[Commentary] Slater Growth Fund – Interim Report for the six months to 30th June 2019

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For a PDF of the Full Report, please click here.

Overview

The Fund delivered a return of +17.84%, compared to +13.12% of the IA OE UK All Companies Index. Over the last two years the United Kingdom market has moved sideways in terms of capital value, leaving total returns resting on dividends alone. The sprightly performance of the last six months was merely a bounce-back from the weakness in the second half of last year, caused by fears of over-tightening by the United States Federal Reserve. Taking the two years since 30th June 2017, the Fund has returned +12.83%, versus +6.85% of the IA OE UK All Companies Index. Over the last ten years, which were generally more buoyant than the last two, the Fund delivered 20% per year, versus 10% from the wider United Kingdom equity market. Are better times likely to return? We can hope so but we hope these figures show that the Fund’s approach can deliver in both good and more challenging conditions.

Commentary

Twelve stocks contributed over +0.50% in the half year. Only four stocks detracted by more than -0.10%. Topping the table was Future, which operates consumer websites and publishes related magazines. It targets the free-spending male hobbyist, advising them on which gadgets to buy and collecting a commission from the resulting ecommerce. During the period the share rose +102%, contributing +4.78%. A record breaking first half of the financial year was well received by the market triggering more broker upgrades. The shares continued to surge higher peaking in mid-June 2019, at which point we took some profits. We see more mileage in the share over the medium term given that significant additional returns can be unlocked simply by bringing ecommerce user spend in the United States closer to that achieved in the United Kingdom. In the second half of June 2019 the share price fell back after a bear note was issued on the stock. However, post period end, the company issued a further trading update countering this, confirming that full year results are expected to be ‘ahead of expectations’.

We were particularly pleased with the +1.30% contribution from serviced office company IWG, which leapt +63% after unveiling a promised, but clearly not widely expected, disposal of its operations in Japan. Net debt also fell by the £320 million sale value, strengthening the balance sheet. This transaction confirmed that third parties will pay a significant premium to acquire an IWG franchise. We expect further large gains as IWG continues to franchise additional territories and, in the case of major markets like the United States, there is an opportunity for numerous individual regions to be carved out. There is now the prospect of plenty of additional positive news flow as franchises are sold to fuel share price momentum. This will also result in IWG acquiring a far more attractive capital light business model generating annuity style revenues, which could also lead to a further re-rating of the share.

Life insurance giant Prudential rose +22% and contributed +0.93%, following a particularly poor second half of 2018. That weakness followed some softer than expected trading in Asia, which is overwhelmingly the focus of Prudential once it demerges its United Kingdom arm, M&G Prudential. The precise timing of the demerger is unclear but the expectation is rising that it will come this year. Demergers are supposed to create value by setting managements free and allowing investors to buy the assets they want. Sometimes they amount to little more than the jettisoning of a troubled division. In Prudential’s case we believe the split will be very successful. M&G Prudential has a large with-profits fund within it which we see as a hidden asset, given that shareholders own 10% of it. Over time we also expect Prudential to demerge its United States and Asian operations as there is little synergy or similarity between them.

dotDigital contributed +0.91% and the shares gained +36%. In February 2019 it reported a 25% rise in Earnings Before Interest, Taxes and Amortisation (EBITA) for the December 2018 first half. This has been driven by excellent growth from the ecommerce platforms. A key investor concern has been the dependence on one of the platforms, Magento, last year acquired by Adobe, which has its own offering in marketing communications. In fact, Adobe’s solution targets very large businesses, whereas dotDigital serves small and mid-cap customers. Also, in February 2019, it announced a three-year extension to its ‘Global Premier Partner’ alliance with Magento. Even more encouraging was the +498% growth in sales on the Shopify platform and +48% on Microsoft Dynamics. We expect the other platforms to contribute more revenues than Magento in the current half year.

Next Fifteen Communications advanced +30% and contributed +0.89%. The company continues to deliver strong returns as it builds its portfolio of marketing technology businesses. At the end of June 2019, the company confirmed that it had started the year in line with expectations and that it remained confident in its prospects for the full financial year. It continues drive returns by shuffling its pack of marketing agencies with Archetype formed in February 2019 from a merger of Text 100 and Bite, the positive effects of which should be felt in the second half of the year. Recent acquisitions continue to make a strong contribution to growth and management sees a strong pipeline of acquisitions in the United States and United Kingdom in pursuit of its on-going ‘buy and build’ strategy. Like Future, with its exposure to the United States, the company is a beneficiary of a strong dollar.

Online payments processing specialist, Safecharge International accepted an $889 million cash bid from Nuvei, a private Canadian company. During the period the shares climbed +83% and contributed +0.86%. The offer is at a premium to peers and locks in a material profit for the Fund, which is pleasing. At our last meeting with the company, the Chief Executive Officer made it clear that he either needed to acquire heavily or be acquired. The payment processing industry is one of scale and staying small is not an option. A satisfactory outcome.

Pharmaceutical services specialist Ergomed contributed +0.83% after the share rose +83%. A trading update in May 2019 confirmed that revenue and profit will be materially above current market expectations following a strong start to the year. Its Clinical Research Organisation (CRO) arm, in particular, has benefited from projects concluding positively. Trading in pharmacovigilance (PV), meanwhile, remains solid and management expects this performance to be sustained throughout 2019. Demand for its full range of pharmaceutical services are described as ‘generally buoyant’. The company has refocused exclusively on these two profitable, growing niches and is no longer distracted by drug development, which is behind the sharp improvement in its financial performance. In May 2019 a new Chief Financial Officer was appointed who had long experience in the CRO sector. We expect further consolidation in PV will have an impact on Ergomed, either as an acquirer or a target.

Codemasters delivered a very satisfying +0.78% contribution, powered by a +40% rise in the shares. The gain was driven by the company’s achievements rather than simply a natural bounce-back from the previous year’s carnage. In January 2019 the company announced a deal to supply technology to NetEase, a Chinese games giant, to help it develop a racing game for playing on mobiles. Thanks to this $8 million deal it raised guidance for its March 2019 year end results. In February 2019, Codemasters partnered with Motorsport Network, the world’s largest motorsport media company. Motorsport will promote its games on its website and will run competitions. This deal coincided with the launch of DiRT Rally 2.0. On 1st April 2019, the company topped off a great quarter with a further trading statement, reporting adjusted EBITDA of £18.5 million in the year to March 2019. This was a splendid recovery from last summer’s disappointing launch of Onrush. In June 2019, the Indian-owned Reliance Big Entertainment sold 14.3%, half its stake, at 220p. We bought some of the placed shares. Reliance is under financial pressure so we expect the other half to be sold reasonably soon. This might hold back the shares in the near-term but will be a welcome clearing of the decks once it happens. A renewal of the licensing deal with Liberty International, owner of Formula One, is the biggest pending event. F1 still represents about 40% of revenue. A successful negotiation should spur upgrades from brokers.

Online holiday business On the Beach bounced +42% and contributed +0.64%. In an industry where established names are tottering, On The Beach has ground out the numbers pretty reliably. March 2019 interim results in May 2019 reported a +16% rise in earnings per share despite only a +5% rise in gross profits. The company has been adept at flexing its marketing spend to protect operating margins. Last year’s sweltering summer caused many people to delay their bookings for this summer. A soggy June seems to have helped. The teetering condition of Thomas Cook has also been helpful, though On The Beach does make heavy use of its airline, so a complete failure would not be welcome. Expansion into Europe remains on the pending list, though we know the company hopes to make an acquisition on the Continent within eight months. Meantime it is busy with its new long haul and traditional package holiday offering. Seriously impressive considering the powerful headwinds.

Document management and shredding specialist, Restore contributed +0.63% after recovering +24%.  It is very much business as usual as attested to by a trading update for the first calendar quarter, which was in line with expectations. The core records management business continued its positive momentum with net box volume growth, whilst scanning is trading as expected and gearing up for a major exam scanning contract. The shredding business is described as ‘stable’ with a continued focus on tight cost control, whilst customer retention and new business development are said to be ‘encouraging’. Trading in the relocation business is ‘satisfactory’ and ‘consistent with prior year levels’. Sometimes being boring and predictable is for the best.

Liontrust Asset Management rose +22% contributing +0.52%. In June 2019 it reported that March 2019 year end pre-tax profits rose +55%. Assets under management (AUM) grew +21% to £12.7 billion and net inflows were strong. As of 25 June AUM had increased by a further +10% to £14 billion revealing that this momentum was continuing in the current year. Last year’s financial performance was achieved against a challenging backdrop with negative retail fund flows across the United Kingdom industry in six out of the seven months up to and including February 2019. It is hard to fault this business, which has been adept at spotting popular trends in fund management and hiring the teams to profit from them as typified by its Sustainable Equity Fund. Unusually for a growth stock, Liontrust also offers a generous 3.8% prospective yield covered almost two times by earnings.

NCC, Inspired Energy, Mears and ITV were the only slightly notable detractors. NCC fell -7% and detracted by -0.11%. In January 2019 the shares took a tumble after weak full year guidance and much discussion about staff retention problems. We are happy with the direction of travel and believe that in time the company’s powerful technical credentials will translate into a stronger performance.

Inspired Energy fell -14% and detracted by -0.12%. We rate the company but until the risk of a Corbyn government is lifted it will struggle to attract investors.

 Mears fell -21% and detracted by -0.21%. It had a stormy half year which began with the management’s reluctant decision to exit housebuilding. This followed intense pressure from investors concerned by the increase in debt. Friction with investors later led to an attempt to appoint outside investors to take over the direction of the company. The attempt narrowly failed but it is clear that this is a management on a final warning. The effort last year to win the large housing contracts for asylum seekers seems to have overtaxed the business. Those contracts were won but the win rate declined for smaller contracts. The shares closed the half year on a forward multiple of 8 and a yield of 5.3%. Down but not out.

ITV retreated -14%, leaving a -0.22% contribution. In May 2019 it reported that 1st quarter revenues fell -4%, with advertising down -7%. The company is pinning its hopes on the growth in video on demand and its 90% stake in BritBox, the streaming joint venture with the BBC. It is unhelpful that the BBC has decided to keep programmes on its iPlayer site for a year after first broadcast rather than the current one month. Viewers are sensitive to price, as Netflix’s recent slowdown has shown. So BritBox’s seems wise to have decided to charge £5.99 per month, versus the equivalent £9.99 at Netflix. At 30 June 2019 ITV stood on a yield of 7.3% and a forward multiple of 8.4.

 Purchases and sales

During the period we completed the disposal of Close Brothers, Quiz and XLMedia. We reduced the holding in Future slightly. We bought The SimplyBiz Group and we increased the holdings in Applegreen, Charles Taylor, Clinigen, Codemasters, CVS, Entertainment One, Ergomed, IWG and JPJ.

Outlook

The carnage of 2018 has reversed in part, as shown in the market’s recovery this year and the Fund’s own performance. But ratings are generally much more attractive than a year ago and we enjoy more choice in stock selection. The political and economic headwinds are well known. We continue to look for companies that can make their own weather, at least in the medium and long term.