Rolls-Royce, Legal & General, Avacta, and Diploma could constitute four of the best UK shares to watch early next year.
As the UK enters winter, the economic situation is starting to look ever more precarious.
On the plus side, the political situation appears to have settled down. Despite reawakened public anger over covid-19 pandemic-era PPE contracts, an early general election is looking more unlikely than it was only a month ago. Current PM Rishi Sunak looks set to remain in office for the foreseeable future.
However, the downsides are mounting. CPI inflation now stands at 11.1% and is expected to rise with increased energy bills in April. And the Bank of England base rate, already at 3%, is set to increase to circa 4.5% by mid-2023.
Add in tax rises, spending cuts, and the lingering effects of the pandemic and Ukraine War, and the OECD has forecast that the UK will record 0% growth in 2023, This is the lowest within the G20 group except for Russia, a country blacklisted by half the globe’s economies.
Against the backdrop of a predicted lengthy recession, many of the country’s workers — including NHS staff, Scottish teachers, posties, rail, border staff et al — are striking.
Government and owners alike are refusing to offer inflation-busting raises, rightly assuming that one raise will set a precedent for all others and arguing that increases will simply fuel the wage-price spiral. But with inflation rocketing, workers cannot afford the basics required to live a normal life.
Accordingly, this all makes selecting the best UK shares to buy something of a challenge. But there are still decent opportunities to consider for the new year.
Best UK Shares
1. Rolls-Royce (LON: RR)
Rolls-Royce shares remain frustratingly below 100p, weighed down by historical expectations, a departing CEO, and relatively high debt in a high interest environment. And with recession coming, revenue at its all-important aircraft manufacturing and servicing sector is expected to remain depressed.
However, as one of the crown jewels of the UK’s tech sector, Rolls is developing multiple potentially revolutionary technologies, including a world record-beating all-electric plane, an UltraFan power gearbox which promises to save 25% of jet fuel compared to the current standard. It’s also planning to build dozens of small modular nuclear reactors and is in talks with both Ineos and the government to begin bringing these into reality.
Most recently, Rolls has partnered with easyJet to set yet another aviation milestone, running the world’s first modern aero engine on hydrogen. And it’s also set to benefit from a recent US army contract to supply the engines within Textron’s Bell V-280 Valor helicopter.
Jefferies analysts believe the contract could be worth ‘up to $5bn to $6bn in production and $6bn to $7bn in services assuming 5,000 installed engines are delivered.’
A breakout next year is not impossible.
2. Legal & General (LON: LGEN)
Down 17% year-to-date to 254p, January may prove a decent opportunity to buy shares in one of the FTSE 100’s most reliable dividend stocks. With a dividend yield at a whopping 9.4%, LGEN is one of the few companies capable of coming reliably close to the official CPI inflation figures.
Despite losing £10 million in the LDI mini-budget crisis, the insurer’s defensive position should carry it in good stead through the recession. And in its recent trading update, the company declared that its Solvency II capital ratio now ranges between 225% and 230%, a significant improvement from the 187% of a year ago.
In addition, new government regulations to further strengthen the risk margin of the UK’s largest insurers by 65% will improve this crucial stat by a further 3-4%.
Of course, LGEN operates within a competitive market alongside blue-chip rivals including Aviva, AIG, and Schroders. But in H1 2022, operating profit grew by 8% year-over-year to £1.18 billion. Not every FTSE 100 company has been so fortunate.
3. Avacta (LON: AVCT)
When entering a recession, it can make sense to diversify one’s portfolio by allocating some capital to riskier FTSE AIM stocks with higher chances of explosive growth.
Avacta was one of the first ‘meme stocks,’ swept up in the social media frenzy of early 2021 to a record 273p, before falling to 42p by March 2022 and then re-rating to 104p today. And having fallen by 18% over the past month, the loss-making drug developer could now once again be in oversold territory.
The company recently acquired leading IVD distributor Launch Diagnostics for £24 million, with an earn-out capped at £13 million. With funding coming from a share placing and capital lent by a subsidiary of Susquehanna International, this acquisition is proposed to be the first of Avacta’s M&A-led strategy to develop an economic moat around its position within the European immunodiagnostics market.
However, investors are currently focused on Avacta’s novel AVA6000 pro-doxorubicin chemotherapy drug. The drug uses patented technology to deliver chemotherapy to cancer patients which, if it works as hoped, will hugely limit the undesired side effects. Trials look promising so far but remain in the early stages.
4. Diploma (LON: DPLM)
Diploma shares have risen by over 150% over the past five years to 2,827p. But they’ve fallen by 17% year-to-date, providing investors with what could be an excellent entry point.
The FTSE 250 operator works within a highly specialist sector with few true competitors. It’s a distributor of industrial components, divided into three sectors: controls, seals, and life sciences. Like many FTSE 250 companies, it’s trading on hope of further growth with an above-average price-to-earnings ratio of 37, but the underlying business could justify this premium.
In November’s full-year results, DPLM saw revenue increase by a sizeable 29% to a tad over £1 billion, while statutory operating profit came in at £144.3 million, an increase of 38%.
However, much of this growth came from its various acquisitions, including R&G Fluid Power in April for £107.5 million. While an acquisitions strategy can generate huge revenue, especially in recessions where quality companies often put themselves on sale at discounted prices, it does amplify the risk factor.
However, with a capable management team, Diploma could be an excellent UK share to buy in early 2023.
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