HL SELECT UK GROWTH SHARES
HL Select UK Growth Shares - New Monthly Review
Monthly roundup
HL SELECT UK GROWTH SHARES
Monthly roundup
Steve Clayton - Fund Manager
14 February 2019
So far this quarter, the UK stock market has been staging something of a recovery after the weakness of late 2018. The market bottomed just after Christmas Day and since then (at time of writing on 13 February) it has recovered by over 9%. Early days of trading in the New Year saw some pretty sharp rotations, with strong recoveries in some of the weakest performers of the previous months, and vice-versa.
In itself, this isn’t that unusual. We often see “bargain hunters” in the market, especially at the start of the year, looking to pick up stocks that have recently had a bit of a tumble. That can be enough to turn the stock around in the short term, but in the long run the business has to deliver to support a strong share price. Our experience is that often, “bombed-out” stocks are actually not yet fully detonated and must be treated with great care, ideally from a distance.
A much-hyped Apocalypse On The High Street turned out to be a tough, but survivable Christmas for most retailers and with worst fears not realised, retailing stocks have enjoyed a rally of around 15% so far this year. At the opposite end of the scale, Vodafone revealed tough trading in its European businesses sending the mobile telephony sector down almost 10%.
We’ve decided to change how we write about the funds, to try and make our blogs more relevant and engaging. Once a quarter, we’ll review performance of the portfolios so you can see what the main driving forces have been. In between the quarterly reviews we’ll be writing in more depth about the stocks we hold in the funds and the changes we make to the portfolios.
We hope you find the blogs interesting and please remember that you can check on the performance of your funds at any time on our website.
Ideagen is one of the smaller companies that we hold in the fund, with a market value of £310m and like many smaller companies is not that widely followed by city analysts. Ideagen provide software packages that allow businesses to perform Integrated Risk Management. This is more exciting than it sounds.
Companies using Ideagen products are found across a wide range of industries, from transport to construction, life sciences and manufacturing. What drives demand is that Ideagen’s products help their users meet regulatory obligations. Whether it’s Governance, Risk Management or Compliance that is critical, Ideagen helps firms capture critical data and then control, measure and manage these issues and report how they’ve performed. And regulations are rarely loosened in this world.
To use a product, the customer must build their peoples’ working practices around it to ensure the data is collected and available for monitoring and analysis. As a result, Ideagen end up deeply embedded into their customers’ daily activities. Switching to an alternative is sure to be bothersome and could have significant costs, once retraining is taken into account. So the group has a lot of recurring revenues and one of the key attractions to us is that this proportion is going up.
Historically, customers would buy a licence to use a product and then pay ongoing maintenance charges to pay for updates to the software, which would sit on their own computers. Increasingly though, software is now being bought and sold as a service. The software sits in the cloud and users access it via the internet. Instead of a big upfront licence fee, and smaller ongoing payments, the customer pays at a relatively steady pace.
In the short term, it costs the customer less, and Ideagen earn less in the early years of a sale. But in the long run, the value of all those annual fees for a cloud-based solution are likely to be significantly greater. Ideagen are converting older customers to the new model where they can and signing a rapidly rising proportion of new clients up to cloud-based solutions. We think this will make the value of the existing clientele greater and raise the value of new business to the group.
Ideagen recently reported half year results and we met up with the Chairman and Chief Executive to discuss the group’s performance. Revenues are growing organically at 8%, despite the switch to cloud-based products, which earn less in Year 1. The group now have recurring revenues equivalent to 100% of their operating costs, which is a great place to be, especially with those revenues growing strongly.
With the benefit of recent acquisitions of smaller software producers, something we hope to continue over the medium term, revenues rose by 22% to £21m for the half year. 67% of these are recurring and Ideagen see that proportion rising over time. Adjusted profits jumped 40% and the interim dividend rose by 15%.
Newly appointed CEO Ben Dorks has come from the sales side of the business, allowing Executive Chairman David Hornsby to focus on scouting out potential acquisitions. Costs are well controlled, with the group building up a strong software development centre in Kuala Lumpur to offset pressure on wage rates in the UK and USA.
We think the business is in great shape, with reliable growth drivers set to remain in place for many years to come.
Sanne Group provide fund administration services, typically to real estate investors, private equity firms or hedge funds. A recent trading statement saw the stock tumbling sharply, even though the group said they had seen strong performance and record new business. As always, the devil was in the detail. The overall result looks on track, but Sanne have reached the finishing post, despite their divisions running at very different speeds.
In the fast lane, Europe and Asia Pacific beat expectations, the USA continued to run at pace, and their Mauritian business accelerated as hoped. But South Africa has been tough and their division that services Private Clients has struggled (and failed) to stand still.
Overall, the group seems to have delivered better than expected revenue, but after a period of rapid growth both organic and acquired, the group needs to invest into its infrastructure to support future expansion. This has eaten into profit margins, leaving the overall profit performance in-line.
At the same time, Sanne announced the retirement of CEO Dean Godwin. Dean is 43. Markets don’t like unwelcome surprises and few were expecting Dean to hang up the reins anytime soon. The combination of a margin squeeze, a struggling (albeit minor) division and the unexpectedly early departure of the man seen as the architect of the group’s growth unnerved the market. In the days following the news, the shares dropped by almost 20%, before mounting something of a recovery.
Full details will only become available once the annual results are published in a few weeks’ time but it’s clear that Sanne has been suffering a degree of growing pains. The industry in which Sanne operates starts from a position of fragmentation with many smaller players. Despite this, there are scale benefits that can accrue to larger operators. Sanne had sought to be the consolidator that achieved that scale. A spree of deals in recent years left it needing to unify and simplify its infrastructure, whilst some management change was also required to cope with the increased scale of the group.
The underlying growth potential of the group appears undiminished, but the profit margins that Sanne will attain will no doubt be a degree lower than had been hoped in the near term. We like what Sanne does; revenues have tended to recur, because funds rarely change their administrators. Little capital needs to be deployed, for this is a know-how business, not heavy industry.
We are disappointed though to see the pace of change in the boardroom, with the original CFO from the time of listing already having departed. The new CEO has come from within, having joined in 2011 and most recently acting as Chief Commercial Officer. His first task will be to convince investors that Sanne can move through the current issues and return to a more consistent growth tack.
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