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HL Select UK Income Shares – August Review

HL SELECT UK INCOME SHARES

HL Select UK Income Shares – August Review

Monthly roundup

Important information - The value of this fund can still fall so you could get back less than you invested, especially over the short term. The information shown is not personal advice and the information about individual companies represents our view as managers of the fund. It is not a personal recommendation to invest in a particular company. If you are at all unsure of the suitability of an investment for your circumstances please contact us for personal advice. The HL Select Funds are managed by our sister company HL Fund Managers Ltd.
Steve Clayton

Steve Clayton - Fund Manager

14 September 2017

The UK stock market made modest gains in August, with the FTSE All Share rising by just over 1%. The Materials sector had another good month, rising by almost 7%, as commodity prices continued to strengthen. We prefer not to speculate on the direction of commodity prices, instead focusing on businesses that have greater control over their own destiny. Our lack of exposure to this sector was a headwind. On the other hand our significant exposure to Consumer Goods was beneficial for performance, with the sector rising by just over 4% in August.*

The performance of the fund this month was negatively impacted by Provident Financial’s profit warning on 22 August. We discuss this below, along with the other positive and negative contributors to fund performance in August. However this is over a very short period and past performance is not a guide to future returns.

Biggest positive contributors

Company Total return (%) Contribution to fund (%)
Sanne Group 9.6% 0.4%
Diageo plc 7.5% 0.3%
Unilever 5.3% 0.3%
Ascential 5.1% 0.2%
Britvic 5.8% 0.2%

Past performance is not a guide to the future. Source: *Bloomberg 01/08/2017 – 31/08/2017.

Sanne enjoyed a strong month in anticipation of strong interims in early September. These were duly delivered, with the company reporting a doubling of revenues and underlying profit as well as a 31% increase to the dividend.

Double digit organic growth was bolstered by substantial contributions from recent acquisitions in the USA and Mauritius. The group is starting to capitalize on the increased cross-selling opportunities that its larger global footprint has created and the new business pipeline is described as healthy. The balance sheet remains lowly leveraged and we would expect Sanne to continue playing a lead role in the consolidation of the fund administration services sector in the years ahead.

Diageo shares continued to make new highs following better than expected full year results at the end of July, with the raised margin target and £1.5bn share buy-back announcement the main highlights. Diageo’s brands and market positions are fabulously strong, but in recent years growth has been a little sluggish. This is probably why investors reacted so positively to the 2017 results.

Ivan Menezes took charge at Diageo in July 2013. Since then he has changed the sales model and raised productivity, making Diageo more agile and more responsive to consumer trends. The evidence suggests these changes are now bearing fruit. We expect this momentum to be sustained given 3G’s failed approach for Unilever, which raises the pressure on all consumer goods giants to up their game, or risk losing their independence.

We haven’t spoken much about Britvic up until now, but the business has continued to make solid progress. Third quarter results at the end of July revealed a 6.5% increase in revenues at constant currency, supported by favourable weather in the UK and a strong performance in France.

Like Diageo, Britvic is doing a lot of work behind the scenes to improve its operations, and is about halfway through a major revamp of its UK supply chain. This is absorbing a lot of Britvic’s strong underlying free cash flow, but should generate significant efficiencies and cost savings in the medium term. We expect margins and free cash flow to improve as the group emerges from this investment phase, supporting further growth in the dividend which has grown at a compound annual rate of 9% over the last decade.

Biggest negative contributors

Company Total return (%) Contribution to fund (%)
Provident Financial -57.1% -2%
WPP -8.1% -0.2%
Fidessa -6.7% -0.2%
Tritax Big Box -4.6% -0.2%
BCA Marketplace -3.1% -0.1%

Past performance is not a guide to the future. Source: Bloomberg 01/08/2017 – 31/08/2017.

We have covered the circumstances surrounding Provident’s profit warning and subsequent sharp fall in our August blogs to investors. Suffice to say it was easily the largest faller and held the fund back 2% in the month. At its low point, the stock traded at 425p and is currently around 820p. We can see a route toward the business recovering some of the lost ground, but with substantial trading and regulatory risks remaining. We have taken the decision to reduce the fund’s holding and sold half the position during a tentative rally, obtaining a price of 905p.

WPP shares reacted badly to a small reduction in the company’s forecast for revenue growth during the remainder of 2017, which is now seen as flat to +1%, compared to earlier predictions of “around 2%”. Major advertising groups are struggling with the pace of change, as the industry shifts ever further toward digital communications.

WPP has been notable for embracing this shift, along with a tilt toward faster growing regions, but it needs to become even more agile. The group’s creative position remains strong, winning the top award at Cannes for the sixth year running and new business wins have picked up. Gongs however, do not pay the bills and WPP must continue winning new business to improve its standing with investors.

Sentiment towards BCA Marketplace weakened after the Society of Motor Manufacturers & Traders (SMMT) issued a report saying that sales of second-hand cars had plummeted by 13.5% in the second quarter of 2017. The figures turned out to be completely wrong and had to be recalculated.

The corrected figures showed that sales of used cars only fell by 0.7% in Q2, and sales for the first half of this year actually went up by 1.3%. BCA shares haven’t fully recovered from the fiasco reflecting a certain nervousness amongst investors over the health of the UK car market.

It is the used car market that matters most to BCA. Recent results from UK car dealers continue to suggest that, while the new car market has weakened somewhat in recent months, the used car market continues to hold up well.

Summary

The economic environment remains uncertain, with North Korea’s actions dominating the headlines currently. We spend little time worrying about these factors, which we can neither control nor predict. We think our time is much better spent researching companies, seeking out those with potential to grow their dividend sustainably over time.

The dividend cut from Provident Financial was disappointing but overall we are encouraged by the dividend growth being delivered by the majority of our holdings (see our previous blog for more detail). This underpins our confidence in achieving the 3.9p per unit payment we are targeting for the fund’s first twelve months.

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Important - This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information. Unless otherwise stated performance figures are from Bloomberg and estimates, including prospective yields, are a consensus of analyst forecasts from Bloomberg. They are not a reliable indicator of future performance. Yields are variable and not guaranteed.