HL Select UK Growth Shares - June review

Charlie Huggins (CFA) - Fund Manager

11 July 2018

UK Equity Market - June 2018

The FTSE All Share Index paused for breath in June, ending the month broadly flat. Strength in more defensive sectors such as Utilities and Telecoms was offset by weakness in economically-sensitive sectors such as Materials and Financials; the latter buffeted by trade war worries.

HL Select UK Growth Shares fund - June 2018

Our limited exposure to the more economically-sensitive sectors such as mining helped the fund to deliver a positive total return of 1.50% this month, compared to -0.09% for the broader stock market.

The month had started on a bad footing after Alfa Financial Software, a recent addition to the portfolio, issued a profit warning wiping almost a percentage point from the fund’s performance. Thankfully encouraging news from a number of our other names, including a takeover bid for BCA Marketplace and well received results from GB Group and Auto Trader, more than offset this.

Positive contributors

BCA Marketplace (“BCA”), the Automotive Services group, enjoyed an eventful month, announcing a bid approach from Apax Partners on 11 June followed by strong full year results on the 28th. As Steve explained in his previous blog, we took advantage of the jump in the share price on the day the takeover bid was announced to lock in some profits by selling around a third of our holdings in BCA.

Before the market opened on Friday 6 July Apax Partners announced that they have decided not to make an offer for BCA, causing the stock to drop back toward its pre-bid levels. With the funds still sitting on cash, we took advantage of the drop in price to rebuild our positions in BCA. We think BCA is a fabulous business, with great cash generation abilities and we expect to retain a significant holding for the long term.

Sticking with the automotive theme, Auto Trader released strong full year results on 7 June with earnings per share and the dividend both growing by 15%. Sentiment towards UK domestic stocks, and auto companies in particular has been weak over the last 12 to 18 months. Although new car sales have declined by a double-digit percentage, Auto Trader is mainly exposed to used car sales which have held up much better.

Our investment case is not predicated on the level of car transactions, but instead the growing demand for data and digital services, which shows little sign of slowing down. The industry is still rather archaic, dominated to a large extent by old school salespeople who have yet to fully embrace digitisation. It seems inevitable that over time digital will rise further up the agenda and we believe Auto Trader looks well placed to benefit from this trend.

GB Group was another strong performer after releasing its results for the year ending 31 March 2018. Earnings per share rose by 17%, enabling the dividend to be lifted by 13%. The recent acquisition of PCA Predict has been successfully integrated and the rest of the business is also performing well. After meeting with management we remain convinced that GB is at a sweet spot in the ecommerce ecosystem and should continue growing at strong organic rates, although of course there are no guarantees. Management will look to mergers and acquisitions to further enhance growth but are determined to only buy assets that are high quality and culturally suited to life within GB.

Ascential confirmed that trading expectations for 2018 are on track, despite a weaker than expected performance from the Cannes Lions festival, due to reduced spending by the advertising agency holding companies. This was made up for by strong performances across digital information subscription products and Money 20/20, the global financial technology payments event. Later in the month Ascential announced the c. £20m acquisition of WARC, a digital subscription business that helps brands, agencies and media platforms assess marketing effectiveness. This looks like a nice addition to Ascential's digital product offering.

There was no meaningful news from the other names listed in the table.

Negative contributors

Past performance is not a guide to the future. Source: Bloomberg 31/05/2018 - 30/06/2018.

By far the biggest negative contributor this month was Alfa Financial Software, which subtracted almost a percentage point from the fund’s performance. This was disappointing especially given that we have only recently added this position to the fund. As we explained in last month’s review, delays in new and existing software installations have seen profit forecasts roughly halve. Alfa sits on tens of millions of net cash, so despite the sudden blow, the business remains healthy and can re-build. It retains its market position and even now has good profit margins. But it could get worse before it gets better meaning we have not added to our position at this stage (the fund’s weighting currently stands at around 1.2%).

Domino's Pizza announced that their Finance Director will leave with immediate effect leading to a c. 10% sell-off in the share price. We admit to being somewhat alarmed by this. Domino’s long serving FD, Lee Ginsberg retired in April 2014 and the group has worked through three successors since. Two lasted a matter of months, the latest departee, Rachel Osborne hung in there for twenty months. We have spoken to the company and can understand the reasons for the departure. No-one will stop ordering pizza because of this, Rachel Osborne apart, perhaps. However, we have made our concerns known and would now like to see some stability.

Just Eat held its Capital Markets Day on 27 June which both Steve and I attended. The day entailed a series of informative presentations from senior management, including a discussion on the push into own delivery services.

Up until now Just Eat has operated a ‘Marketplace’ model, with the restaurants handling the delivery themselves. Here, Just Eat is simply acting as a middle man, connecting takeaway owners with hungry customers via its platform. This business model is highly profitable and throws off cash because Just Eat doesn’t have to bear the costs of delivering food to the customer.

Recently Just Eat has been trialling delivery services with certain branded restaurant chains such as KFC and Burger King, which lack their own delivery network. Following these pilots it has decided to expand this part of the business further. In this model, Just Eat is responsible for getting the food to the customer (in the UK it has decided to outsource this function to a third party logistic provider) and must bear the associated costs. This is a more competitive market, occupied by the likes of Deliveroo and UberEats, and the economics are much less favourable with significantly lower profit margins than Just Eat’s traditional ‘Marketplace’ business. Inevitably, this has unnerved investors.

During the Capital Markets event Just Eat’s management laid out a strong argument in support of its new strategy. The high-margin Marketplace will remain central to its plans and will provide funds to steadily expand the delivery operations. Investment will weigh on near term margins. But looking at the bigger picture, adding restaurants like KFC and Burger King to its platform should make the proposition even more compelling, leading to more orders from new and existing customers. At the same time it should weaken the position of Deliveroo and UberEats, which unlike Just Eat do not have access to cash flows from a high margin Marketplace. There’s no guarantee this new strategy will work but we think the rewards that will accrue to the ultimate winner are worth the risks. We are maintaining our position.

There were no meaningful announcements from Medica or Burford.

Please note the author and/or his connected parties own shares in Reckitt Benckiser, Ascential and Sanne Group.

Past performance is not a guide to the future. Source: Lipper IM to 30/06/2018.

Please note the author and/or his connected parties own shares in Reckitt Benckiser, Ascential and Sanne Group.

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