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Neil Woodford’s Portfolio: Downside For BT Group plc, Centrica plc, Rolls-Royce Holdings plc, Smith & Nephew plc & G4S plc

WOODFORDNeil Woodford is showing how a diversified portfolio should be managed. So, I wouldn’t be surprised if his fund continued to trim exposure to BT Group (LSE: BT-A), Rolls-Royce (LSE: RR) G4S (LSE:GFS), Centrica (LSE: CNA), and Smith & Nephew (LSE: SN)

What’s Going On: July Holdings…

In July, Mr Woodford’s equity fund cut its position in AstraZeneca (down to 7.5% weighting from 8.3%), which turned out to be a very reasonable move. If I were to invest in Astra, I wouldn’t hold more than 3% of Astra stock as part of a diversified portfolio. Exposure to GlaxoSmithKline, Mr Woodford’s second largest holding, is virtually unchanged (6.9%); the same applies to British American Tobacco, Roche, Rolls and BT.

Mr Woodford has bought more shares of Imperial Tobacco, Reynolds America and Capita — all of which remain in the top ten. Imperial Innovations is out of the top ten, while BAE Systems is in.

BT: A Tough Nut To Crack

BTBT is not such a defensive play in the current environment. Since mid-July — when volatility surged significantly for the first time in a while — BT shares have lost almost 4% of value, and it doesn’t look like a rally is on the cards unless BT management give investors a good reason to buy.

In fact, BT shares have surged well beyond fair value in the last couple of years. While earnings per share are expected to rise into 2017, revenue and operating profit aren’t likely to record meaningful growth over the period. BT has room to lever up though, which means shareholder-friendly activity may boost value. That should be considered.

Upside For Rolls-Royce?

rrRolls-Royce shares are down 4% since the company announced last month it would use proceeds from disposals to buy back its own shares. While I would agree that the industrial world in the UK is faced with several headwinds, including a strong British pound that renders the sector less appealing than others, Rolls-Royce shares don’t look fully priced at this level.

So, a 5% to 10% upside to the end of the year is a distinct possibility under a best-case scenario, but there’s no reason why Rolls-Royce should belong to the top ten. Its shares yield less than the market, and lots of uncertainty still surrounds the company’s strategy, in my view.

Centrica, G4S, Smith & Nephew

The fund has mildly cut its exposure to Centrica, G4S and Smith & Nephew. Well, Mr Woodford should be more aggressive. 

The risks surrounding Centrica are a real concern for investors. While it’s true that the shares are cheap, there are several reasons why they do not offer any long-term value. As I have recently argued, Centrica has problems spanning working capital management, high leverage ratios and poor profitability. The competitive landscape isn’t favourable, either.

Elsewhere, the shares of Smith & Nephew have been hammered in the last few days of trading as investors seem to have come to terms with the idea that if anybody showed up to acquire this medical device maker it will be on less convenient terms for S&N shareholders. S&N shares are down about 5% from their one-month high. More downside is apparent.

Finally, G4S is arguably a very risky equity investment based on fundamentals, a tough competitive landscape and an overstretched capital structure. A cash injection shouldn’t be ruled out.

There are better alternatives in a market where a few other stocks trade below fair value. Want to know more? 

In this report, our analysts have identified five shares that are currently undervalued and would prove to be defensive if volatility springs back. 

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Alessandro Pasetti has no position in any shares mentioned. The Motley Fool owns shares of Smith & Nephew and has recommended GlaxoSmithKline.