HL Select UK Growth Shares - July Review

Steve Clayton - Fund Manager

8 August 2018

The UK market began the second half of the year strongly with a total return, including dividends, of 1.3% during July. Strength was driven by the consumer staples sectors, which provided around half of the market’s overall return and health care stocks which delivered much of the rest.

Positive sentiment came from signs that trade tensions could be easing and generally positive economic growth indicators. The US reported its strongest pace of expansion for several years.

Darker clouds came in the shape of sharp falls in the prices of some leading US technology companies after disappointing earnings reports from Facebook and Netflix.

How did the fund do?

The fund made progress during the month, improving 1.4% in value, just ahead of the wider market return. Positive impacts to the fund’s relative performance came from its positions in the Consumer Staples sectors and above all, the performance of Burford Capital within the Financials sectors, offset by weaker outcomes from Consumer Discretionary, Healthcare and Technology sector positions.

In the table, we compare performance of the biggest positive and negative stocks by their relative contribution to the fund’s return*. Remember these details are over a short period of time and past performance is not a guide to future returns.

Biggest positive and negative contributors

Past performance is not a guide to the future. Bloomberg 01/07/2018 – 31/07/2018

*Relative contribution: The best way to explain this measure is with an example. Burford Capital went up by 22.9% in the month. Through the HL Select UK Growth Shares fund, you have a 4.9% position in this company but if you had invested in the UK Stock Market (FTSE All-Share index) instead, you would have no exposure to Burford because it’s listed on the FTSE AIM market. The difference between these weightings, multiplied by the company’s performance, is Burford’s relative contribution to your return.

For most of these companies there was no obvious reason for their positive or negative contribution. But we did have many of our companies report trading updates during the month, so we’ve taken the opportunity to write a longer update on each of these stocks.

Burford Capital – happy with our largest holding

Burford Capital reported interim results that promptly sent the stock sharply higher. Many analysts had expected the company to report lower sales and profits, because last year had seemed exceptionally strong.

Burford provide little guidance about likely outcomes, because they themselves have little visibility as to when cases will actually settle. Burford only recognise revenues and profits when cases make definitive progress, and even when they win, the full amount will not be recognised until it has been received.

So when the company reported a 17% rise in income and profits and a 61% leap in cash generation, it was always going to be well received. The group committed $540m to new investments during the period. If they can maintain their success rate with the cases they finance then the outlook for profits is very promising as a result, although there are no guarantees.

Burford is pretty unique. Investing in the outcome of other businesses’ legal disputes is far removed from the ups and downs of the wider economy and stock markets.

But they are the leading provider of litigation finance, which itself is still an under-developed market, with only a small fraction of cases utilising third party funding. So we remain very happy with running Burford as our largest holding in the fund.

The group also revealed a further increase in the value of the Petersen matter, a dispute with Argentina regarding an expropriated oil company. It may be years before that case is decided, but it holds the potential to generate substantial profits for Burford.

Diageo – consistency its greatest attraction

Diageo, purveyors of Guinness and Johnnie Walker, released full year results that were pretty close to market expectations.

Diageo’s consistency is its greatest attraction. The group has generated over a billion pounds of free cash flow in each of the last fifteen years, supporting an unbroken record of dividend growth, stretching back into the last millennium.

With margins set to rise and exchange rates posing less of a headwind to growth, the outlook for the group seems encouraging.

British American Tobacco – up for the challenge

British American Tobacco’s (BATS) half year results contained few surprises, confirming the group is on track for another year of constant currency earnings growth (i.e. growth after the effect of currency movements have been eliminated).

The sector has been a weak performer over the last year because of regulatory pressures and concerns over the transition from traditional combustibles to Next Generation Products (NGPs). The sharp rally in the share price following these numbers suggests to us that the valuation already reflects a lot of bad news.

Despite slower than expected uptake of Next Generation devices in Japan and South Korea, BATS remains confident of exceeding £1 billion of NGP revenues in 2018, with a number of new launches planned for the second half.

Growth in the traditional cigarette portfolio is also expected to pick up. Meanwhile, cash generation remains robust, underpinning a prospective yield of 5% (variable and not guaranteed). We acknowledge that the transition to NGPs creates uncertainty for the wider industry, but the evidence so far suggests BATS is up to the challenge.

Reckitt Benckiser – improving outlook

Reckitt Benckiser (RB) have raised their outlook for the full year, following a strong second quarter. RB reported 5% sales growth and a 12% increase in earnings per share, allowing the group to lift the interim dividend by 6%. The shares jumped 8% on the day of the announcement.

RB is busily splitting itself into two divisions, one focused on consumer and infant health, with the group’s Home and Hygiene products in the other.

Progress is said to be on track, and $75m of an expected $300m cost savings from the integration of Mead Johnson Nutrition (MJN) into the Health business have been secured so far.

RB look to be delivering against targets, after a few tough quarters. MJN, which took RB into the infant formula market in China and the USA is looking increasingly promising. The business had been struggling when RB acquired it, but sales are now moving apace, led by renewed strength in China.

Last year was a tough one for RB, but growth now looks set to accelerate. Strong cash flow underpins the dividend, which we expect to grow consistently given improving profitability and ample dividend cover although there are of course no guarantees.

Rightmove - impressive growth

Rightmove’s half year results showed double-digit growth across the board (including a 14% rise in the interim dividend), although this wasn’t enough to prevent the share price from falling.

The shares had been very strong up to that point and with no new positive catalysts we are not surprised to see some profit-taking.

This growth is all the more impressive given the pressures being faced by the group’s estate agency customer base, which is suffering from a very low level of housing transactions. To us this speaks volumes about the value its products provide.

As well as the core listings business, Rightmove provides lead generation and administration tools that are integral to the day-to-day operations of its customers. This explains why the Rightmove subscription is one of the very last things an estate agent will cut back on in difficult times.

So long as market conditions don’t deteriorate to the point where large numbers of estate agents start exiting the industry, we think the prospects for Rightmove remain strong.

Ascential – mixed bag

Ascential’s half year results were slightly mixed, with a very strong performance from Money 20/20 and digital-subscription products offsetting weaker performances from the marketing brands – Cannes Lions and MediaLink.

Having met with management we are reassured that the declines in marketing should prove temporary, reflecting industry pressures but also internal actions from the company to raise long term growth prospects.

For example, the Cannes Lions festival underwent a major restructuring this year, with the number of days shortened and the removal of several award categories.

The changes have been very well received by customers giving the group confidence that Cannes can return to growth next year.

Outside of marketing, the portfolio remains in strong shape and the balance sheet is now debt free following the recent disposal of the Exhibitions business for £284m. We expect this money to be used for acquisitions which further bolster the group’s digital credentials.

Ideagen - bang in line

Ideagen’s full year results were bang in line with expectations. Revenue, profit and earnings per share all grew by more than 30%.

Demand for the group’s risk and compliance based software shows no sign of slowing down, retention rates remain very high at 96% (illustrating the stickiness of the software) and the proportion of recurring revenues continues to rise.

The integration of recently acquired businesses is progressing to plan. Although deal values have moved up, they are not prohibitive for the type of business Ideagen is trying to buy (small and niche).

While never without risk, the group’s track record of identifying and integrating acquisition targets is excellent so we expect this to be an on-going source of value creation.

Medica – sticking with it

Medica has until recently proved itself an unpalatable medicine within the fund, but we are sticking with the holding.

The group provides Teleradiology services, the interpretation of scans and X-rays remotely. This allows hospitals access to Medica’s radiologist services outside of regular hours, or to work through backlogs of scans that have built up.

An interim trading update in July gave reassurance on the group’s performance. Organic revenues have grown by 18% compared to last year, with demand buoyant.

Fully qualified radiologists are in short supply, with too few having passed through training for many years. Medica can offer flexible working, meaning it can appeal to radiologists who might otherwise be retired, or looking to take career gaps to raise families.

Recruitment rates in the first half rose sharply, giving the group more capacity. The shares reacted well, rising almost 20% on the day. If Medica can deliver an equally robust full year results the group could begin to see something of a re-rating.

Past performance is not a guide to the future. Source: Lipper IM to 31/07/2018.

*Full year data prior to July 2017 is not available.

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