposed merger with US rival Pfizer back in 2014, noting that the firm was in a better position in the long run on its own.

“The argument then was that we would make more money in the longer term from Astra as an independent entity because we believed in [chief executive Pascal] Soriot’s transformation of the business.

“Clearly it had yet to go through a difficult period with patents expiring and sales falling but it has navigated that period incredibly well in my view and now the upside is beginning to emerge and emerge prominently.

“I think it is at an inflection point and the outlook looks very bright – that’s why it is the biggest holding in the fund.”

 

Woodford runs the CF Woodford Equity Income fund, which since its launch has returned 27.88 per cent, beating both the FTSE All Share and the IA UK Equity Income average over that period.

Performance of fund vs sector and benchmark

 

Source: FE Analytics

However, it has struggled more recently, returning 1.29 per cent over the last 12 months while the market has returned 13.93 per cent.

“We have had a very difficult 12 months from a relative performance point of view due, I would say, to different performance-based factors at the early part of 2016,” Woodford said, adding that the market was “dangerous” and “extreme”.

The fund has a yield of 3.52 per cent and a clean ongoing charges figure (OCF) of 0.75 per cent.

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