November 2018 Portfolio Update

It's hard to believe that 2018 is almost over. Following a great 2017 this has turned into a very mixed year after such early promise. Having been burnt in October I believe that buyers remain cautious (myself included). Still this was all over-shadowed by the excellent two days that I spent at Mello London in Chiswick. Probably the best private investor event organised anywhere in the country I had a great time meeting interesting companies, hanging out with like-minded investors and hosting the biggest Stockopedia StockSlam so far.

One of the most apposite presentations involved a panel discussion around Patisserie Valerie and what investors could learn from this calamitous collapse. With a great deal of insight it became clear that internally the company was not being run effectively with a very dominant chairman, Luke Johnson, being surrounded by cronies and subject to minimal oversight. This might be the simple reason why one or more directors were able to hide poor trading and huge debts from anyone else. Equally usefully Steve Clapham, from Behind the Balance Sheet, showed how forensic analysis of the accounts indicated that the numbers were too good to be true. On one hand Patisserie Valerie appeared to be as profitable as Starbucks, despite having much larger fixed costs, while on the other employees/locations weren't as efficient as comparable companies in the dining sector.

Anyway the big takeaway for me is that I need to attend Steve's course on investigative accounting and possibly also his introductory courses! I've been in touch with Steve about this and will shortly be posting about an offer that he has made around putting on a bespoke course for private investors. If there is enough interest from us then he should be able to make this happen early next year. Watch this space.


Keywords Studios Bought 1509p - November 18

It's interesting to me that following the big October sell-off a good number of shares have bounced back vigorously while others, such as Keywords Studios, have continued to languish. Given solid HY results in September, a FY forecast which has risen 20% in the past year and an undemanding P/E of ~30 I don't see a good reason for share price weakness here. From a longer term perspective I also believe that KWS has much opportunity for growth both organically and through acquisition (in a generally fragmented sector). So I can see it acting as a consolidator for several years to come and feel happy enough topping up my holding here.

Later note: Well that was a spectacularly bad piece of timing! Clearly nobody else agrees with my thinking even though Keywords is growing strongly and should be unaffected by Brexit given that it's based in Ireland.

Games Workshop Bought 2935p - November 18

This has been a very profitable holding for me over the last couple of years but it's clear, with hindsight, that the price got ahead of itself a few months ago when it breached £40 per share. With moderate expectations for growth, compared to some outstanding prior years, this put the forward P/E over 20. However with the price falling back to under £30 we have price/earnings below 18 and this is broadly the average P/E for the decade 1996-2006. In contrast the average P/E for recent years, 2010-18, stands at ~14 as the company has rediscovered its mojo. Now if you believe that this progress is sustainable, which I do, then the current price for Games Workshop is quite reasonable considering the capex-light scalability of the business and its cash-generative ability.

Watkin Jones Bought 198p - November 18

With all of my holdings I've been considering where they sit on the cheap/expensive scale and Watkin Jones comes up as one that's priced economically. While it's only been listed for a few years, so data is limited, in that time the P/E ratio has stayed in the fairly tight range of 12-17. Now with analysts pencilling in 15p of earnings this year the forecast ratio stands at about 13 (at a share price <200p). Given the stability of earnings, with future developments being forward sold, and a well covered yield over 3.5% I see a decent opportunity being presented here. In comparison the main competitor Unite Group has a higher P/E, higher debt, a lower ROCE and doesn't pay as good a dividend. As such I see the risk/reward ratio being pretty good with WJG right now.


Accesso Technology Sold at 1860p - November 18 - 0.2% loss

I've held Accesso for a while and have followed them for much longer. In fact I put together some detailed analysis of them 4 years ago where I (mistakenly) decided that there was too much expectation for future growth built into the share price. Anyway later on, after a number of excellent result statements, I did take out a position and it did very well as expansion continued. Unfortunately after peaking at £29.75 in September the share price has plummeted through my stop-loss and is now down by over 40% from the ATH. Partly this is down to the October sale and potentially it's also related to the short position recommendation put out by Tom Winnifrith recently. While I don't agree with all of his comments his thoughts on cash-flow, capitalisation and organic growth hold water and I can see sentiment remaining negative here. Thus I've taken the opportunity to protect my capital.

Dart Group Sold at 789p - November 18 - 23.9% gain

In my commentary on the recent results (below) I mention how I was comfortable with the outlook even as other investors were selling down their Dart holdings. Well a few days later, with the share price still falling, one of my stop-loss alerts went off and I took the opportunity to reconsider my position. In the long run I think that Dart will continue to do well, despite Brexit, since they offer a decent holiday package at a keen price (and demand for these isn't going to fall as Sterling weakens). However in the short-term I do need to retain some capital and I can't just watch every one of my holdings diminishing day by day; at some point we'll hit the bottom and I'll need cash to pick up what appear to be bargains. So I decided to cut my position here, with a decent overall gain, in order that cash might move towards the 20% level. I'm not there yet but I'm sure that other selling opportunities will force themselves upon me!

Treatt Sold at 451p - November 18 - 30.1% gain

I've held Treatt for a while and see it as a quality company which is investing sensibly for future growth. However, as a consequence of the recent market volatility, I've been looking at the valuations of my holdings to see how they stack up against their historical averages. As expected quite a few are still somewhat above their average (thanks to the bull market), some are at the bottom of their range (possibly a buying opportunity) while others remain at a higher P/E than I'm comfortable with. Treatt falls into the latter category with the current P/E of ~25 being much higher than the range of 10-15 which held true for almost 20 years (1998-2016). With results coming up, and the scars to remind me how harshly investors are currently treating less than stellar numbers, I've decided that there's no point keeping my capital at risk in this position. If the company meets expectations then the price will probably remain more or less at the same level while any caution in the outlook statement is likely to end in de-rating. So on balance I've decided that it's better to be out than in right now.


Zoo Digital: This is an interesting company in that it's an absolute story stock with very little in the way of earnings to support its nose-bleed valuation; not at all my usual investment. However I have a small position here because I believe that Zoo Digital have carved out a niche in the subtitling/dubbing world and have the potential to significantly disrupt the industry in a scalable manner. With the whole streaming content sector itself growing strongly worldwide (which requires language localisation) then possibly ZOO could benefit from a double-whammy of growth. As such these H1 results are useful in showing that sales are growing, with much of this driven by their new dubbing technology, while disruption from one of their major OTT providers reorganising their buying is now in the rear view mirror. Also the current order book is strong, analyst expectations (of a significant jump to profitability) should be met and H2 will generate cash. Looks pretty good to me. (Results)

AdEPT Technology: Decent HY results here as a 9.5% rise in sales leads to EPS of 14.5p up by 11.7%. The reason for the difference is that managed services are now up to 74% of total revenue and margins here are higher than in the legacy business (overall EBITDA margin now 21.2%). As a result trading is in-line with expectations where these are for earnings of 30.7p which seems very achievable. It's fair to say that due to the Shift F7 acquisition (costing £4.5m) net debt of £25.1m is about as high as I'd like to see even with cash-flow generation being very good. Still there is a good acquisition record here with earn-outs for recent purchases (OurIT and Atomwide) paying out in full during the period - which indicates that they've traded at least as well as expected. In addition recurring revenues remain high at 79.3% which is great for sales predictability. Despite this, and a solid history of earnings increasing at a double-digit rate for the last 5 years, the group is still only priced at 12x earnings and, to me, this smells like an opportunity. (Results)

Bodycote: Expectations for FY18 earnings are fairly modest here with EPS predicted to increase by 12.2% to 53.4p. Given that the company did 27.3p in H1 (a 16% rise) this target doesn't seem too onerous given that trading in the first 4 months of H2 has been solid. Almost all areas of the business have seen growth, of 4-14%, despite market uncertainty in the automotive, aerospace and energy sectors. Only the Industrial Gas Turbine business appears to be weakening with sales dropping by >25%. Another issue for investors is that the final 2 months will find it difficult to match the strong trading seen at that time last year. Overall though the board's outlook remains unchanged. (Update)

Dart Group: A classic cyclical business Dart makes all of its annual profit, and some more, in H1 before giving a chunk of it back in H2. Typically the second-half loss has been 40-50% of the first-half earnings and with 186p being earned here (up a huge 56% from 2017) we're looking at around 100p EPS for FY18. This ties in with forecasts for 96p, where these have been significantly upgraded twice in the year, and a P/E of 8-9. On the face of it Dart looks pretty cheap but it is an airline and these results flag up a number of headwinds beyond the extrinsic Brexit threat; these boil down to investment in additional planes and marketing plus a need to pay staff more as the group continues to expand. A nice problem to have but I can see why the share price is down 20% from its recent ATH as investors look to avoid risk (putting them back to where they were before the "substantially exceed" upgrade in July). Personally I think that Dart is in a sweet-spot as people search for holiday value as the pound weakens but I expect turbulence ahead. (Results)

3i Group: As an investment company 3i has done spectacularly well since the financial crisis and these H1 results continue the trend with NAV up 7% to 776p (and up 19% in the last year). Much of this growth has been driven by their large investment in Action, the European discount retailer. This business looks to be growing strongly with 257 new stores opened in the year (around a 25% increase in store count) along with additional distribution centres. The investment in 3i Infrastructure, which is listed, also seems to be going well with additional investments driving the share price to a new ATH of 252p. Still a note of caution is struck by the board in that competition for private assets remains strong as investment managers have high levels of unallocated cash and a need to buy assets. It seems that the 3i board have learnt from the past in that they're not highly leveraged and aren't chasing high returns. As such the fact that the share price has retraced to a low NAV premium of just 2% could be seen as an opportunity; whenever the discount has shrunk so much, in the last five years, the share price has always bounced back to a reasonable premium. (Results)

Focusrite: Very solid results from this global audio products company. Growth in all regions pushed sales up by 15.3% (constant currency) with operating profit increasing 22.6% as margins improved and customer discounts reduced. At the bottom line adjusted EPS grew 18.9% while net cash leapt from £14.2m to £22.8m. Operationally the business is firing on all fronts with growth in both major segments (Focusrite and Novation), across all major ranges and in all major geographic regions. This is very impressive and appears to be the result of continuous development, both in hardware and software, along with increased customer penetration at all levels from amateur to professional. An interesting development is that the board have appointed a Business Development Manager to analyse opportunities now that they have the cash and desire to add complementary brands. Given the generally conservative outlook statement (as a result of Brexit and last Xmas showing unusual demand) a sensible acquisition could well enhance the moderate growth forecast by analysts for FY19 and FY20. (Results)

NewRiver REIT: Yuk. The share price here has been relentlessly grinding down for a number of months now and is almost 40% below the ATH. This isn't all down to the NAV though which is down just 2% to 283p. Instead the former "premium to NAV" position has switched to a discount with this coming in at almost 20%! Expectations here are massively negative. The thing is that NRR are actively avoiding the casual dining and department store sectors with the result being that CVAs haven't hugely affected them (at 1.9% of the annual rent). They're also very active in supporting their occupiers and have useful diversification with their pub portfolio. In addition the company is also involved in managing shopping centres for local authorities, trialling Click & Collect at a number of pubs and in residential development above some commercial premises. On the plus side the yield here is almost 10%, although it's uncovered by earnings, while the greatest discount to NAV was ~25% back in 2012. So I'm inclined to stick with NRR as a long-term investment (5-10 years) since it'll take time for their developments to bear fruit and for asset values in the wider market to crater before recovering. (Results)

Palace Capital: Double yuk. Share performance here has been depressing as well with the price currently down 20% from the mid-year high (never mind that they hit almost 400p in 2015). In contrast, with these results, the NAV stands at 421p and the discount is up to a massive 30% (which is as high as it has ever been I believe)! The reason for this is that Palace is being shunned just like other property REITS even though it isn't a REIT and it has very low exposure to either retail tenants or London property. In contrast this is a very actively managed company that focuses on industrial/office space in regional areas where there is strong demand. At the same time the management team is patient enough to wait for the right acquisition opportunity at the right price (which can be a little frustrating for investors) and have kept gearing low in order to have funds available as required. As an example a large portfolio of assets was purchased in 2017 and Palace is now selling 50 residential units in North London (from that purchase) at 97% of book value; a good result given that they were always intended for sale and a useful injection of cash. For more detail a decent report has just been put out by Hardman & Co.. In summary there's no doubt that the sector is out of favour but that's leading to a massive discount and I'm inclined to take advantage of the opportunity. (Results)

IG Design Group: For once I seem to have made a well-timed purchase with my opportunistic trade in mid-October! These superb HY results show group profit up by 79% on a still hefty 23% rise in sales which suggests that operational gearing has kicked in as margins have improved; in fact the underlying operating margin has jumped to 9.3% from 6.7%. Performance drivers here seem to be organic growth in higher margin products, targetted efficiency improvements and the acquisition of Impact. Apparently IG are now the largest consumer gift packaging business in the world and that can't hurt client negotiations. That said if you exclude FX effects and the addition of Impact then group sales were only up by 4% with PBT up 38%; pretty good but perhaps it's best not to get carried away by the headline figures? In addition US sales were actually down by 2.6% when the large contribution of Impact is stripped out and UK/Asia only grew by 2.3%. As these regions provided 79% of sales I do wonder if they're somewhat mature? That said the board are pretty optimistic about the future and I'm certainly not about to take a quick profit! (Results)

Ramsdens Holdings: In-line HY results here from my favourite Northern pawnbroker. On the downside growth in currency exchange has stalled (down 2%) although the company puts this down to our stunning summer combined with Easter falling outside the trading period. I can broadly believe these excuses but I'll be looking to see growth returning in the next results. On the upside retail jewellery grew a nifty 27% (to a material £4.5m of sales) with online revenue up 126%. Elsewhere pawnbroking and precious metals were slightly up. Overall a reasonable result for a business priced on a P/E multiple of less than 10 and yielding over 4%. Looking forward the four stores opened in the period are trading ahead of expectations and four more have opened since the period end; this suggests to me that management are being fairly disciplined in their expansion and bodes well for FY growth. Along these lines I watched an interview with the FD and the group are relocating a small number of stores to more appropriate town centre locations as well; in other words they're keeping their eye on the ball. I probably won't increase my holding without a better then in-line update but I'm certainly happy to hold Ramsdens right now. (Results)

Softcat: A decent first quarter update here with customer demand remaining strong across all segments and year-on-year growth at the top and bottom line. Of course it's early in the year and thus the board is right to consider that they're trading in-line with expectations. However these are for just an 8% rise in earnings and if the sales momentum continues, which seems to be the case for Q2 so far, then I can see these numbers being exceeded as they have been in the past. (Update)

End of month summary

I can't deny feeling a little punch-drunk this month after the volatility in October. I suppose that we're looking at the classic five stages of grief here (see the Kübler-Ross model) and I'm currently in the depression/acceptance phase! So I haven't done much trading this month (why bother when everything's going down?) but I have accepted the need to cut some losses where necessary. On the flip-side I do have an active watchlist of shares that I want to buy when the price is right - just like everyone else...

Still at least some of my holdings have gone up this month with Zoo Digital, Focusrite and Bioventix putting in some excellent recoveries. I can't quite bring myself to buy any more Zoo, without seeing an above expectations update, but anyone who cannily bought some at less than a quid has done very well indeed. At the other end of the spectrum my top-ups in Keywords Studios, Burford Capital and XP Power have done me no favours with all of them continuing to fall in price. Long term they'll be fine I'm sure but sentiment is weak with these ones.

Winning positions for the month: ZOO 24%, TUNE 23%, BVXP 18%, K3C 12%, IGR 11%, BMY 7%, PPH 4%, RFX 4%, ADT 4%, BKS 3%

Losing positions for the month: RM -1%, BOOT -1%, GAW -1%, FDM -1%, DOTD -2%, VLE -3%, BOWL -3%, III -5%, PCA -6%, SCT -7%, WJG -7%, SOM -7%, BOY -7%, XPP -8%, BUR -9%, NRR -10%, HAT -11%, IPX -12%, RWA -13%, KWS -13%

Overall this choppy month dragged the portfolio down by -1.3% and so my YTD performance has slipped further to -3.0%. It seems unlikely that I'll be able to make up this ground without a stunning Santa rally and I'm sure that my full-year performance will remain in negative territory. Obviously that's disappointing, given how things looked in September, but the numbers don't lie. Let's hope that 2019 proves more rewarding!

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

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