HL Select UK Income Shares: June Review

Charlie Huggins (CFA) - Fund Manager

6 July 2017

June has been a slightly more difficult month for the fund, not helped by a falling market (the FTSE All Share Index ended June 2.5% lower), sector headwinds (Materials outperformed, whereas Consumer Staples underperformed, for example), and some stock-specific weakness. With the exception of Provident Financial, which we discuss below, results from our companies have been generally encouraging, with solid updates from the likes of WPP, Greene King, and Legal & General; while full year numbers from BCA Marketplace showed profits growing by 38%.

Below we highlight the biggest positive and negative contributors to the fund in June. However this is over a very short period and past performance is not a guide to future returns. We are also pleased to reveal a new holding for the fund.

Biggest positive contributors

Only three of our holdings made a positive contribution to the fund this month:

Past performance is not a guide to the future. Source: Bloomberg

Standard Life gained approval for its merger with Aberdeen Asset Management this month. The combined group will benefit from much greater scale, with the merger offering the potential for substantial cost savings.

Legal & General issued a trading statement on 13 June, saying that it has had a strong start to the year. The group has completed over £1bn of bulk annuity sales and the market pipeline for UK bulk deals remains strong at over £12bn; while L&G Investment Management now has assets under management of over £950bn, having experienced £16.8bn of net inflows.

There was no news concerning Primary Health Properties during the month.

Biggest negative contributors

Past performance is not a guide to the future. Source: Bloomberg.

By far the worst performer this month was Provident Financial Group (PFG) after the group issued a profit warning relating to its Home Collected Credit division. PFG is making a substantial change to its business model in this division. This has led to higher than expected business disruption meaning profits are expected to come in significantly below expectations.

We have decided to maintain our position. Although we are disappointed with how this transition has been handled, we believe the problems in Home Collected Credit will prove temporary, and that the business will emerge stronger with time. Vanquis, their largest division, continues to perform well, meaning we expect the dividend to be maintained, but remember, dividends are variable and not guaranteed. You can read more about our thoughts on the profit warning here.

Sentiment towards Ascential, the owner of Cannes Lions, weakened after media giant Publicis said it will not enter work or attend award shows and festivals, including Cannes, in 2018, while it invests in a new technology platform. This looks like a one-off decision, specific to Publicis. Cannes Lions is too important an event for creative talent to ignore, with Sir Martin Sorrell, CEO of WPP describing it as the “Oscars of our industry”. We suspect Publicis will be back before too long.

Greene King reported full year results that showed revenues and profits up 7%, a 3.6% increase in the dividend and a return on capital employed of 9.4%. Their largest division, the Pub Company, delivered positive like for like (LFL) sales growth of 1.5%, whilst Pub Partners, which holds their tenancies saw LFL profits move ahead 5%. The group has completed the integration of Spirit ahead of plan, with synergies of £35m achieved.

There are a lot of positives in the Greene King story; the group’s scale gives it real clout and there is a great deal of asset backing to the group, with over £3.6bn of Property, Plant and Equipment on the balance sheet. But near term trading is tough, reflecting the costs of the National Living Wage, pressure on many consumers’ real incomes and growing competition in the casual dining sector.

This has driven the shares down to a level where, on consensus forecasts, they trade on a single-digit price earnings ratio and offer a yield of over 5%. Greene King has a history of steadily raising its dividend through thick and thin and with the payment covered twice by earnings, we see little chance of the group breaking its track record any time soon, although there are no guarantees.

New Holding – Sanne Group

We’ve added a new holding to HL Select UK Income Shares, in the shape of Sanne Group. The business provides fund administration services around the world to the managers of alternative investment products, such as private equity funds and leveraged debt investments. We’ve known the group for a while, and after a recent meeting with the Chief Executive of Sanne, decided that the time was right to add it to the fund.

The chief attraction is the repeating nature of Sanne’s revenues, coupled with the growth of the markets they serve. What they do requires technical skills and regulatory knowledge, rather than heavy investments into physical assets. That allows the group to generate lots of cash and as a result, we are expecting a rapid rate of dividend growth from the group in the years ahead.

Management are taking a sensible approach to using debt to fund deals, keeping the balance sheet in good shape. Recent acquisitions in the USA and Mauritius have increased the geographies served by the group and given it the scope to serve the larger, more demanding fund groups that seek global partners.

Sanne has an EU presence already, but we expect it to add further to this as a hedge against possible negative impacts on UK clients from Brexit. In the meantime, organic sales growth has been running at double digit levels (22%) in the last financial year and we expect to see continued progress in the current year. The stock’s dividend yield is modest, but consensus forecasts suggest sustained double-digit dividend growth in the next few years.

Summary

The UK election result has had relatively little impact on the markets or our funds. Although we invest in UK stocks, holdings like Unilever, Diageo and Reckitt Benckiser earn the vast majority of their income abroad. A number of our holdings benefit from technological trends, like the rise of e-commerce and data intelligence; which will continue regardless of who is in power. As such, we remain very happy with how the portfolio is positioned.

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Please note the author or his connected parties own shares in Aberdeen Asset Management, Ascential and Sanne Group.