November Week 2: Climate No Change

Being Honest, being humble;

Risers/Fallers/Transactions - #VLX #DX #QTX #BOTB (EUGH!) #AVON (DOUBLE EUGH!!)

Updates from: #SHED #PHP

So we had another week of climate chitchat, inflation & markets rallying (US was down, but that was after 5 weeks of up up up) & a midweek dip that got bought.

Before I unleash my cynicism on global leaders, I want to say that getting many countries with many stakeholders to agree on anything is very very hard - I imagine it is a scaled up version of a multinational bank!

Public Service

Terry Smith Blog Archive

I came across this archive from Terry Smith - Climate is covered as our sovereign obligations - what I found most interesting was the need to be honest with people & I think that is something the climate debate (and many other debates) would benefit from too.

I am not able to doubt the science nor do I follow it - my own anecdotal observation is that London is warmer now than 10-20 years ago. I am personally cautious around reaching definitive conclusions on deeply complex issues with incomplete datasets. The B & C words come to mind!

My knowledge is non-existent but in the context of the climate/earth, science is also in its infancy I understand. Humility on all sides may serve well, hypocrisy & railroading less so.

I think there is a lot to be said for having some sort of resource/emission cost of capital & it does not surprise me that the financial industry bodies lobby for another tradeable financial instrument.

Cursory Macro/Market Observations

So the market continues its run as does inflation but nobody cares.

Inflation continues to run hot, even adjusted inflation is running hot but it is still not a problem - clearly inflation is not & never was a problem, it was just the transitory that was the issue - perhaps an assessment of what they got right and what went wrong in the higher than anticipated inflation would help (and I have no doubt it is taking place behind the scenes).

In the meantime, real yields are more negative & the S&P500 now has a negative real yield - can dividend yields go negative - it seems a number of investment trusts seem to have no problems issuing shares at a premium (which is how a negative yielding sovereign works I believe).

But really - why does nobody care - especially the bond market - they are smart? 

I am a permabear so maybe growth is going to be problematic - higher taxes, lower stimulus, China assumed growth vs realised - it could happen!

Anyway, moving onto cheerier subjects, our leaders continued for a second week to save our home from assured destruction (Elon notwithstanding - understand he is going to have a bit more cash available).

I reiterate, trying to get an agreement was a tough ask so well done for trying if nothing else.

I understand they want to reduce internal combustion engines to reduce emission & I understand the carmakers were like Nein zu Alles.

They wanted to phase out coal, in stead they will phase down coal but India & China said, we will phase down. Last week, I thought China did not even bother to turn up?

I have sympathy with the argument that developed markets benefitted from a reduced energy cost of capital. 

I appreciate that the Rockefellers didn't know about it at the time, may I suggest the Rockefeller foundation in stead of investing in renewables & ESG just give some money - like they do for all the buildings!

Portfolio Review

Well, a week is a long time in markets - good stock picking last week - keep your mouth shut & maintain some humility (at least externally, but ideally internally too!). 

An unashamedly bad week, which is not apparent given the risers/fallers. The majority of the damage was caused by Avon, which does not appear on the list of fallers as it was sold on Friday. Damage was also caused to a lesser extent by Volex, but that too has been sold.

I do not wish to call it its name, but BOTB has been added - glutton for punishment!

There was very little by way of portfolio RNSs, but what little there was, was brutal in one instance & meh in others.

Lessons:

The issues with Avon got me thinking about when to sell - take my word for it - the price didn't move above £21 and drifted back towards my purchase price - I had better opportunities in my portfolio & I considered selling for no good reason.

I think the conclusion I reach and not one often talked about is that you should sell if there are better opportunities - notwithstanding unnecessary churn & using market noise/price as the factor driving what is a better opportunity.

Transactions

Sell AVON

• Avon announced on Friday, a brutal profit warning & a strategic review of their Body Armour business.
• One might think a 50% fall was an overreaction to a hit to 12% of revenues, but in my view this was not a profit warning, but rather a business warning.
• No real information on what this business will look like, but it most certainly will not be the same business - large impairments & sunk R&D - Must question management here - acquisition of the business & then their own share purchase.
• Lessons from Clanger number 2:
• Investing into a profit warning - completely wrong assessment of "good profit warning" - Half year results indicated 2nd half weighting & if that was not coming good - then it was a bad sign - in your own notes, you said the impairment is a 3rd sign & ignored it.
• Research failure - did not realise the risks around the approval process and considered it more a formality - indeed the "moat" which is once you are in, you don’t change proved to be the downfall - Was outside competence (hence completely missed the point), did it as a trade/recovery as opposed to my more considered purchases - style drift
• Given style drift, it was poor execution - when it didn't make the higher high - failed around the £21 level - it should have been exited
• One piece of fairness on execution - if it had continued to drift, I would have exited & I did - the realised risk was higher than anticipated - which can be kind of good process bad outcome!

Sell VOLEX

• A reluctant sale in some respects but in a contradiction of terms, I was looking to sell this (because of the position size) and maybe I read the results (and write now) with that lens on.
• Results themselves read very well - Revenues up 44% to $292m (202.5m) £230, U/L Op Profit up 31% to $27m (21.3m) PBT 25m up 21.5%, EPS up 8% to 11c - 8p, dividend 1.2p - 21.8m Net Debt + 18m in Lease liabilities - My view is that there was a cash outflow of 50m, whether they think it was 3m free cash inflow or not.
• EVs up 210%, Consumer Electricals 74% including DEKA, Medical Sales up 15%, Complex assemblies (slight reduction - down 3% - need to do a lot of scrolling to get to the ability to calculate the reduction) - unlike other divisions! 
• Asia 15% of total up 10% to 70m - majority consumer electricals, Europe 33% of total up 124% to 101m - DEKA acquisition, US 41% of total up 30% to 121m - has the EVs. 
• Not a single mention of organic growth or 2019 comps or margin details in the divisions!
• U/L EBIT Margin down 1%, because GM down 1% to 21% - don't present divisional margins - suggest that EV margin is lower - bridge blames on materials/freight costs - lag to passing on prices - Reduced admin costs as % of revenue by 2.8% - DEK margin improvement 1.6% & 1.2% from cost control. Product mix hit GM by 0.8%.
• Complex industrials - 58m in Revenue, down 3% - data centres reduced, returning now - 400gbps product due for 2023 sales developed, one customer qualified - if that is true could be good
• Medical - 62m up from 54m - strong return of demand - probably a reasonable end market to be in - production ahead but extended lead times
• Consumer Electricals 127.4m up from 73m - in home entertainment/office - DEKA very strong since acquisition
• EVs 45.3m up from 14.6m (very impressive) - 1st quarter strong, 2nd quarter tapering - shortages - will become more competitive (Product mix margin impact?) - strategy to remain lowest cost
• 3 acquisitions, 2 post year end - Irvine, Promadex & TC - other 29 October 2021 - post year end in 2022 year end - making a lot of acquisitions - another 50m to go out - would suggest the balance sheet is getting / going to get / is stretched - which is very odd for an owner managed business - 140m in acquistions over 3 years on 6 businesses
• My views & why I sold:
• There is a lot to like in terms of the picks & shovels into all these structural growth markets and the forecasts (adjusted as they are) should be met if not beaten given the impact of acquisitions. Fact that they are not saying so creates a problem. 
• Share options vest & they are dangling the carrot for 2023 in the business that should be very strong & reading in between the lines on EVs - I think that is coming under margin pressure
• Valuation not there - basically valued as if they have already achieved their targets & those targets will likely come at some dilution & the margin target is at risk. 
• I was holding it because I thought technically it was looking good - that has broken down. Only reason to hold now is the Director purchase (but I think they have an incentive to support the share price)
• Call - Calculate U/L Free cash flow based on Adj EBITDA of 31m - WC - CAPEX of 4m - depreciation/amortisation/lease repayments take up over 60% of ADJ EBITDA - that is quite ridiculous presentation!!! Increase in receivables is well above the increase in sales
• 6m in adjustments - remarkably consistent level of adjustments in absolute terms overall but lots of stuff going on - interesting that every number at the top line to the bottom - the movement gets progressively worse
• The CFO & CEO have some conflict on need for equity issuance - say shareholder aligned/will stand their corner - however the presentation of the results & that free cash flow is ridiculous
• There was a lot of positive commentary around the results, but I could not get over the cash flow presentation.
• I felt it had gotten very fully valued but held because I thought it was technically looking strong - in light of the cash flow, I am not surprised by the reaction - may well be one I prove to regret (and there is definitely and element of acting because of Avon) - in light of the structural growth, retain & revisit next year. 
• Uncomfortable holding & I am surprised that 3m free cashflow was accepted in the commentary as a given - guess that is what the endowment effect & 3x will do for you!

Sell DX Group

• Better execution this time with an ex-holding. I bought it hoping to make a quick gain on the results - as the morning bounce did not sustain, I exited.
• Glanced through the results - nothing wrong with them & I think there is potentially some value there, but in my view, if you want to play the logistics game as a long term investor, you are better going for the largest scale businesses - FEDEX/UPS/DeutschePost/Amazon

Sell Quartix

• A very small holding that was just stray in the portfolio - I was unlikely to buy any more unless there is some share price noise / results demonstrate that growth is much higher than currently anticipated (which is a very different situation to Arcontech) so I decided to exit.

Buy BOTB (EUGH!)

• Trading consistent with management's revised expectations - engagement from enlarged user base has also normalised - order values & frequency similar to pre-pandemic levels
• Customer acquisition costs stabilised, but at higher levels that were previously reported - confident in prospects 2nd half & beyond - focused on growth strategy - details in interim results in January
• Enlarged user base back to pre-pandemic levels is a positive sign - should result in 6% uplift from 50% of revenues, whereas new customer revenue 40% below prior year & not suggesting they are increasing marketing
• One positive for management in the August update was they are focused on profitable growth as opposed to growing for the sake of it - with 50p EPS & their cash conversion - should be around 5m free cash on 60m M/Cap
• Growth is unreliable and maybe management also. Moat is uncertain to say the least - to be proven (they have a user baser which seems to have some value) & if we say they are not growing because they turned of marketing than maybe they do have something.
• Actually my purchase was driven by a desire to get liquidity in the SIPP for Tate and/or CCC, so I purchased the shares in my ISA (that way it would not be a bitty holding in two accounts) - how I wish I had just sold Avon.
• As it turns out, with the sale of Avon + others, I don't need to free up the cash (at least not with any urgency), so I have decided to retain because anger aside, this is cheap in the context of the cash generation & does not need heavy growth to support the valuation - interim results / special dividends could provide support. 
• Think of this as a quality income stock that is very illiquid & should be treated as such - as opposed to capital light high margin growth into expanding markets!
• If I was looking at it fresh without my history, I would look at this as a screaming buy. Will never get previous multiple due to unpredicatability / loss of quality compounder / hold forever label
• I think this is a better alternative than a lot of what I have - lessons from last time noted but decisions based on anger are poor decisions - key lesson for me is considering this a quality compounder - capital light high margin growing and expanding markets BUT RATHER a quality income stock that is very illiquid & should be treated as such - with quality to be confirmed
• HOLD

Portfolio Risers > 5% - NONE

Portfolio Fallers > 5%

G4M down 9.83%

• I expect it is noise or on the back of the strong recovery over the preceding weeks following the sellers remorse - maybe buyers are having their doubts now?
• I am happy to take no action for now - I would like to buy more of this at some stage but will wait for the results - clearly there is someone who wants to sell after a reasonable/reassuring update & I will respect the efficiency of the market
• HOLD - Not long to wait for results.

REAT  down 5.06%

• No idea - I tried to sell but couldn't get a fill - a wonderful reminder of MicroCaps!
• SELL - No action sale.

Additional Updates & Results

Updates from a couple of REITs - PHP with very limited information - which is getting increasingly irritating (and they did it again today) and interim results from Urban Logistics.

SHED

• In the context of overvalued Real Estate Investment Trusts, this was/is my favourite and reading the results does not change my mind.
• 99.7% rent collection, like for like valuation growth 11% (increase in Net Assets somewhat BS given 25% cash raise) & 9% growth in ERV, vacancy sub 0.5%!!! 8 year WAULT - decent increase, 11 new assets acquired for 81m & forward funding 6 developments - 55m. 164p NAV, 3.25p dividend
• 134million spent from equity raise (108m) on 5 assets - 5-8% NIY & 400m pipeline - will raise funds for it - moving to premium listing may increase the premium in line with BBOX/WHR (although not sure that has premium)
• Valuation increase mainly the result of active management, longer leases & rent increases as well as yield compression - good that it is not just yield compression delivering the 11% improvement. Lots of competition but they are better than everyone else
• Positive macro - onshoring of manufacturing requires increased warehouse space - Just In Case - should increase demand for their stuff - Lots of demand & supply is constrained with shortages & so on -  Is land not a constraint with these things (so premium deserved?) - do they go vertical with Amazon drones or something?
• Shorten supply chains & hold greater stock in the UK - focused on goods/pharma/staple products - 3rd party logistics providers are some of the largest customers - benefitted from asset management & think portfolio can continue to do so
• Reasonable initial yields on acquisition & lease events adding a decent amount to the rental roll - fairly positive reading these results to be honest - not sure why the higher building costs are not impacting their initial yields on forward developments
• One large unit vacant for 5 months of the year, now let - so hopefully that rental number should be better & costs ratio hopefully comes down as acquisitions & post period end acquisitons absorb higher costs - maybe could have mentioned that up top when you said vacancy is only 0.6%! Balance sheet is very safe for now - will be fine going post investment/fund raise.
• HOLD - May add in the placing at 170 - idea being that I will be purchasing at or near the likely full year NAV - 5% premium is tolerable I think

PHP

• Acquisition for 5m - 20 year unexpired lease term, WAULT accretive - no information on yield - again!!!
• Hold to Sell - same thought process as BBOX - with this premium - I am not sure it serves inflation protection - maybe it serves against deflation protection!

And Finally

Our future in Space

I mentioned the need for humility with respect to climate change & the talk above from the Ignatius institute (Jeff Bezos was a guest - 41 minutes) but the whole thing is worth a listen (I think). It is truly humbling.

As an aside, theologians, billionaires, military & commodities (World For Sale - We go anywhere, where others don't want to go) - there is a powerful stakeholder group gunning for victory.

What I find interesting with Jeff Bezos' approach is an acknowledgement of the problem with climate change with a tried & tested human approach to solving problems.

Of course, because in solving problems, we create a whole heap of new ones (Industrial Revolution!) so I am grateful that admission fees to Planet Earth National Park are likely beyond my lifetime.

Adieu