HL Select UK Growth Shares - First Quarter Review

Steve Clayton - Fund Manager

18 April 2019

The first three months of 2019 saw a welcome recovery in the stock market, reversing much of the weakness of late 2018. Economies around the world have generally proved weaker than expected, confounding expectations of higher interest rates later in the year. With yields in bond markets contracting, the attractions of income from shares provided support to markets.

It was, in many ways, the mirror of the previous quarter, which had seen rising bond yields and expectations of higher interest rates in the USA and the UK depressing sentiment and sending share prices lower.

At home of course, the market mood has been much influenced by the course of the Brexit process. As expectations of a hard Brexit receded, domestically oriented shares enjoyed something of a recovery since December. Retailers in particular enjoyed a relief rally after Xmas trading turned out merely to be poor, rather than the utter disaster that had been hyped in the media.

The UK economy has benefited from precautionary stockpiling which has supported the manufacturing and warehousing sectors. We would expect this to unwind in future, which could pose some headwinds to UK economic growth.

The services sector has recently slipped into reverse, as the uncertainties surrounding the course of Brexit continue to swirl. With so many variables at play in the UK currently, near term predictions are even harder than usual.

With the funds’ companies having substantial exposures to international markets we continue to hold the view that the course of Brexit will have relatively little impact upon their long term value. Changes in the value of sterling could be the larger contributor to any impact, as we saw after the referendum.

Fund Performance

Past performance is not a guide to the future. Source: Lipper IM, correct as at 31/3/2019.

The fund registered useful gains in the first quarter, but nevertheless lagged the market by 2.2%. The table below shows the shares that made the biggest contributions, good and bad, to the fund over the quarter:

What pushed the fund forward?

Past performance is not a guide to the future. Source: Bloomberg, 31/12/2018 – 31/3/2019.

GB Group delivered a strong showing, outperforming the market by over 6%. Its substantial weighting in the fund, approaching 5% led to it adding almost 0.8% to the value of the fund.

During the quarter, GB announced the acquisition of IDology, a US firm specialising in electronic ID verification and fraud prevention services. GB had been working with IDology on shared clients for some time, so they were able to have confidence it would be a good fit, especially alongside their Loqate customer location services.

At £233m, this is GB’s largest deal to date and the company part financed the deal with an equity issue, which we participated in. So far, we’re pleased with the outcome; we increased our holdings at 420p per share and the stock is currently trading at over 500p. We recently met with the group and came away reassured that, so far, the acquisition is performing as hoped. We remain excited about GB’s long term potential.

Tobacco shares have been under the cosh lately, and we regard the strength of BAT last quarter as more of a recovery from extremely negative sentiment, rather than a result of improved trading. During Q1 the industry lost a major court case in Canada, the ramifications of which are set to rumble on as the case proceeds through every possible further stage of appeal for several years to come.

In the meantime, much of the value within the industry is dependent upon the success of new generation products, believed to be less harmful, where volumes are rising fast as smokers switch away from traditional tobacco products.

Rightmove and Auto Trader both enjoyed strong performances as investors warmed to their ability to continue generating strong cash flows, even in difficult underlying markets. Both home and automobile sales have struggled somewhat of late, but the value that these companies create for estate agents and motor dealers is so substantial that they command extraordinary pricing power, enabling high profit margins to be earned in almost any environment.

Challenges do exist though; if agents and dealers were to shut up shop altogether, that would impact on revenues. So far however, all the evidence suggests that whilst customers remain in business, the last cost they feel able to cut is their subscription to Rightmove or Auto Trader.

Just Eat has challenges of its own, not least the threats from Deliveroo and Uber Eats. Its response has been to invest in its own delivery offering, at great cost. Whilst that had been weighing on the stock, the arrival on the share register of an activist investor, Cat Rock Capital Management has livened things up no end.

Cat Rock are arguing that new management should be appointed, that a valuable stake in their Latin American associate should be sold off and that ultimately, Just Eat should seek to merge with an international rival.

So far the company is playing hard to get, but the prospect of radical changes to its strategy and a possible merger or takeover has highlighted the value within Just Eat.

LVMH strengthened after robust full year results and encouraging comments on Chinese demand for luxury goods. The group saw demand for their Fashion & Leather Goods surge by over 15% in the Xmas quarter, underlining the vast strength of the Louis Vuitton brand.

What held the fund back?

Past performance is not a guide to the future. Source: Bloomberg, 31/12/2018 – 31/3/2019.

Even in rising markets, there will always be some stocks that fail to participate. Looking at the list of laggards we can’t say that any of them have committed any great sins.

BCA Marketplace has made no announcements of substance, unless you regard the Chairman giving 2 million of her shares to her daughter for free as such. Certainly, one has to assume that young Ms. Palmer-Baunack regarded it so, but it hardly counts as a reason for the shares to decline by 10% in the quarter.

Sentiment surrounding the automotive sector is depressed, with manufacturers reporting tough conditions. But BCA is not exposed to new car sales, just the buying and selling of second hand vehicles and associated services. Their most recent trading update, back in November was most encouraging, we felt.

Sanne Group had a volatile start to the year, falling sharply after announcing that the Chief Executive was retiring, even though he appeared to have only just grown out of his school uniform (he’s 42).

We met with Dean Godwin, the retiring CEO, his successor Martin Schnaier and James Ireland, Finance Director. We’re happy that Dean’s decision was an entirely personal one, and that Mr Schnaier, previously the Chief Operating Officer is a strong replacement. Their results showed the group reporting double-digit organic growth and we think that the opportunities in front of Sanne look exciting. We expect it to report strong growth for many years to come.

XPS Pensions have made no announcements since late November, other than a change of non-executive director. So the stock’s performance looks odd. We confess to feeling a little apprehensive currently, for the company took part in a major merger a little over a year ago, and revealed slightly underwhelming progress when they reported their interim results.

On the face of it, XPS looks like an attractive growth story, supporting pension fund clients that will be around for decades. But we suspect that the market is going to remain sceptical on XPS’s ability to convert its opportunities into profit until it has demonstrated that the Punter Southall deal is delivering to plan and that top line growth is accelerating.

Past performance is not a guide to the future. Source: Lipper IM to 31/3/2019. Full year data prior to March 2017 is not available.

We are also launching the new HL Select Global Growth Shares fund to provide further global diversification for Investors. You can find out more about it here.