HL Select UK Income Shares - March review

Charlie Huggins (CFA) - Fund Manager

6 April 2018

Global equity markets came under pressure in March as trade tensions between the US and China intensified and US technology stocks sold off sharply.

Politics will always have the potential to unnerve markets in the short term, but in the long run it’s the ability of companies to generate cash that matters. The global economy remains in good shape and most companies are growing their profits and cash flows.

Companies that are on the wrong side of technological change are the notable exception and we have positioned our portfolios as best we can to avoid these situations.

Over the last month the FAANG stocks (Facebook, Apple, Amazon, Netflix, and Alphabet's Google – none of which we hold in the fund because they are US listed) have declined by 8% on average, in the wake of Facebook’s data privacy issues. However it’s important to put these moves into perspective. Over the last year they have gained 38% and over 5 years they’re up 460%.

What might seem important in the short term often pales into insignificance when viewed from a long term perspective. We will continue to focus on the business results of companies we own rather than speculate on political, stock market and economic manoeuvres.

Fund performance

In similar fashion to February, the HL Select UK Income Shares fund held up better than the market in March, losing 1.5% compared with a 1.8% decline for the FTSE All Share. We discuss the major contributors below. However, this is over a very short period and past performance is not a guide to future returns.

Biggest positive contributors

Past performance is not a guide to the future. Source: Bloomberg 01/03/2018 – 31/03/2018

Sanne Group reported an encouraging set of full year results with revenues and underlying profits increasing by over 75%, driven mainly by recent acquisitions. A well thought-through and disciplined acquisition strategy can be a very effective way of accelerating growth, but buy the wrong business or pay too much and you risk destroying value.

The evidence to date suggests Sanne has bought well and we’re encouraged that recent acquisitions appear to have bedded in nicely. Overall the business seems in good shape. We believe organic growth prospects are strong and the opportunity for Sanne to further consolidate its markets is substantial.

Having been rather weak in the last 6 months, our consumer goods names had a better month. Unilever announced that it intends to combine to form a single legal entity in the Netherlands. This could see it removed from the UK’s FTSE 100 index but should better enable the group to make acquisitions and disposals, which we welcome.

RB rallied after discussions to acquire Pfizer’s Consumer Healthcare business ended. We are pleased to see RB’s management exercise such discipline. Hopefully, management can now concentrate on reducing leverage and improving the performance of the recently acquired Mead Johnson brands.

A day after the RB announcement, GSK also announced that it has ended its interest in acquiring Pfizer’s Consumer Health business. Instead GSK announced it will buy out Novartis's 36.5% stake in their Consumer Healthcare Joint Venture for $13bn (£9.2bn). We think this deal makes sense at it’s a business that GSK knows very well and the extra cash flow should help to underpin the dividend.

Tritax rose after solid full year results, accompanied by a 3.2% rise in the dividend. Increasing e-commerce penetration is boosting demand for large warehouse assets, and supply is currently unable to keep pace. As a result the group expect rental growth and values to remain robust in 2018.

Our utilities holdings (National Grid & Pennon) have been hit hard by fears over what a possible future Labour administration might do, but March was a better month as investors sought refuge in more defensive sectors. Pennon released a trading update on 26 March saying that financial performance is in line with expectations.

Biggest negative contributors

Past performance is not a guide to the future. Source: Bloomberg 01/03/2018 – 31/03/2018

Just Eat weakened following an announcement of excellent results, offset by a decision to invest in providing delivery services on behalf of branded restaurant groups such as KFC and Burger King. We suspect the wider sell-off in the US tech sector also contributed to this weak performance. The finer details concerning the expansion of its delivery operations will be outlined in a Capital Markets Day in June, which we will be attending.

Close Brothers fell despite reporting mid-single digit growth in profits and dividends at the half year stage. Impairments continue to run at very low levels. At some point more people will start defaulting on their loans, but the strength of the group’s balance sheet and margins means we think it ought to be well positioned to withstand this.

There were no significant announcements from HSBC, Imperial Brands, Greene King or Sage.

Outlook

Currency is likely to present a headwind for international earners in 2018, following the recent strengthening of sterling. That aside, we see plenty to be encouraged by. The vast majority of our companies are growing profits and dividends, and are quietly confident of making further progress in 2018 and beyond.

Past performance is not a guide to the future. Source: Lipper IM to 31/03/2018.

*Full year performance data not available

Please note the author or his connected parties hold shares in Sanne Group, Reckitt Benckiser, Tritax, GSK, HSBC and Imperial Brands.

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