December Weeks 1 and 2: REUNITED

Business Return vs Market Return;
Central Banks: Dovish Hawks, Hawkish Doves & ECB

🤩: #SUP #TPFG #BATS #SOM #GAW #GSK 
💩: #BOTB #FCAP #SDI #IGP #ARC #FNX #DUKE

Transactions: Sell #PHP #REAT; 
Updates from: #SPSY #SOM #DUKE #BATS #GAW #SDI #SUP #PHP #BNZL #BMY #SRC

With this entry covering two weeks & me suffering from whatever the opposite of writers block is, this is a long one and I apologise for that. But given I wrote it, I am probably most apologetic to myself!

Public Service:

Actually, on this instance and with no reason to feel emboldened, I thought I'd offer some original thought and specifically the much maligned dividends and the idea of investing for income.

When I look at my portfolio and see some of the better performers, they have all benefitted from multiple expansion. Multiples I understand represent the market view of the future return whereas more mundane things like earnings & book value represent business returns (perhaps past business returns). 

I appreciate Accountants are useless, but much like politicians, we are the best you have! 

And in the interest of full disclosure, us Accountants were pretty useless well before the rise of the 

INTANGIBLE;

BUT

I think it is a bold call to say that the difference between the realised market return and accounting return (book value) is exclusively a result of the apathy of the accounting profession & not at all a result of the exuberance of the markets profession.

Disclosure: 

Other than Algy Hall's repeated attacks on what I spent time and money studying (did get paid for it, which makes a change from other letters I have accumulated), his articles have been amazing and I am sad to see him leave Investors' Chronicle. 

There was most definitely no accounting standard for "Nobody gets fired for hiring IBM" & even Mr Buffett got that one wrong!

I have to take this view - I will be paying ICAEW membership fees imminently

I read a great deal about UK being obsessed with dividends unlike the US. I am not sure I concur with the US/UK dichotomy. 

I still like dividends (although I view them less holy grail than I did).

The reason is I don't think I am personally capable of isolating (with any accuracy) how much of the market return represents business return vs everything else. I do think the dividend is a (hideously imperfect perhaps) method to reconcile the two. 

For a boring fuddy duddy have fun staying poor like me, the dividend ensures that I capture an element of the business return in the market return..

San Francisco/Silicon Valley and other pockets of the US are very special (as are pockets of the UK & the rest of the world for that matter), but in mature economies, there are a number of good companies in decline (my own portfolio is pretty heavy on the consumer defensives). 

I am not sure how different a dividend is to a buyback in an effort to support the share price. US is amazing, EPS keeps going up vs no growth UK - that is market Chumpiness as opposed to UK Chumpiness (in my view). Take a look at the EV:Sales multiple in buyback mania!

That said, in a country where huge swathes of very successful corporations are quite tightly held, dividends may not be the preferred method of distribution. To borrow from an earlier post, this has little to do with Economists or Modigliani/Miller and a lot to do with fiscal policy.

As far as Marshall Wace and call me an embittered entitled Xennial but I think a lot of retained earnings have been spent making good unconsidered promises on pensions, but I guess Marshall Wace were far too irrelevant to talk about what they felt in 1997 (Gordon or Tony) when employer pension contributions were suddenly no longer tax deductible (Lots of salt there - well before my time and I didn't verify)

Anyway, happenstance would have it that as I was thinking about difference the between business returns someone harder working, more intelligent & more articulate than I am came up with this. 

Not a short read but worth the time I think.

Where is the Return

I really enjoyed reading this - I think it added context to a lot of the battles I have with myself & my portfolio (and why that assessment exercise I did was so useful)

Not to be all Myers Briggs but different people are different (Yes several years of funding & research to come up with the brilliant conclusion that different people are different!)

Investors are looking at different things and place different values (weights) on different things. 

When I assessed my portfolio (equal weight for each criteria), internally I put more emphasis on valuation & quality and less on technical/beta/liquidity and I can understand why other people have a completely different approach. I have scores ex liquidity/ex beta - not ex Quality or ex Valuation.

The biggest actual learning from reading the above, I got some "rational, not just up and to the right" context around multiple expansion, Stage 1/2/3 stocks and when things break down, where the protection may or may not come from.

Also, maybe with this value & growth investors / traders & investors can all stop beating each other up, empathise / think locally and use this to their respective advantages.

Cursory Macro/Market Observations

Inflation 

This is the last appearance on this blog until the 2021 review and then in 2022 posts, but until then.

One more time and it was monster print but less monster than it could have been. 

I am bored of inflation but probably tend more to the inflationista end (higher for longer shall we say).

For all those that say inflation is transitory (CBs don't anymore, but they do kind off) and many of the CB apologists certainly do.

But lets reconcile differences, I will accept that current levels of inflation are transitory if team transitory can admit that they never thought we would be seeing the levels were are seeing / have seen over the last 6 months. 

Restrictions

Moving on from inflation, we were greeted with the next vowel in the Alphabet - OMI Plan B. Other people can be angry about the events of Downing Street last year, so I don't need to be.

Are our esteemed leaders controlling the media narrative as opposed to following the science or was CoVid always a threat to our civil liberties. I am not a conspiracy theorist, but these theorists have an awful habit of capturing a pang of truth in their conspiracies.

Whichever side you are on, the events of Downing Street did manage to unite a big chunk of mask & non-mask wearers so for that we can give them some credit. Indeed, I think some hard right evil capitalists were agreeing with Jeremy Corbyn and some butter wouldn’t melt lefty liberals were agreeing with Boris Johnson.

All I have to say is what we are dealing with in the UK and how we are being treated in the UK is substantially better than other countries a little to the east. I am proud to be British & I am proud of British values - maybe just maybe politicians are in a strait jacket because of the electorate?

And I am not going to attempt to reunite the Brexit & Remain wings - be easier to part the Red Sea!

From what I can tell, the market has been reasonably resilient after the initial sell off - I am still not convinced by CoVid recovery plays - yes they will eventually turnaround - I just don't want individual holdings impacted by the whim of governments given the entire portfolio is!

Central Banks speakers 

Jerome Powell was hawkish or wash he dovish - who even knows any more but he did cause the market to rally. What we did learn was that the term transitory was transitory - as is inflation but without the use of said term. 

I was surprised by the rally, but I should be given I fell asleep during the press conference. The last thing I remember was why do we still need QE given circumstances & Chairman Powell said markets are sensitive to it - he has our back! (If ever you want confirmation that people hear what they want to hear, even while they are sleeping!!)

Andrew Bailey on the other hand - unreliable boyfriend surprising the markets once again. I understand before the announcement, it was 50:50 whether the market thought rates would rise. Now that rates have risen, we are in the well trodden path of 50% of market participants were right because of their immense skills, whereas 50% were wrong because Andrew Bailey does not know how to communicate. Either way, I am not sure how much an extra 15bps makes in the grand scheme of things, but if I have to pay a 1-1.5% premium to fix for 2 years, I'd stick with the tracker.

ECB & Miss Lagarde - she confirmed that it is indeed her job to control spreads should they get out of hand in the event anything they do is wrongly interpreted as hawkish. Beyond that, you can refer to any of the previous announcements. 

Press conference took place to confirm nothing new - she comes across as a big fan of reading out loud (or alternatively her own voice).

I appreciate this sounds cynical, but I did an MBA where they produce the leaders you can trust (or leaders of tomorrow, or leaders that make a mark) - lots of marketing people in MBA programs! 

MBAs learn a great deal - they definitely learn how to talk about things they know little about (as readers here might have noticed) - Class participation marks are actually handed out for reading out loud! I can't imagine law school being that different.

Anyway, moving on from the things I can't control to other things I can't control!

Portfolio Review

As you can see form the above, I underperformed on a one week, each week & two week basis - at least even with roughly 30 holdings, nobody can accuse me of being a tracker.

YTD return (18th December) is 3.2% - a poor year especially on relative terms - hope to finish the year positive, but any news subsequent to 18th is likely to be bad news so let's see how it turns out.

I have no exposure to Banks, Oil & Miners & I am not sure if that is the reason the All Share rallied - sometimes I get a feel for what is driving the index and sometimes I don't - think this one fits in the latter for me at least.

Then only thing that came to mind was China going BRRR, or RRR to use the technical acronym!

There was a fair amount of news over the two weeks & the market seemed on the whole pretty unmoved - does not seem to have much time for positive updates pending Santa.

There was some tidy up on the transactions front - just getting rid of small holdings that I have been dilly dallying with so bit the bullet - something about the calendar I guess.

Lessons:

Repeat lesson this week - punch in the mouth to remind me of the plan - actually this is just pure greed overriding fear until I get punched in the mouth & then I think ooh, that's scary. The transaction actually took place on Monday 20 December (Reduce SDI, but should have been done earlier (and would have been anything from 5-10% higher than the price I sold at, but wasn't!

I doubt this is the last time the lesson will be appearing.

Transactions

Sell REAT

• They announced an incremental contract so there seemed to be some liquidity on the day.
• My write up on this was - HOLD - What were you thinking - especially after the director sale in May as well (at the peak no less)
• I sold because I couldn't think of a reason to hold and with the pull back there are better uses for cash should I choose to use it. Quite frankly, I was only holding because didn't want to take the loss.
• In this instance, always an element of bull market BS but the big mistake here was seeing a share - missing out (Hindsight is great but thinking about it, 15-20x EBITDA for a microcap glorified contract cleaner was ridiculous)
• Chasing - if you missed it, you missed it - another one that was a function of too much cash in the portfolio at the time & GREED - focusing on the upside, not the downside!

Sell Primary Health Properties

• Again they greeted us with news of a couple of acquisitions but refuse to tell us what NIYs they are getting - quite frankly this is pretty basic information that they should provide and the fact that they don't has made me increasingly uncomfortable and annoyed.
• As per above - they are getting at best 4% on book cost & trading at a 30-40% premium, which suggests my capital is being re-invested at sub 3%
• Very long way for the premium to close & holding this is just poor capital allocation

Portfolio Risers > 5%

SUP 7.89%, TPFG 7.14%, BATS 6.93%, SOM 6.25%, GAW 5.85% & GSK 5.26%

• TPFG - Not sure to be honest - it reacted well to a readacross from Belvoir & I think there was an investor show where Jack Brumby talked about it so maybe garnered some attention.
• GSK did have some news but not sure I am in a position to assess it - plant based vaccine sounds pretty on trend and a drug that is effective against Omicron spike protein
• The rest were all news / updates related so will cover separately & I am not sure how much longer GSK will remain in the portfolio.

SUP up 7.89%

• I added recently on the view that the interim results would be well received and that was indeed the case.
• Revenue up 9% to 61m (56.3m), GM 30% (up from 25%), ADJ EBITDA up 20% to 10m 17% margin (up from 15%). Adj EPS 5.9p, Net Debt 8.4m
• Overheads tightly controlled, minimal investment to deliver growth. Acquisitions - Battery/Lighting distributor in Ireland, Sci MX (sports nutrition)
• Vaping 13% growth to 21.7m (organic), Wellness 6.4m (192% growth - new products & acquisitions), two brands launched good traction since launch. Strategy take stable cash from battery/lighting & invest in growing vaping/nutrition - higher margin & tailwinds
• Managing supply chain / higher inventory & raw material, marginal impact but remain vigilant. Good start to H2, ADJ EBITDA at least in line with expectations. Outperforming their markets - sound confident in model/relationships
• CapEx funded from Operating Cash 4.2m vs 3.4m - 40% of EBITDA taken in working capital - Creditors/inventory offset - in receivables - half year receivables as % of half year sales better - credit insurance unless CEO says otherwise!!
• HOLD - Thesis playing out, growth in higher margin busines, ambitous & entrepreneurial - think probably was somewhat opportunistic IPO but priced well & change in business hides that opportunism.

BATS up 6.93%

• I understand why many people will exclude this automatically but if I showed you the numbers/metrics and did't tell you the name, I expect a lot of people would be willing to pay a high teens/low 20s multiple
• That said, they don't really like talking about 90% of their business (makes quite a change from other management teams) and the BATS share price moving positively to an announcement is also quite the change.
• Cigs value share up 10bps & US share up 50bps - volumes flat globally, US down 5.5% - pricing power is still there - margin pressure as volume growth in lower margin EM
• On way to non-combustibles 5bn in Revenues, GloHyper gaining share & entering new markets (IQOS is entrenched in US I think), VUSE gaining share in west
• Cash conversion at 90%, 5% constant currency revenue growth & mid single digit EPS growth. 3x Net Debt to EBITDA
• 30% margin, growing single digits on a single digit PE & the yield is covered & scores well on sustainability (not sure how much shareholders care about their sustainability ranking)
• With a 14% free cash flow yield, I think the question boils down to is the terminal value greater than zero & is the terminus more than 7 years away - I'd answer yes to both.
• HOLD - This is a screaming buy as long as you can get past the whole tobacco thing

SOM up 6.25%

• Momentum continued into H2 - consistently able to deliver customer orders - strong in N America, contribution from Europe & Australia, others "as expected"
• Raising guidance: Revenues $130m, EBITDA $45m, Cash $39m ($120, $42, $39) - Cash conversion remains fantabulous but margins a little lower?
• N America conditions remain healthy - high level of customer workloads & project backlogs well into 2022
• I am regretting my top slices here earlier in the year & also that I was not able to get a fill in one of the market hoohaas but that should not impact my decisions today.
• Add: Ranked highly in the portfolio assessment so should be a larger hold - backlogs well into 2022 suggests that the end of cycle is not nigh.

GAW up 5.85%

• Never sell GAW as they say.
• Sales not less than £190m (197m CC, 187m PY), PBT of 86m (91.6m PY) - 67m ex Royalties vs 83m ex Royalties in prior year. Royalties at 19m (8.7m PY) - very impressive / very lumpy!
• Growth in trade & retail channels (online?) - focusing on thing within control (good) - 15m decline in Op Profit (approx half in FX), higher carriage & staff costs
• Ex royalties, the core business has gone from 44% to 34% operating margins which is pretty dramatic given the valuation. Royalties very very impressive - how guaranteed are the guarantees?
• If the royalty income has a much longer cash cycle & margins are declining then will look less cash generative. Expect an amount of royalty income was received in cash given higher dividends - core alone wouldn't be able to do that.
• Royalty income is delivering a lot for the overall margin - expect that is the reason the share price has been so resilient because the core profit performance is disappointing (temporary or not)
• Forecasts are full / dependent on more licensing income - an IP licensing business should get a higher multiple - Marvel esque? Will too much licensing alienate their core customers?
• Guess there is a view that not less than is usually much bigger - personally I think most of those not less than have come before the reporting period ended.
• HOLD - Happy I reduced (not P&L happy, but still) - surprised at resilience but the licensing income is remarkable

Portfolio Fallers > 5%

BOTB -15.2%, FCAP -13%, SDI -11.2%, IGP -10.5%, ARC -10.1%, FNX -7.65%, DUKE-5.08%

• All I can say is that this is really not a market for small caps, especially illiquid ones at that.
• Clearly someone wants to sell FCAP & there are a fair few embittered holders on BOTB. I am disconcerted by the valuation on IGP but given the size of the holding, am more comfortable with the speculation.
• SDI had interim results  & DUKE had some newsflow as well - neither well received it would appear, although was on the whole positive - DUKE seem to be firing. 

GAW up 5.85%

• Never sell GAW as they say.
• Sales not less than £190m (197m CC, 187m PY), PBT of 86m (91.6m PY) - 67m ex Royalties vs 83m ex Royalties in prior year. Royalties at 19m (8.7m PY) - very impressive / very lumpy!
• Growth in trade & retail channels (online?) - focusing on thing within control (good) - 15m decline in Op Profit (approx half in FX), higher carriage & staff costs
• Ex royalties, the core business has gone from 44% to 34% operating margins which is pretty dramatic given the valuation. Royalties very very impressive - how guaranteed are the guarantees?
• If the royalty income has a much longer cash cycle & margins are declining then will look less cash generative. Expect an amount of royalty income was received in cash given higher dividends - core alone wouldn't be able to do that.
• Royalty income is delivering a lot for the overall margin - expect that is the reason the share price has been so resilient because the core profit performance is disappointing (temporary or not)
• Forecasts are full / dependent on more licensing income - an IP licensing business should get a higher multiple - Marvel esque? Will too much licensing alienate their core customers?
• Guess there is a view that not less than is usually much bigger - personally I think most of those not less than have come before the reporting period ended.
• HOLD - Happy I reduced (not P&L happy, but still) - surprised at resilience but the licensing income is remarkable

DUKE down 5.08%

• Two announcements - one for the deal and one stating the increase in the dividend.
• Largest investment - $21m (16m£) - US signage/advertising - billboards and whatnot - Family owned, founded in 1992 - refinance existing debt/working capital/growth
• 12.5% cash yield paid monthly - 30 year term - presence in US replace conventional private credit - long term & remove need for periodic refinancing for the borrower
• 10.5m financing agreement - Tristone Healthcare Ltd - residential & domicillary care provider - young adults leaving social care & acute mental illness
• Refinance existing capital structure, provide follow on funding over next 18 months for acquisitions - 13.5% per annum starting immediately
• Also, the adjustment based on revenues - isn't that helpful for borrowers (especially with difficulty accessing capital) - like turnover based rents.
• Increase in dividend to 0.6p (quarterly from 0.55p) - healthy increase & makes sense given cash generation - a 5%+ dividend increasing by 10% - that is pretty good going and would have thought the market would do more than shrug!
• Call on the whole was positive although I have reservations about the accounting treatment for royalty investments. They are not hiding anything (would not have asked the question if they did not say pricing builds in repayment)
• HOLD to REDUCE - Risky business but all going well at the moment and see the value proposition to the borrower - balance sheet values are meaning less. A strange one for me, I think it is an uneasy feeling which is unwarranted that makes me feel this should be a reduce but at the same time the business and the offering is actually growing on me.

SDI down 11.2%

• I thought these results would be well received but was always a planned reduce for me on valuation grounds - was wrong on the former I guess.
• Revenue up 75% to 24.7m (14m) - 42% organic, ex Atik avg organic growth 22% & 4.6m from acquisitions. Reported/Adj Op Profit up 105 & 82% (5.2 & 5.8m), PBT 5.1m (adj 5.7m)
• Cash from Ops 4.4m (4.7m - Working capital unwind), EPS 3.4p Adj 3.92p. 1.1m Net cash. FY Revenue expected 45m, PBT 9.2m.
• Ex Atik 2 year organic growth of 16% - reasonable resilience in a crash & certainly seems an element of structural growth - niche picks & shovels into some big industrial trends. ATIK 5.7m from 2.2m in 2020
• Lower Gross margin - product mix & higher costs - customer acceptance of this (generally) - overheads higher due to furlough/travel - imply can operate at lower overhead base
• Hope to close one acquisition in year, Atik & therefore lower sales/profits, ex Atik continuation in favourable trading conditions seen in H1 - 20m (plus 10m lender discretion) financing for acquisitions - suggests acquisitions will not require new share issues which is good/important
• CapEx - Graticules Optics, modern factory for expansion & Uniform Engineering, efficiency/capacity.
• Expect sourcing difficulties in components/alternatives to persist, recruitment less of an issue but filling open positions is a challenge - can pass on price increases
• Marketing easier with trade fairs/exhibitions & design-in with OEM restarting - continued with R&D throughout the period, Monmouth made 150k acquisition (a supplier IIRC)
• Maybe potential for a small beat ex Atik based on how they speak about the outlook
• Declining margins on higher/similar asset base - quality will look worse, growth rate falls off as does EPS & on 2023 (currently) they are at 36x & on current year 28x. If can't find acquisitions good discipline but then will not trade at growth multiple
• Huge amount of the return has been buying private business & putting them on a public multiple & that is a very heady multiple.
• Do like the company, strategy not over insisting on acquisitions/not compromising on criteria / due diligence but cannot get past the fact that my holding is bigger than Microsoft as is the company's valuation.
• Buying companies in growth industries, OEM suppliers where the OEM is growing but there is economic sensitivity - Chell Instruments having a hard time.
• General feeling on call - quite a few new shareholders have come on board & they sound more growth/acquisition oriented - 15-20% growth over next two years - management stated as challenging but possible. 
• Would say that should be the level needed to support the multiple given that is in line with high single digit
• To be honest, I don't think anything in these results would have changed my conclusion to reduce this holding although the call with management certainly did a lot in that regard. (Might be reasonable relative to Judges & Halma, but two overvaluations do not an undervaluation make!)
• In the absence of a dividend, the market has returned substantially more than the business has and I wanted to capture some of that.
• REDUCE - Done on Monday - mouth punch plan! I should have actually just done it as part of the tidy up exercise when selling but it was rallying and I was getting FOMO

Additional Updates & Results

Still a few announcements and updates but without much of a market reaction - I certainly prefer strong & stable to YoYo.

SPSY 

• New customer K-Cup orders exceed expectations - order since September $394k - 93% of expected 2021 Revenue. Two customers exceed 1m high margin Revenue in 2022
• Requires leap of faith in sensor orders in outer years & optionality being realised - patent expiry as opposed to death of banknotes?
• Not really in a position to assess leap of faith, but in meantime, there seems to be a healthy business. Market is saying sensor orders/optionality won't come through
• HOLD - If I needed up to free up cash, this might be a sell but would like to keep the faith

BNZL

• Revenue - high single digit growth vs 2019 & 7%CC growth vs 2020 (2% actual), acquisitions impact similar to U//Growth (so 1%)
• Operating margin only slightly ahead of historical levels. Strong recovery in base business offering CoVid one offs running off
• 2022 revenues - slightly higher than 2021 & further normalising of operating margins - less recovery in base & decline of CoVid with higher plateau
• Stand by the 20 year hold - do nothing classification - that said, forecasts do not show normalising in operating margin & revenues are probably safe
• Too many times - market has taken one off as permanent up and down.
• HOLD to REDUCE

BMY

• Acquisiton of ABC-CLIO - US business - academic/professional/online curriculum/non-fiction publisher - schools/academic/public libraries
• 22.9m$ (£17.3M) purchase price (existing cash resources, deferral meaningless). 14.7m Revenue, 1.2m PBT in prior year, immediately earnings accretive- £2.1m revenues & 0.3m PBT in current year (cash is still on a very high multiple these days so makes sense!)
• Looking at £1.8m taking full year for the 0.3m for 2 months - 1.4m after tax, which actually makes the acquisition multiple pretty reasonable at 12x. $2.7m - annualising to $16m vs 14.7m - 10% growth - reasonable
• Bring their 32 databases onto digital resources platform - scale offering globally - add presence in US market 
• Business is firing - not sure they can repeat the book run they had this year (2 recommendations from Obama, Business Book of the Year & Nobel prize for literature) but awards in current year should create demand in 2022
• Would be add but getting jitters with the position size - I feel confident that the forecasts were going to be beaten before this acquisition & this seems like a decent acquisition in terms of longer term strategy/quality
• HOLD - Position size preventing add 

SRC

• I am surprised by how far this has pulled back and how there was little reaction to ahead of expectations given the pull back.
• Revenues at 236.5m in 11 months (vs 242.5m in forecasts I see). LFL up 13.4% on 9 months & 9.4% in H2 to date (would have been some catch up in H2 PY)
• Product availability remained good & cost inflation managed - contractual pass through of costs - U/L EBITDA ahead of consensus expectations
• Carrying good momentum into year end (support organic progress in 2022) active initiatives from cash generation to accelerate growth/biz development and Nordkalk integration going well - increase materials utilisation (interesting given Nordkalk had higher margins)
• Greenbloc now with quite a few distributors in the UK & starting to work with contracts to assess for infrastructure projects - will ofer technology across its concrete products from Jan 2022
• Residential construction & infrastructure demand outlook very good & structural demand for higher grade materials
• I first bought this in December 2020 on the view that revenues would be ahead of expectations & then wanted to add but for some reason did not push the trigger until I got confirmation from Simon Thompson.
• I am of the same view today and probably should not wait for Simon Thomson - valuation is reasonable and the company does a lot for the portfolio in addressing the lack of cyclical/materials exposure.
• ADD - Still not a big fan of adjusted EBITDA but another instance where business is doing well (upgrading even) and there has been a substantial pull back - reasonable valuation given Nordkalk is there in EV but not in EBITDA

And Finally

No music this week - Peaches & Herb would have been far too obvious & Wu Tang clan come with a parental advisory warning.

Anyway, I am writing this on a flight to Houston and by the time it is published, I will be reunited with family out there.

I hope to put out a 2021 review - the damage or not in the last two weeks of the year will be covered as part of this. 

Until then, I wish you all a wonderful Christmas Break and a very Happy New Year.

And for those of a more secular bent, YippeeKaaYay M.....F.....s

Adieu