June 2019 Portfolio Update

For quite a while it seemed that June would be a quiet month. It turns out that two major profit warnings, from Somero and Craneware, takes quite the shine off of things. Neither of these were events that I thought likely given their track record of solid trading during positive economic conditions. Just goes to show why diversification is so important. Curiously both of these warnings stemmed from difficulties in North America and maybe this is the start of a trend? A joke obviously but it wouldn't be the first time that a conclusion has been extracted from two data points. Hopefully July will prove much less exciting, as the financial markets start winding down for the summer, and I'll be able to relax in the sunshine.


K3 Capital Bought at 127p - June 19

As mentioned below I doubled my holding here on the morning of their positive trading update. The driver for me was that trading appeared to have stabilised and that, for now, there remains the potential for a hefty rebound in 2020. This must rely on a number of the large deals completing in the year but if the board can't manage to get a few of these over the line then the whole expansionary business model must come under suspicion. It's nice to see that a few directors have followed me in increasing their holdings and we've all done well with the share price bouncing 90% in the three weeks following the update!

NewRiver Retail Bought at 195p - June 19

According to their recent results NRR have an EPRA NAV of 261p and an annual dividend of 21.6p which they intend to maintain while working to improve the dividend cover from 84% of UFFO. With the NAV falling by 10%, mostly as a result of the portfolio valuation falling by 6.4%, the share price has been weak of late. In addition Neil Woodford has (or had) a large holding here and has been steadily liquidating. In consequence the share price has fallen from recent highs of ~250p down to below 200p. When the price fell to 216p, giving a yield of 10%, I almost bought but held off due to the Woodford issue. However when it fell below 196.4p, implying an 11% yield, I decided that this was a fair point to top up and unsurprisingly there was plenty of liquidity on offer! From here the price could easily fall further but it's not often that you find a company offering this sort of dividend when it's not actually in distress. Clearly I'm looking on this as a long-term holding.

Quartix Holdings Bought at 283p - June 19

I've long seen Quartix as being a high quality, founder managed business that I'd like to take a stake in. However the relatively punchy valuation (forward P/E ~25) combined with a forecast 20% drop in profits for 2019 has quite sensibly put me off until now. The catalyst that I was waiting for was that the company was getting on top of the decline in their lower-margin insurance tracking operations while materially growing their fleet business. It's the latter segment which will propel profits in the future as international expansion bears fruit and the self-install tracker option becomes prevalent. Looking at their mid-June trading statement I think that this pivot point has been reached with new fleet installations up 45% and new clients being won in Poland and Spain. At the same time insurance telematics are down to just 20% of sales (and less than that fraction of profits) which means that the impact of further shrinkage is steadily reducing. The other aspect that interests me is that the share price has formed an obvious base over the last 8 months which suggests that there's not a lot of selling pressure and that any movement is likely to be to the upside. I guess that this thesis will be tested when the interims are published in July.

Scientific Digital Imaging Bought at 55p - June 19

This is very much the "one that got away" for me as I saw Mike Creedon present way back in November 2015 (at this ShareSoc seminar). As mentioned in my notes I was very impressed by Mike's presentation and could see that he had a firm grip on the business. With the acquisition of Sentek in the bag it was clear that Mike wanted to explore more buy and build options, finances notwithstanding. That said SDI was a tiny company back in 2015 with very little share liquidity and low quality characteristics. So I moved on and that was the right decision at the time. Since then Mike has done everything that he wanted to do and more with the share price more than quintupling in less than 4 years (despite a tripling in the number of shares). A phenomenal result and now that SDI is a £50m company with double-digit operating margins it's a much better match for my investment criteria (although I do like to see even a minimal dividend). In a lot of ways SDI is like a mini-Judges Scientific and if Mike can replicate even some of that success it'll be a hell of a result. With that in mind the catalyst for my starter purchase are two recent trading updates confirming that sales would be ahead of expectations, with lots of outcomes going the company's way, and that debt is just £1.6m. This leaves plenty of headroom and I suspect that this is just the end of the beginning for SDI.

Craneware Bought at 2030p - June 19

I've probably (certainly?) jumped the gun here with this post-profit warning purchase and am certainly guilty of price anchoring. Just because people were happy to pay £30 a share before the warning doesn't make £20 a bargain price (and the high P/E suggests that the price is anything but a steal). That said I see Craneware as a very profitable and successful business that has a hard to disrupt presence in the American healthcare market. This type of moat isn't going to evaporate overnight and I find it hard to believe that management have changed direction severely enough to do permanent harm. After all co-founder and CEO Keith Neilson still owns 12.7% of the company and even today that's worth north of £60m. In the long run then I'm betting that the current warning really is a timing issue, rather than a sign that Craneware has lost its USP, and that the share price will recover. On reflection though it's likely that it'll take some time to rebuild investor confidence and that the share price will drift. This is why one of my mental guidelines is to wait for positive news when buying (even if the price has jumped) rather than guessing that a price fall has come to end. Slap on the wrist for me.

Things I thought about buying (but didn't)

Ten Entertainment

With Neil Woodford holding quite a lot of TEG, and seemingly dumping it into the market, I got quite interested when the price headed towards 200p. I already own Hollywood Bowl and didn't mind having additional exposure to a sector that'll do alright in most economic conditions (and it's probably oblivious to Brexit). In addition the quality metrics look good with a ROCE heading towards 20% and a mid-teens operating margin. However it was with the operations side of the business that I started to become concerned. If you look online at both customer and staff reviews then you should prepare to be shocked at how relentlessly critical and negative the majority are. I know that people are more likely to post complaints rather than compliments but this is something else. Then I recalled that Christopher Mills is both the guy who floated TEG and still holds 28% of the shares. I don't know much about him except that he spent £40m taking over Essenden Leisure, the previous incarnation of Ten Entertainment, before floating it for more than £100m in 2017. Since then he's made more then £50m selling his shares and other directors have pretty much followed suit. So I've come to the conclusion that if the directors involved in the company don't see it as a good investment then that's a red flag. I've missed out on the sharp 10% bounce in share price but that's a small price to pay for peace of mind.

UP Global Sourcing Holdings

Here's another company floated in 2017 which has had its ups and downs - principally with a rather large profit warning six months after listing. A key part of this was a large European retailer changing their supply arrangement from Free on Board to a landed arrangement. The impact of this is that UPGS remains responsible for goods for a much longer period which ties up working capital and delays the point at which a sale can be recorded. At the same time retailers in general were becoming more cautious and ended up delaying purchases of non-food goods until the last minute. However UPGS seems to have worked its way through these issues over the last 18 months and earnings forecasts for 2019 have risen by a third since December with a predicted EPS of 7.2p putting the group on a P/E of ~12. This feels pretty cheap given the 30%+ earnings growth seen in recent years. On the other hand the share price has already tripled since the analysts started upgrading and it's plausible that the re-rating has already completed? Another consideration is that the company mainly floated so that the selling shareholders could extract £52m from the company. This concerns me as the company pivoted a number of times while growing and perhaps the owners were taking the opportunity to get out while the going was good? Certainly UPGS seems to be somewhat at the mercy of its customers and I wonder how much control it has over its out-sourced suppliers in China? Overall then there are more questions than answers here and I'm not sure UPGS is of a high enough quality to make the effort worthwhile!



Things I thought about selling (but didn't)



Palace Capital: As a real estate investment company this is definitely a problem child in my portfolio. The sector is utterly out of favour and anything with retail exposure is getting hammered - perhaps rightfully so as high-street rents are on the decline. In fact it could be argued that sector NAVs need to fall further as the directors of PCA don't see value at current prices either and aren't making new investments. That said the directors of PCA identified this risk a number of years ago and that's why retail makes up only 10% of the portfolio. The largest chunk, 47%, is given over to regional office space and this seems to be pretty robust. The board seem to have a good relationship with customers and proactively refurbish space to ensure that it's attractive and able to achieve higher rental rates. The other two major parts of the portfolio are leisure (14%) and industrial (13%). The latter covers warehouses and similar, which are in demand, while leisure is somewhat weaker as providers are forced to react to changing user demands. The other major exposure is the Hudson Quarter development in York with this set to complete in 2021. From everything that I've read this will be an A+ development in a desirable location but it's going to take a while to see a return. To me this feels like a strategically sensible portfolio, one hardly deserving of a 27.5% discount, but this appears to be a contrarian viewpoint. It's probably no surprise that I view PCA as a long-term holding. As an aside this is a useful piece of corporate research: https://www.hardmanandco.com/research/corporate-research/conversion-to-reit-status-fy19-results-announced/. (Results)

K3 Capital: It's been a tough ride here recently with the delay of some large deals hitting forecasts hard. This update steadies the ship somewhat by stating that adjusted EBITDA should be at the upper end of market guidance although it's worth remembering that this guidance was reduced heavily not so long ago. Even so the pipeline for FY20 is strong and no change is made to the outlook for this period. This last bit is important because forecasts are pointing to EPS of 13.9p and that puts the company on a sub-10 P/E ratio. On this basis I decided to double my (admittedly small) holding on the morning of the update. With two related parties buying 50,000 and 38,000 shares the following day I get the sense that I'm not the only one seeing green shoots. Even so the board still have a lot to prove, regarding larger deals, but this is a starting point. (Update)

Learning Technologies: Here's another share which has had a bumpy time over the last six months. This AGM update doesn't provide much in the way of figures but cross-selling initiatives and a focus on cost control seem to be helping give a very positive performance so far this year. With a strategic goal of £200m in sales by the end of 2021 there's a lot to aim for here. (Update)

Games Workshop: Very well received full-year update here with sales and profit growth continuing across all channels. In a slight improvement on the wording of a previous update PBT will now be not less than £80m which is good news. Not much else to say except the Games Workshop continue to execute well and seem to truly understand their customers - which makes sense given that they are enthusiasts themselves. (Update)

Somero Enterprises: On a more sombre note Somero spoilt my morning with this unexpected profit warning. Until today analysts were forecasting sales up 4.5% to $98m and an EBITDA of $31.3m. Now because of exceedingly high levels of rainfall in the US, their biggest market, project starts were delayed and equipment orders reduced during the generally busy March and April months. While trading improved in May it's unlikely that the lost ground will be made up in 2019. At the same time foreign markets have seen variable trading levels which I think (although this is unsaid) have contributed to the profit warning. All in all this is a bit of a downer but if management are playing with a straight bat, which they always have in the past, then this is a setback that will be overcome in time. So I don't plan on selling any of my holding unless something else changes here. As a side-note this was my 2nd or 3rd biggest holding, I think, and I was a bit reluctant to check the impact on my portfolio today. I was somewhat relieved to see that I was down by <1% - chalk one up for diversification (and holding GAW)! (Update)

B.P. Marsh: Steady results from this specialist investor with NAV up to 350p from 339p a year ago (including the impact of the mid-year placing at 252p). During the year the company invested in ATC Insurance Solutions, in Australia, and topped up holdings in XPT Group and Nexus Underwriting Management. The latter is the 2nd largest holding in the fund at £30m and it specialises in a range of niche insurance products (such as Political Risks Insurance and Latent Defect Insurance). Only LEBC Holdings is larger at £35m and this group provides IFA services to individuals and corporates. There was some hope that LEBC would float during the year, leading to a valuation uplift, but this was put on hold due to market volatility. Seems like a reasonable excuse and LEBC seems to be trading well. Of course we're really relying on the expertise of the board to guide us here but Brian Marsh has been successfully investing in this space since 1990 and I don't sense that he's lost his touch. In addition the company will buy back shares at a 15% discount to the NAV, which is 297.5p, so that provides some level of downside protection. A solid hold then. (Results)

IG Design Group: As previously flagged FY19 sales rose a mighty 37% to £448m with EPS up 33% to 29.3p (a smaller rise due to equity placings during the year). With the latter coming in 9% ahead of analyst forecasts for 26.9p it's a little surprising that the share price was flat on the day but then again ~600p has acted as a ceiling for the last 9 months. What we need is a strong trading update! I don't know if this will happen but business in the US is going well due to the Impact acquisition and investment is ongoing with a new printing press arriving and upgrades to the US IT system. Also in that region Walmart is now the group's largest customer at ~20% of sales with very little exposure to weaker retailers who may fail to pay their bills. The only downside to deriving ~50% of sales from America is that margins there are tight, at 6.9%, while Europe and Australia allow for double-digit margins! Things should improve this year though, as integration benefits mature, and it's pleasing to hear that the business has effectively managed the effect of US-China tariffs. Elsewhere Europe is growing well, the UK remains competitive and Australia is expected to reduce somewhat as national accounts are rationalised. So while everything isn't perfect it seems reasonable to believe that IGR will meet analyst expectations for 17.5% earnings growth this year - and maybe a little more. (Results)

Ramsdens Holdings: Solid results from the northern pawnbrokers with all business lines reporting growth (although with the store count up 19% to 156 stores that's not unexpected). Using my trusty highlighter there aren't many words in red - mainly stuff to do with the challenging High Street, Brexit and last year's amazing summer. All of these sound reasonable and I'm inclined to believe management when they talk about the strength of their diversified business model. In more detail the pawnbroking interest grew 8% to £7.5m, FX commission grew 3% to £11.6m and jewellery gross profit jumped an impressive 22% to £5m. Clearly foreign exchange is a significant driver of profits and it's impressive that RFX have increased this side of the business despite so many headwinds. From reading through these results I get the feeling that management are both cautious and ambitious; they want to grow the business but they remain focused on margin and cost control within the existing stores. I like management who care about the business this way and it doesn't seem unreasonable that they'll be able to grow earnings by around 12% next year (according to analysts). With this putting RFX on a P/E of ~9 and a yield over 4% I hardly think that the market is being over-optimistic with its rating! Seems like a good reason to keep holding. (Results)

Craneware: Well this is a nasty surprise on the last trading day of the month! In a nutshell they haven't made enough sales in H2 to meet expectations. This may or may not be down to the launch of three new products but either way this shortfall is out of line with their history of high recurring revenue and new business wins. Previously sales were predicted to rise 18% and EBITDA a strong 22%. These increases have now been cut sharply to just 6% and 10% respectively which suggests that H2 revenue has come in equal or perhaps just slightly behind H1. Still the company has plenty of cash and the board are spending significantly on R&D so it seems to me that this is more of a "timing" warning than a sign that the business is falling apart. On this basis I haven't sold my starter size holding and have, in fact, doubled it. Given the history of most profit warnings I've probably acted too precipitously but I happen to think that a price fall of a third offers a decent long-term opportunity. (Update)

End of month summary

This has definitely not been one of my better months but it's hardly my worst either. I can't deny that I've been distracted by the day job but that's no excuse; my portfolio should be able to trundle along without too much volatility (hence no biotech, oil & gas or mining companies). As ever it's quite a surprise to see the movements that have taken place. Clearly LTG and GAW have been in favour this month, with double-digit returns, while there's quite a long tail of small positive gains. On the downside CRW and SOM are way out in the naughty corner but it's a bit annoying to see BKS down almost a quarter; clearly quite a few investors have given up on them roping in another Tier 1 client. I'm not ready to throw in the towel yet but I certainly haven't called this investment right so far.

Winning positions for the month: K3C 46%, LTG 12%, GAW 11%, PCA 9%, RFX 7%, SCT 7%, KWS 7%, BOY 6%, DOTD 6%, III 6%, IGR 2%, PPH 1%, RWA 1%, BOOT 1%, PAGE 1%, BPM 1%

Losing positions for the month: ADT -1%, RM -1%, HAT -1%, BOWL -3%, FDM -3%, GAMA -4%, WJG -4%, BUR -7%, SBIZ -10%, NRR -13%, SOM -22%, BKS -23%, CRW -44%

After all of that I was expecting to be notably down for the month and yet, and yet, I've come out at just -0.3% which feels to me like a minor miracle. I can't take all of the credit for this. It's the simple outcome of having a moderately diversified portfolio with no outsize positions. I'm not the kind of person who can run a concentrated portfolio, making farm bets, and for that I'm grateful. Sure my portfolio will never double, or triple in a year, but neither is it likely to halve. Hence I'm very happy to have gained 16.6% in H1 and if that's all I get for 2019 I still won't be too disappointed.

Disclaimer: the author holds, or used to hold, all of the shares discussed here

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