HL SELECT UK INCOME SHARES

How are the newcomers settling in?

Managers' thoughts

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Steve Clayton - Fund Manager

16 May 2018

Back in January we introduced some new investments into the portfolio with the aim of boosting the fund’s exposure to faster growing companies. As we head toward the half year stage, we thought it worth taking a peek to see how the new names have fared in their early months.

We introduced five completely new names, and finished building a position in one other, Xafinity that we had begun building in December last year. Here is how they have fared so far.

Auto Trader - well placed

Auto Trader is currently trading around 7% higher than our average purchase price. The company dominates the automotive online listings market, being far larger than all the other competitors. The stock had been held back by fears over a decline in the new car market and any feed through to the second hand market, where Auto Trader does most of its business.

Auto Trader has an extremely strong market position. It acts only as an advertising venue, rather than owning the vehicles and with the marginal cost of adding a new client being close to zero, the business generates cash even when it is growing quickly.

The business is recession-resistant, if not recession-proof, since customers, who are largely motor traders, rather than consumers, will still have to use Auto Trader to advertise their stock regardless of market conditions.

Some customers will shut down if the economy takes a hit, and others might drop some of the bells and whistles that Auto Trader sells alongside the core listings. But by and large, the clients will keep coming back and with margins of around 65% Auto Trader is likely to remain highly profitable regardless. Plus we consider it to have excellent dividend paying potential.

Rightmove – boosted by its rival

Rightmove came into the fund and is now trading just over 2.7% higher. We recently attended a meeting with the company and came away encouraged by the pace of innovation underway at Rightmove.

Home buyers and sellers tend to just see the properties on the website or the app and don’t realise the breadth of services Rightmove are providing to the agents, which help them advise sellers on pricing, monitor market activity and identify the best areas for agents to target in their locality. Lettings is an interesting source of future growth, with Rightmove driving innovations to simplify the process for landlords and tenants alike.

In recent days, both Rightmove and AutoTrader have enjoyed a boost from a cash takeover offer for ZPG, the company that owns rival listings site Zoopla. Zoopla is the number two player in property listings, yet a consortium has paid a high multiple of earnings to take it private. What multiple might the market leaders in UK property and vehicle listings be worth?

Compass - catering for the future

Compass Group is the world’s leading contract caterer, running works canteens, food concessions everywhere from shopping centres to hospitals and sports stadia. The shares are currently about 2% below the level we bought in at, having just reported slightly dull, but worthy interim results.

Compass is a prodigious cash generator, for often it operates out of kitchens that are owned by their clients, requiring little upfront investment on Compass’s behalf. Underlying growth is solid enough, even if currency conversion is a bit of a headwind currently. We see little to suggest that Compass will not become a very successful investment for the fund in the years ahead although, of course, this is not guaranteed.

It’s important to remember that we are investing for the years, not the days or months ahead. In the short term, markets are erratic, but in the long run, companies that deliver growth tend to win out.

GB Group - ahead of expectations

GB Group is delivering growth in the short term too. A recent trading update confirmed an acceleration in their underlying rate of growth to 17% and the shares responded smartly, up 25% since they entered the fund. They will probably need to consolidate for a while after such a spike, but we remain big fans of the business.

GB allows online merchants to validate the identity of customers and facilitates employers’ DBS checks on the backgrounds of prospective staff. Customers embed GB’s software systems into their own workflows and tend to remain with the group once signed up.

This combination of repeating revenues from software with limited marginal costs of maintenance makes GB a great cash generator and indeed the trading update revealed a net cash position well ahead of analyst’s expectations.

Just Eat - bumpy delivery

Just Eat connects hungry people to food delivery outlets like pizza parlours and curry houses, who then deliver the meals to the diners themselves. So far, it’s been a bumpy delivery. We bought in at 805p and the shares promptly headed higher, getting within a whisker of 900p.

Then the group announced a push into working with branded restaurants, like KFC and Burger King, with Just Eat organising the delivery service themselves. That sent the shares crashing down below 700p, before mounting a fight back, currently standing just below our purchase price.

The company are spending around £50m trialling the delivery service, which has spooked the market. Historically, the group always said it preferred to deliver the order to the restaurant, not the food to the diner. It is a big shift in strategy, and the jury is out.

If the trial does not succeed, Just Eat can stop trying and go back to its former marketplace model. They have experience of running deliveries in their Canadian subsidiary, Skip the Dishes, which they can transplant over to the UK.

The business is still growing at approaching 50% and generates cash at a faster pace than most businesses can ever aspire to. They are going to set out their plans in more detail at an event in June and we will be there.

All of these companies have substantial potential to grow. Rightmove, Auto Trader, GB Group and Just Eat are leading their sectors of the digital economy. Compass provides an essential service globally, with plenty of scope to add new locations, for only around half of the market has outsourced so far.

Xafinity - on course

Xafinity is the pensions administrator that we added to the fund, starting in December. We’ve met with them since and the company has put out a confident trading update. The share price has hardly budged so far.

Xafinity have bought a major competitor and we expect to see them participating in further consolidation of a still fragmented sector in the years ahead. With secure, long term cash flows coming from administering schemes that typically have decades of life yet to run, Xafinity should be an excellent income stock for the fund.

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