HL Select UK Income Shares - November Review

Charlie Huggins (CFA) - Fund Manager

8 December 2017

The FTSE All Share index fell by 1.7% during November driven by weakness across the board. Sterling made decent gains against the US Dollar this month, although domestic stocks still generally remain out of favour with investors.

Companies that miss analyst expectations, even by only a small amount, are being severely punished. As are ‘old economy’ stocks whose business models are being disrupted by technological change; traditional retailers being the prime example here. Many businesses continue to perform well, however, particularly those considered to be on the right side of these technological forces.

Impact on HL Select UK Income Shares

Several of our companies released results this month. The domestic duo of BCA Marketplace and Close Brothers both reported encouraging progress, while Sage and Britvic issued better than expected full year results.

National Grid, Imperial Brands, Pennon, AstraZeneca and Paypoint reported solid progress during the month, although Greene King is still finding life tough (the company did however maintain its interim dividend) and Playtech delivered a disappointing profit warning.

We discuss a number of these developments below while highlighting the biggest positive and negative contributors to the HL Select UK Income Shares fund performance in November. Remember 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 01/11/2017 – 30/11/2017

The positive move in Ascential’s share price came shortly after their Capital Markets Day, which we attended, giving investors a deeper dive into three of the group’s businesses - Cannes Lions, MediaLink and Money 20/20. The event reinforced the quality and unique nature of each of these assets. With the group investing heavily in digital initiatives and new products to deepen its competitive advantage and drive stronger growth, we are confident of further progress from Ascential in the years ahead.

Sage Group’s share price rose following a strong set of full year numbers, which showed organic revenues growing by 6.6%, operating profit up 10% and the dividend rising by 9%. Encouragingly the group is now seeing rapid take up of its cloud-based software offerings, helping subscription revenues to leap by 30%. Overall, future growth prospects look better than for some time at Sage with the company guiding towards an acceleration in organic revenue growth to 8% in the coming year.

Despite on-going jitters over the health of the UK economy, Close Brothers and BCA Marketplace reported encouraging progress. Close Brother’s Banking division grew its loan book by 1.4% in the first quarter with margins and impairments remaining stable. BCA Marketplace reported excellent first half results with adjusted operating profit rising by 18%, reflecting strong progress from both the vehicle auctions and WeBuyAnyCar. The interim dividend was increased by 18% which we view as a strong vote of confidence from the Board.

Britvic rose after full year results came in comfortably above analysts’ expectations. Revenue and adjusted earnings per share both rose by more than 7%, underpinning an 8% rise in the full year dividend. Free cash flow rose despite heavy investment in the supply chain – this coming financial year is the last year of this investment programme. Once it is complete, free cash flow will improve substantially which we expect to support further increases in the dividend (although remember, dividends are variable and not guaranteed).

Imperial Brands rose on the back of full year results which showed the group investing heavily to re-ignite growth of its strongest brands. There are encouraging signs of progress here with Growth Brand volumes rising by 5.5%. Imperial’s cash flow was once again extremely impressive, enabling the group to grow its full year dividend by 10%, while paying down debt. The stock also benefited from comments by rival Japan Tobacco which suggested it may be moving into a predatory phase of deal-making. Several City analysts suggested that Imperial Tobacco could be a possible target.

Fidessa shares have been strong over the last 3 months, but had been rather weak between June and August. Business performance has remained steady during this period so we are struggling to explain these moves.

Biggest negative contributors

Past performance is not a guide to the future.

Source: Bloomberg 01/11/2017 – 30/11/2017

A profit warning from Playtech, the provider of software and services to the gambling industry, was particularly disappointing. On-going challenges with its Sun Bingo contract combined with a crackdown on online gambling sites from the Malaysian government, were principally to blame. As a result, the group expects full year earnings to be around 5% below the bottom end of market expectations.

The shares lost around a quarter of their value on the day of the announcement, which we felt was an over-reaction. They have since recovered somewhat, ending the month around 15% down. There are many things we like about Playtech’s business model, including a strong balance sheet and excellent market positions. However, changing regulations and government actions present a constant risk in this industry. For now we are maintaining our position.

Lloyd’s shares fell after the Bank of England raised the amount of precautionary capital that major banks must hold, as part of its annual stress tests on the industry. Lloyds still comfortably passed the stress scenario, which measures resilience in the face of a series of challenging possible future economic events. We note that Lloyd’s balance sheet is substantially stronger than it was during the global financial crisis giving us confidence in its ability to navigate a range of market conditions.

AstraZeneca shares fell despite reporting broadly in-line with market expectations and there was no significant news concerning Sanne, GlaxoSmithKline, RB or British American Tobacco.

Conclusion

Change is a constant in the business world, but right now it seems like things are changing faster than ever. Amazon is looking to conquer the world, with the group foraying into new industries at a relentless pace, consumer preferences are evolving rapidly, and the internet is changing the way we shop and search for a whole host of goods and services.

Our aim is to invest in businesses that can not only survive, but thrive in this evolving environment. Specifically, we are looking for businesses that are:

• Adaptable, rather than set in their ways
• Creating lots of value for their customers, rather than relying too heavily on price increases or a lack of transparency in their markets
• Protected in some way by a ‘moat’ (brands, network effects, scale; for example) that will remain relevant in this changing environment and can help defend against the threat of new competitive entrants.

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Please note the author or his connected parties own shares in Ascential, Imperial Brands, Sanne, GlaxoSmithKline, RB, AstraZeneca, British American Tobacco and invest in the HL Select UK Income Shares fund.