HL Select UK Growth Shares - Quarterly Review

Steve Clayton - Fund Manager

11 July 2019

The last three months saw the stock market return to a gentler pace of change after the sharp falls and recoveries of the previous periods. Overall, the UK stock market delivered a total return in the quarter of 3.3%, as measured by the FTSE All Share Index.

Economic growth looks to have weakened during the quarter, with the Construction sector especially impacted. Manufacturing activity slipped back, as stockpiling ahead of an expected Brexit in late March came to an end.

Uncertainties abound, with trade disputes between President Trump and pretty much everyone else sapping confidence abroad. Back home, Brexit and the broader political malaise have hardly helped to lift animal spirits. But despite this markets continued to make progress.

Predicting the future course of the stock market is rarely achieved with any accuracy and current conditions hardly help. We prefer to just focus on the individual companies that we invest in and look for signs of progress or setbacks in their longer term prospects.

If the companies’ revenues and profits perform as we expect, then we would expect the investments to prosper in the long run. Most of our investments are in companies with long track records of success. Indeed that is one of the most important factors we consider when making our selections for the funds. Please remember that past performance is not a guide to the future. All investments will rise and fall in value so you could get back less than you invest.

Fund performance

The fund made good progress during the quarter, advancing 7.5%*. The tables in the sections below show the shares that made the biggest contributions, good and bad, to the fund over the quarter.

Past performance is not a guide to the future. Source: Lipper IM*, Correct as at 30/06/2019.

Annual Performance

Past performance is not a guide to the future. Source: Lipper IM*, Correct as at 30/06/2019.

N/A† full year data unavailable as the fund launched in December 2016.

Strongest contributors

Past performance is not a guide to the future. Source: Bloomberg, Correct as at 30/06/2019.

Sanne Group enjoyed a welcome return to form after a while in the doldrums. The stock had suffered from unexpected management change, as we reported last quarter, but it had also reported strong underlying growth.

In a shift of sentiment the market has refocused upon Sanne’s growth potential which we believe to be strong. The Alternative Asset markets that Sanne serves look set to continue to receive strong investment flows whilst interest rates remain at rock bottom levels. This is fertile ground for Sanne, and we expect demand for their fund administration services to be robust.

We hold the shares because once signed up to administer a fund, the arrangement tends to continue for the entire life of the fund. That makes Sanne’s revenues highly recurring, which coupled with underlying market expansion creates a potent growth cocktail.

Merlin Entertainments and BCA Marketplace have both received takeover offers, allowing the fund to crystallize some gains.

Merlin, which operates the LEGOLAND parks around the globe, is being acquired by the family that own LEGO, who already held a large stake in Merlin. Backed by a private equity firm’s capital the bid looks like a knockout offer. We took the opportunity to exit our position after the bid was announced.

BCA Marketplace is being acquired by TDR Capital, a private equity firm with other interests in the automotive sector. We’re sad to see BCA go; we thought they had great potential for long term cash generation, even if automotive markets generally are facing an uphill struggle currently. Auctioning vehicles carries on, whatever the state of the new car market and auction lots are little more than a strip of tarmac, costing little to run.

Amongst the other major winners, many reported robust results.

We mentioned in last quarter’s review that GB Group had acquired IDology. The existing business reported organic underlying growth of 11.5%. We see a huge runway for growth in front of GB Group. Demand for their identity and location verification services from the e-commerce sector is buoyant, and many of their services end up deeply embedded in their clients’ workflows, giving them a strong recurring nature.

LVMH, our first overseas investment for the fund has enjoyed strong investor demand after reporting double-digit growth from Chinese buyers of its luxury brands, especially the Louis Vuitton leathergoods division.

Experian continues to lead the credit agency sector, aided no doubt by rival Equifax’s data breach a year or so ago. The data that Experian controls is getting more and more valuable in the digital economy and we believe them capable of growing strongly for years to come.

Relx is one of those businesses where it is easy to fall asleep whilst watching them grow. The markets they serve tend to be rather predictable and management show little sign of wishing to spring surprises onto shareholders. We like it a lot. The business is increasingly digital and almost entirely based around selling intellectual property, from academic research to risk analysis to customers who come back again and again.

Weakest contributors

Past performance is not a guide to the future. Source: Bloomberg, Correct as at 30/06/2019.

XPS Pensions, the defined benefit pension’s administrator, released very disappointing full year numbers on 27 June. Both profitability and sales came in below expectations and cash conversion was much weaker than expected. This led to a c. 40% decline in the share price.

We are quite frankly dismayed by these results. XPS should be a highly predictable cash machine. The business should be thriving, given a number of recent favourable regulatory developments in the marketplace. The reason it isn’t can only be put down to poor management execution.

The Punter Southall (PS) acquisition has proved much more difficult and time consuming to integrate than management anticipated and this has distracted them from taking advantage of opportunities in the core business. It’s now clear the management team didn’t understand the PS business as well as they thought and the integration process has been poorly handled.

Just Eat continues to wrestle with the challenges of the fast evolving food delivery market. In particular it is the transition from being an intermediary, who connected hungry people to takeaways, to also organising the delivery service on behalf of branded chains like KFC.

The business has actually performed pretty well, although UK order growth is slowing. But the cost of setting up physical operations is significant. Sentiment was knocked during the quarter by the announcement that Amazon was funding rival operator Deliveroo.

Burford Capital gave a confident presentation to investors in its Capital Markets event earlier in the year and has subsequently reported a positive interlocutory judgement in its largest case to date, the Petersen affair, when the US Supreme Court refused Argentina’s request to transfer proceedings to Buenos Aires.

The group sold a further slice of its interest in the case at a price valuing its original interest at $1bn. We think the weakness in the shares is more connected to the well-publicised need for liquidity of another investor in the company and we remain committed to Burford.

Transactions

Alfa Financial Software has been a very disappointing investment. Shortly after starting a position in March 2018, the company issued a major profit warning, owing to a number of clients delaying their software implementations. Initially we were prepared to give them the benefit of the doubt and retained our position. However, since then, the company has made little progress in signing up new customers.

We aim to own companies that are largely in charge of their own destiny and with Alfa we got it wrong. The business model has proven to be much less predictable than we had anticipated. As such we have been gradually selling down our position over the last few months and have now fully exited.

We also exited from Bunzl, which we discussed in an earlier blog, so we won’t repeat. Likewise, we discussed the fund’s purchase of Adobe in another earlier missive. So far, Adobe has gone up since we bought and Bunzl has gone down since we sold.