Some of the best UK shares bosting excellent long-term investment cases, but which have been beaten down by the wider recessionary environment, may soon start looking attractive.

Best UK shares to buy in October 2022

On Friday, newly appointed Chancellor Kwasi Kwarteng will present Parliament with a ‘mini-budget,’ which is likely to include a reversal of the previous Chancellor’s increase in National Insurance contributions, and a freeze in corporation tax at 19%, a reduction from the previously pencilled-in rise to 25% in April 2023.

Further cuts to VAT, income and dividend taxes, and even inheritance tax are also on the table. Alongside PM Truss’ £150 billion energy bills freeze, Bank of England Governor Andrew Bailey is now under pressure to increase the base rate by 75 basis points to 2.5%. And the markets are pricing in a further rise to 4.5% by mid-2023 as the Federal Reserve responds to hotter-than-expected inflation.

This leaves two important considerations for UK stocks. First, the Chancellor’s focus ‘entirely on growth’ means that highly-indebted companies may be given lifelines even as interest rates rise. Rate rises may even have an unofficial ceiling regardless of inflation, as the Chancellor and Governor begin their political sparring contest.

And second, the falling value of Sterling — down to $1.14 from $1.37 a year ago — means UK stocks are now intrinsically cheaper for international investors.

1) ITM Power (LON: ITM)

ITM Power shares were a darling of the pandemic era, rising from 110p in February 2020 to a high of 682p by January 2021. However, the hydrogen stock has now seen all its pandemic gains erased, falling by 45% in the past month alone.

However, the Financial Times calls the FTSE AIM company ‘one of Britain’s big hopes for homegrown hydrogen power.’ ITM is one of the only pure-play domestic hydrogen stocks, and is backed by the likes of JCB and Snam.

But it’s fighting multiple headwinds, not least delays in production plans caused by ‘cost escalation, supply constraints and time delays.’ And long-term CEO Graham Cooley is leaving once his successor has been found, acknowledging that the company needs ‘a CEO with international manufacturing experience who can expand us from where we are today.’

In last week’s FY22 results, pre-tax losses nearly doubled in the fiscal year to £46.7 million on revenues of just £5.6 million. And the electrolyser manufacturer announced that it is scrapping key targets, including prior plans to have 5GW of production capacity by 2024, and to build a second UK factory. Instead, it hopes to ramp up capacity at its sole UK facility from 1GW to 1.5GW per annum by 2025.

But the company sits on a £366 million cash pile, having raised £250 million from investors in November 2021. And long term, hydrogen proponents view the net zero solution as key to decarbonising the economy.

Cooley is already seeking government support, a request likely to enjoy a warm reception given recent promises to better UK energy independence and Kwarteng’s previous enthusiasm for hydrogen, wind, and solar power. The government has already announced a clean-hydrogen subsidy scheme targeting 10GW by 2030.

RBC analysts think the new market dynamics have ‘significantly de-risked' the stock, though cite ‘a number of uncertainties related to the timing of large purchase orders and ramp-up costs potentially affecting near-term profitability.’

This could leave ITM Power shares as a high-risk, high-reward FTSE AIM stock to buy.

Key risk: Berenberg cautions it is ‘not out of the woods,’ citing scale-up challenges and weak FY23 revenue guidance, and has slashed its price target to 100p from 185p.

2) Harbour Energy (LON: HBR)

Harbour Energy shares could be a FTSE 250 stock to buy in October. The oil and gas company is the largest London-listed independent producer in the UK and largest commodity extractor in the North Sea.

The stock is up 33% over the past year, benefitting from the sky-high prices of the commodities it produces, despite sinking in late May after former Chancellor Rishi Sunak announced a windfall tax — the energy profits levy— on North Sea oil and gas profits.

While the tax came with a generous 91% rebate conditional on further reinvestment in the North Sea, CEO Linda Cook argues the plan ‘seriously flawed’ as it will disproportionately impact independent companies like Harbour Energy at the benefit of globally operating oil majors like BP and Shell.

However, having already recovered most of this lost ground, Harbour Energy shares could also be boosted by the new political status quo. The new PM has categorically ruled out further windfall taxes, providing investment clarity. While a U-turn is possible, danger from this front has receded.

In addition, Truss has promised to speed up licence approvals of further North Sea oil and gas drilling. Harbour Energy could well be a primary beneficiary. The FTSE 250 company is spending $1.2 billion in capital expenditure over the next year, with new projects at Tolmount, Everest, and J-Area.

In August’s half-year results, revenue increased to $2.67 billion, up from $1.5 billion in the same period last year, boosted by the falling value of Sterling. Accordingly, pre-tax profits rose to $1.49 billion from just $120 million in H1 2021, and it’s increased its share buyback to $300 million.

In addition, the company has cut its £2.15 billion debt pile by more than 50% to $992 million, and expects to be debt-free by year-end 2023. This is a good sign in times of rising interest rates.

Key risk: Demand destruction in the event of a global recession. Harbour Energy barely turned a profit in the decade before the pandemic, and those days could return if energy prices fall.

3) Howden Joinery (LON: HWDN)

Perhaps a contrarian FTSE 100 stock pick, Howden Joinery shares have fallen by 42% over the past year to 547p, erasing the pandemic gains which saw it strike a record 963p in September 2021. The company is now trading at an attractive price-to-equity ratio of just 9.7.

The company is a designer and supplier of fitted kitchens, selling materials and plans to tradespeople across the UK and France. But with recession expected and consumer confidence falling, average UK house prices are predicted to fall by 4.5% in 2023 according to the Centre for Economics and Business Research. This could put Howden Joinery in a difficult position.

However, most of its top-line growth comes from existing homeowners seeking to renovate. And despite its share price fall, half-year results saw revenue rise by 16.3% year-over-year, and 39.9% on a pre-pandemic basis, to a record £913.1 million. Moreover, despite double-digit CPI inflation, profit margins actually increased, sending operating profits up by 20%.

Given the rising cost of living and weaker prospects for the housing market, Howden Joinery could simply be suffering from wider negative investor sentiment. But house prices are still rising according to the most recent ONS statistics, and the company may continue to post record revenue even in a downturn.

This is because its business model relies on consumer carrots and sticks. A homeowner wishing to upgrade their property must either move or renovate. As the average UK house now costs £292,000, moving costs include stamp duty of £4,600, and then even more in the form of legal fees, surveys, and estate agency fees.

Alternatively, a homeowner can choose to renovate their kitchen for a fraction of the cost of moving, while also seeing an investment return as their home value rises.

Key risk: More negative sentiment or a worse-than-predicted recession could see buyers and renovators tighten their belts further.

Charles Archer | Financial Writer, London
20 September 2022