With Brexit on the horizon, should we be worried about a UK recession hitting the profits of stocks in our portfolio?
To be honest, predicting the economic impact of Brexit is above my paygrade. But I think it’s fair to say that there’s a possibility of some disruption to the UK economy. With this risk in mind, I’ve been screening the FTSE 100 for companies which should be a safe buy, even in an economic storm.
Mine’s a double
The group’s top brands include Johnnie Walker, Smirnoff, Captain Morgan and Guinness. Net sales totalled £12.2bn last year, about two-thirds of which were made outside Europe. Diageo’s brands range from mass market to super premium, so although demand for premium drinks might weaken in a recession, the company would almost certainly pick up this lost trade through its more affordable offerings.
Management’s relentless focus on brand-building translates into high profit margins and strong cash generation. The group reported an operating margin of 30% last year and converted more than 80% of its earnings into free cash flow. This provides solid support for the dividend.
The right time to buy?
In a trading update today, Diageo confirmed that it’s on track to increase profit margins by 1.75% over the three-year period to 30 June 2019. Sales are expected to rise by “a mid-single digit” percentage this year, in line with last year’s performance.
Looking ahead, the shares trade on a 2018/19 forecast P/E of 21, with a prospective yield of 2.6%. That’s not cheap, but the shares have pulled back by 10% from the all-time highs seen in July. I think this could be a decent time to buy more for a long-term holding.
Even better than booze
Diageo has delivered a solid 9% gain over the last year, a period when the FTSE 100 has been largely flat. But specialty chemicals group Croda International (LSE: CRDA) has performed much better, rising by 35% over the last 12 months.
This outperformance stretches back to 2010, since when Croda shares have tripled in value. About half the group’s profits come from its personal care division, which produces ingredients used in products such as cosmetics. The remainder of the group’s profits come from a mix of healthcare, agricultural and industrial products. About two-thirds of sales come from the Americas and Asia, with the remainder taking place in Europe.
A tight focus on specialist products where Croda can develop a competitive advantage means that this is a highly profitable business. Last year, the group’s operating margin and its return on capital employed were both 23.7%.
This high level of profitability means that the company generates a lot of free cash flow and has been able to expand without needing much debt.
Of course, such a high-quality business comes at a price. Trading on a forecast P/E of 27 and with a prospective yield of just 1.7%, Croda is more expensive than Diageo.
This is a company I’d like to own, but I’d prefer to wait for a market dip to secure a more attractive buying price. However, for investors seeking a long-term defensive position, I wouldn’t rule out buying today.
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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has recommended Diageo. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.