2 of the best UK-focused recovery stocks

Recovery stocks can be among the most profitable investments. One reason for this is that the market usually expects disappointing financial performance from them, which generally means low valuations. If the companies in question are able to beat market forecasts and deliver a sustained turnaround, it can lead to above-average valuations. The end result is often a high profit for investors.

UK troubles

One recovery theme for the long term could be UK-focused companies. The UK economy faces perhaps its biggest challenges since the financial crisis due to Brexit, and stocks which rely on it for the bulk of their revenue could see their financial performance suffer.


Within this theme, retailers may offer the most significant recovery potential. CPI inflation has hit 2.9%, which is 1.1% above wage growth. Historically, an inflation rate which is significantly ahead of wage growth causes consumer spending to come under pressure. Individuals will either hold back on spending on a wide range of discretionary items, or trade down to cheaper options on consumer staples.

Potential impact

The effect of this on retailers can be devastating. In search of higher sales, an investment in pricing often follows. While this may help support like-for-like (LFL) sales for a time, the effect on margin can be negative. Alternatively, retailers seeking to maintain margins are likely to see sales fall as their rivals slash prices in a bid to appeal to consumers who are becoming increasingly price conscious.

Deteriorating financial performance usually leads to downgrades to forecasts and valuations. During the financial crisis, a range of retailers suffered from the effects of a consumer slowdown. However, this proved to be a buying opportunity for less risk averse investors. Companies which were able to change their strategies to appeal to a new era for UK retail benefited, while other companies were forced to fundamentally change their business models. In both situations, turnarounds were sometimes achieved.

Opportunities

Two retailers which could present recovery opportunities in the long run are Next (LON:NXT) and Tesco (LON:TSCO). Both rely on the UK for a large proportion of their revenue, and both companies could be negatively affected by the challenges faced within the UK economy. That’s why Tesco has a PEG ratio of 0.4 and Next’s prospective P/E is 9. In other words, the market has priced in possible downgrades to their earnings amidst the difficult trading conditions they face.


This could provide an investment opportunity. In Tesco’s case, it is becoming more efficient through asset disposals and changes to its operational activity. The acquisition of Booker could provide synergies as well as a possible catalyst for growth. Meanwhile, Next has a high degree of customer loyalty and was able to not only remain profitable during the credit crunch, but grow its bottom line from 2010 onwards. Therefore, it may be more resilient than most of its sector peers.

Both stocks may experience high volatility and uncertainty. However, they could present profitable investments for the long term. For more possible recovery plays both in the UK and internationally, sign up for the Master Investor magazine below.