HL Select UK Income Shares - October Review

Charlie Huggins (CFA) - Fund Manager

8 November 2017

The stock market enjoyed a robust performance during October. A total return of almost 2% was driven by strength across the board, especially within the energy (where we have zero exposure) and information technology sectors, which both gained over 5%. The only sectors to fall in value by any meaningful degree were healthcare and utilities, both losing a little over 2%*.

The month marked the 30th anniversary of the Crash of 1987, an event that saw billions wiped off stock markets around the world. Thankfully there was no repeat. Economic news was broadly as expected, whilst politics continued to be dominated by Brexit at home and President Trump’s “unique style of governance” across the pond. Little changed, despite many headlines.

The energy sector recovery was driven by signs of much improved cash flows in the sector as efforts to mitigate the lower oil prices of recent years bear fruit. Mining shares rallied in sympathy. GlaxoSmithKline made the largest negative contribution to the market after a poorly received set of quarterly earnings. The bank sector achieved the feat of providing both a leading positive contributor in the shape of HSBC, and a leading loser in Barclays, where Q3 figures were greeted with dismay.

Below we highlight the biggest positive and negative contributors to the HL Select UK Income Shares fund performance in October. 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 01/10/2017 – 31/10/2017

Domino’s Pizza posted an encouraging trading statement, showing strong gains in sales across its system, especially in some of its overseas operations. The company looks to have navigated through the patch of tougher trading it suffered at the start of the year, and should begin to move toward a period of easier comparatives after the important fourth quarter.

Deliveroo, Uber Eats and Just Eat are all offering consumers new routes to enjoy meals delivered to the door, but Domino’s continues to dominate the Pizza sector. With a highly cash generative business model, based around franchisees who own the stores and put up most of the capital needed by the system, we remain big fans of Domino’s.

Relx has gained a reputation for consistency in recent years and its nine month trading update did little to change that perception, with underlying revenue growing by 4%. All-in-all, we’re pleased with how the business is performing currently and remain confident in the group’s long term prospects.

Relx enjoys high levels of recurring revenues generated from supplying must-have information to its customers. Motor insurers use the group’s data to help them assess risks and set prices for their policies; scientists’ subscriptions to Relx’s academic journals give them access to cutting edge research. We like businesses supplying products that are integral to the day-to-day operations of their customers because it tends to lead to strong pricing power and margins. Relx very much fits this mould.

Like Relx, Sage generates recurring revenues from providing a must-have product to its customers; in this case accountancy software to small and medium sized businesses. This leads to predictable earnings and cash flows, both attractive qualities given the uncertain economic and political environment.

Combined, Domino’s Pizza, Sage and Relx added 0.8% to the fund’s value during October.

Biggest negative contributors

Past performance is not a guide to the future. Source: *Bloomberg 01/10/2017 – 31/10/2017

GlaxoSmithKline reported what looked to us to be a “business as usual” set of Q3 numbers. Sales were up 4% to £7.8bn for the quarter and adjusted earnings per share moved ahead 3%. Newly launched pharmaceutical products grew by 40%, more than offsetting declines in older drugs, and the group won some important new drug launch approvals.

GSK also reiterated its commitment to paying out a dividend of 80p per share this year and next, with a plan to grow the payment once free cash flow improves.

The share price reaction was initially muted, but slipped after management commented on a conference call that they would look at Pfizer’s consumer health business, reportedly up for sale. A likely cost of at least £12bn for this asset could leave the balance sheet looking rather stretched.

We would be surprised if GSK took this option, given the importance of the dividend to investors, but we cannot rule it out and continue to monitor developments closely. The position cost 0.4% of the fund’s value during October.

Weakness in BCA Marketplace can be attributed to concerns over the state of the automotive sector. Rapid growth in PCP finance plans in recent years suggests a large volume of used cars will come to market in the next few years. With real incomes under pressure, the used car market could see tougher trading.

One thing is certain, those cars will need to be sold. BCA earn most of their money in fees and commissions from selling the vehicles passing across their auction sites. More vehicles being sold ought to be good for them.

BCA’s webuyanycar subsidiary does take ownership, but only for a few days, limiting the scope for a hit on residual value. Loans made to dealers are secured on the cars themselves and as the leading auctioneer, BCA can convert problem loans back to cash pretty swiftly. So we remain happy with the position, which cost 0.2% of the fund’s value in October.

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Please note the author or his connected parties own shares in GlaxoSmithKline and Imperial Brands.