Neil Woodford’s Risky Portfolio, ft. AstraZeneca plc And Imperial Tobacco Group PLC

AstraZeneca (LSE: AZN), BT Group (LSE: BT-A), Rolls-Royce (LSE: RR) and Imperial Tobacco (LSE: IMT) account for about 23% of Neil Woodford’s new equity portfolio. BAE Systems, Legal & General and Centrica make up for an additional 7%.

Has Mr Woodford lost his mind? No, he has not. His equity income fund portfolio comprises a total of 61 companies. Sifting through the full list, one may argue that Mr Woodford seems to be betting on the current M&A wave more than on fundamentals, however.

AstraZeneca: How Safe Is It?

Astra is the largest holding (8.3%) in Mr Woodford’s portfolio. Astra is not expected to deliver growth in revenue and earnings for some time. It’s a value play, the bulls argue, for shareholders who believe management will meet their long-term projections.

Astra is virtually debt-free and boasts hefty operating margins, which is typical for large pharmaceutical companies. Its most interesting feature: Astra is still a takeover target for Pfizer. The shares are overpriced by about 20% right now, based on fundamentals, in my view.

GlaxoSmithKline (7.1%) is Mr Woodford’s second-largest holding. GSK is not necessarily an M&A play, yet its assets base may change over time — which could benefit shareholders. And GSK stock is dirt cheap.

Tobacco Consolidation & BT

The tobacco industry is already consolidated, but recent M&A talk has placed the spotlight on Imperial Tobacco, which ranks fifth (5.3%) in Mr Woodford’s portfolio. Meanwhile, British American Tobacco ranks third (6.2%), and could be a consolidator.

Elsewhere, BT ranks fourth (6.02%), and this is probably the most surprising name in the top 10. It’s cheap by most metrics, but it’s hard to fathom why anybody would invest in a business whose revenue growth will barely match inflation in the next couple of years. Decent earnings growth is also in doubt. 

BT is a restructuring play, of course. “With a low beta and a 2.6% dividend yield, BT stock will likely mirror the market trends unless it takes a more aggressive stance on investment at this point in the business cycle,” I argued on 9 May, when BT stock traded at about £3.80. The shares now change hands at £3.82.

Will a change in BT’s corporate structure and/or extraordinary corporate activity provide a fillip to shareholders? Mr Woodford may be betting on these elements. 

More To Do Rolls-Royce 

Rolls ranks ninth (3.47%). I believe the company’s appeal comes from recent corporate activity that proved management were eager to reward shareholders by investing proceeds from asset sales into buybacks. As it shrinks, and more disposals occur, Rolls could become a takeover target, too. It boasts a market cap of about £20bn; Rolls could be swallowed by a larger American rival.

Others….

BAE is included just outside the top 10, which begs the question: is Mr Woodford betting on a merger with EADS? It has been a while since rumours about such a tie-up emerged after a failed attempt in 2012.

There’s a lot to like in Mr Woodford’s approach – transparency, for instance. His defensive portfolio, however, could be riskier than it seems at first glance at this point in the M&A cycle. 

Further down, Legal & General (takeover target), Centrica (takeover target), Smith & Nephew (takeover target), Reckitt (break-up candidate), G4S (takeover target), Serco (takeover target), Meggitt (takeover target), Cobham (takeover target) are just a few companies that could likely be involved in M&A, one way or another.