[Commentary] Slater Growth Fund – Annual Report for the year to 31st December 2019

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Performance

Six months

1 year

3 years

5 years

Since launch*

Slater Growth Fund P unit class

+16.99%

+37.87%

+53.18%

+77.42%

+549.60%

Investment Association (IA) OE UK All Companies

+8.16%

+22.37%

+24.00%

+44.18%

+186.13%

*A unit class launch 30 March 2005

We are pleased with the Fund’s short and longer term performance. In 2019, the Fund was able to take advantage of mispricing that occurred as a result of the tumultuous final months of 2018 when share prices fell sharply.

Topping the table was Future, which operates consumer websites and publishes related magazines. It targets free-spending male hobbyists, advising them on which gadgets to buy and collecting a commission from the resulting ecommerce. The shares leapt +204% and the contribution was +9.44%. Full year results in September 2019 showed a 95% rise in adjusted earnings. Acquisitions in the United States (US) contributed strongly to growth, in particular as Future gradually raises the average revenue per American user towards the higher levels already achieved in the United Kingdom (UK). In the fourth quarter there was a change of direction when the company paid £140 million for TI Media, the publisher of over 40 well-established UK weekly and monthly magazines, such as Woman’s Weekly, TV Times and Horse & Hound. This was a departure both in being more female-oriented but also in increasing Future’s dependence on print as compared to the advertising and e-commerce from its tech-oriented websites. The purchase was part-funded this a £104 million placing. We expect most of the acquired titles’ content to migrate online.

Future likes to curate broker forecasts with an iron rod. After the full year results it loosened its grip a little, allowing the consensus for financial year 2020 to rise sharply. Some of the increase reflected the benefit from TI, but only modestly as it may not be included in profits until April 2020 for competition reasons. The shares closed 2019 on a forward price to earnings ratio of 25 and a price/earnings to growth ratio of 0.7. We cannot reasonably expect a similar share or profit performance this year, but we will see operational progress to continue, particularly in the US. Video will also be a highlight. Future has largely been a wordsmith but it sees video content growing much faster.

Serviced office company IWG contributed +2.54% after surging +109%. In March 2019 the company laid out its plan to sell its network to franchisees, leaving IWG to focus on marketing and other support services. In May 2019 it started the process with sale of its Japanese operations. This was followed by deals in Taiwan and Switzerland. Major disposals are expected in the US in the near term. Superior returns in serviced offices are achieved through selling additional services at high margins: for instance hiring out meeting rooms for conferences. This year should be transformational for IWG as its franchising campaign moves from the periphery to the heart of its network of 3,300 serviced offices.

Entertainment One succumbed to a $4 billion bid from toymaker Hasbro. This generated a contribution of +2.44%. Hasbro was interested in the Peppa Pig and PJ Masks franchises, with all their associated merchandise. Early hopes of a counter-bid came to nothing but this remains a very satisfactory outcome, lifting the shares 58% during the year.

Veterinary chain CVS closed off a year of spectacular recovery, having started the year with a warning and a plunge in its share price. By year end it had nearly trebled from the low. The contribution over the year was +2.43% and the price rose a giddy +73%. Chief Executive Officer Simon Innes was replaced by Chief Financial Officer Richard Fairman. We welcomed this move, as did the market, as it reflected the fact that CVS must rely on organic growth rather than acquisitions. Simon Innes was primarily interested in corporate deal-making. This became harder as private equity bid up prices and as the veterinary market reached a high level of consolidation. By contrast, Fairman’s focus in on operational improvement. A trading statement in November 2019 reported an 8% rise in like for like sales. The shares closed the year on a price to earnings ratio of 22. Current forecasts only assume a 1% growth in earnings in the next financial year, to June 2021, but we can see scope for upgrades as CVS continues to grow by improving rather than buying.

Liontrust Asset Management gained +86% and contributed +2.20%. Assets under Management (AuM) reached £17.4 billion on 1st October 2019, boosted by £2.7 billion from Neptune Asset Management but also reflecting a £1.4 billion inflow between April and September 2019. Interim results in November 2019 showed a 27% rise in earnings per share. The company has a great track record of spotting attractive sectors and then building or buying teams to service them. The sustainable investments team now handles £4.6 billion, nearly double the AuM when they were acquired in April 2017. We met Liontrust’s management to discuss the results. They explained that their focus is now on expanding sales on the Continent. By contrast they have no immediate interest in the US market.

Codemasters moved into top gear in the final quarter of 2019. The first important event was the sale in November 2019 of the last 14% held by Reliance Big Entertainment, which had owned the company outright before it floated. Reliance was a distressed seller and it acted like a slow puncture on the share price. Half year results showed a 5.6% fall in earnings, but this merely reflected the timing of major launches. The biggest news in the quarter was the up-to-$196 million purchase of rival racing games developer Slightly Mad Studios (SMS). The terms sound high but only $30 million was paid up front with the rest almost entirely funded from earnouts over the next three years. SMS has four games on consoles and PCs and it is also launching a game for the next instalment in the highly popular Fast & Furious film franchise. We are pleased with this deal as it reinforces Codemasters as the go-to producer of racing games. The broader portfolio will also make profits less sensitive to the launch timing of individual titles. The shares raced +74% ahead in the quarter and contributed +1.94%.

Document storage and shredding company Restore has well and truly emerged from the doghouse. Its shares rose +71% in the year, contributing +1.91%. We attended the company’s capital markets day in November 2019 which was a catalyst for its sharp rally. Newish Chief Executive Officer Charles Bligh set out his plans to promote cross-selling of the company’s various services. The main takeaway from the meeting was that Restore is focusing on operational improvement. Growth by acquisition is largely over. The share price action shows that investors put more value on organic growth than on profits derived from financial engineering. Investors will be watching closely to see if the promised cross-selling emerges and delivers upgrades to profits.

Ergomed continued its stunning transformation. A year ago it was afflicted by repeated commercial and accounting setbacks. It was also still tainted by its risk-sharing in some customers’ clinical programmes and by the fate of its own cash-hungry Haemostatix project. Move on a year and founder Dr Miroslav Reljanovic is firmly back in charge. No more risk-sharing projects are being undertaken and Haemostatix has been parked. The company is instead focused on expanding clinical research services in the US. The C-suite has been strengthened with a new Chief Financial Officer and the very welcome appointment in December 2019 of a Chief Operating Officer with deep experience in the US clinical services market. A year ago the main interest was on expansion of the pharmacovigilance (PV) division which collects data on drugs after launch. Now it is firmly on clinical research contracting. The logic behind this shift is compelling. PV is essentially an administrative activity which attracts large IT-based services competitors. Most contracts are derived from the large US pharma groups, where Ergomed is at a disadvantage due to its European base. Growth by acquisition is too expensive to be attractive. By contrast, expansion is much easier in the clinical services market because there is a ready supply of specialist sub-contractors. Essentially a clinical research organisation (CRO) only needs a marketing arm for winning business and an audit function to ensure the subcontractors work properly. The consolidation of competing CROs has created a market segment of smaller clinical trials which Ergomed believes is being neglected. Forecasts rose strongly in the quarter, helping the shares rise +150% and giving a contribution of +1.56%.

Alliance Pharma decided to abandon its efforts to commercialise Xonvea, a morning sickness drug. Acknowledgement of failure is not normally warmly applauded by investors, but in this case it was cheered. The shares rose +24% and contributed +1.23%. Alliance has a proven record of keeping older drugs alive or even breathing new life into them. Xonvea was outside its sales force’s normal medical area and also needed a different type of marketing and sales approach. We expect the company to resume its pattern of steady growth.

Online payments processing specialist, Safecharge International accepted an $889 million cash bid from Nuvei, a private Canadian company. During the period the shares climbed +85% and contributed +1.00%. 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.

Walt Disney contributed +0.87% and the shares gained +32% in dollar terms. The excitement in the year was not the reported numbers but rather the launch of its Disney+ streaming service. During the year the company also took full control of Hulu, which a more traditional streamed alternative to broadcast TV. Disney+ will not become profitable for a couple of years as the immediate aim is to build market share. There is some cannibalisation here, as Disney also owns the ABC broadcast network and ESPN cable sports. The movie divisions obviously feeds in content as well. Consumers have finite time and finite wallets, so ultimately there will be winners and losers. Disney seems uniquely well placed for whatever pattern emerges.

Investors in Marston’s might reasonably have been braced for another year of poor returns thanks to subdued consumer spending and surging employment costs. In the event the shares rose +35% and the contribution was a cheering +0.84%. Some of this recovery was undoubtedly thanks to the surprise £2.7 billion takeover of Greene King in August 2019 at a 49% premium. There was also some self-help at Marston’s, where newish Chairman William Rucker drilled home to management that debt reduction is investors’ priority. The company had not convinced the market that its spending on new hotels was justified by the returns. Full year results in November 2019 showed adjusted earnings per share down 3% but it did report progress in cutting the £1.4 billion net debt. A £200 million reduction by 2023 is targeted. We remain impressed by the brewing division but unfortunately this only accounted for 18% of underlying profits in the year. The promised rapid increase in the living wage is a further concern.

Charles Taylor, the insurance services group, received a private equity backed management buyout bid at 315p plus the 3.65p interim dividend. Previously we had been unhappy with the share price performance and engaged with the Chairman to find a buyer for the company. After further discussion the bid was reluctantly increased to 345p. Although this has been a profitable investment we are not overly pleased with this outcome, especially with the Executive Directors so conflicted. The shares laboured under the extreme complexity of the financial statements, made much worse by the presence of a small life assurance business on the balance sheet. Underlying cashflows were hard to analyse as a result. We suspect Charles Taylor is about to see an acceleration of growth from its insurance technology business. The take-out multiple was only 14 times earnings.

The consensus forecasts for ITV stabilised in the second half. The shares reacted by rising +21% and contributing +0.67%. A trading statement in November 2019 forecast 5% growth over the full year for ITV Studios though advertising revenue was predicted to fall 2%, still an improvement from earlier trends. ITV and the BBC launched BritBox, the monthly subscription service. Perhaps just as importantly, the trading statement said the addressable advertising platform would be ready for launch in the first quarter. Streaming is a perfect medium for advertising because viewers simply have to watch it in order to see the programme. Also, the adverts will be personalised and there will be scope for click through transactions. Just as Spotify saved the fortunes of the music industry, streaming may restore the fortunes of TV as it moves from broadcasting to narrowcasting.

dotDigital contributed +0.64% and the shares gained +24%. Forecasts were scaled back during the year as the company got a better grip on expectations. During the year it announced that the bulk of the Comapi messaging business which was bought in 2018 would be closed down. Comapi’s multi-channel technology has been integrated into dotDigital’s offering, which was the main purpose of the purchase. Full year group results were reported in October 2019. These showed organic revenues up 15% and average revenue per user rising 14%. Recurring revenues were 86% of total sales. We believe forecasts have now been trimmed back enough for the company to start again to beat expectations.

NCC contributed +0.57%, rising +29%. This recovery only took the shares back to their level of two years earlier. The market tailwinds in IT security blow ever stronger and NCC is the only UK quoted company of any scale. We also believe Chief Executive Officer Adam Palser has found his feet after a fairly wobbly start with investors. The US market was strong last whereas the UK was sluggish, reflecting a hesitation seen in many areas of IT.  We expect NCC’s security division will outperform the hesitant performance of the escrow division. This has been a splendid cash cow over the years but its future remains unclear in the context of cloud computing, though NCC has in fact launched a product specifically for cloud escrow.

The election result came as a particular boon for quarry and tarmac group Breedon. Its shares rose +41% between early November 2019 and the year end. The full year gain was +40% and the contribution was +0.54%. The consensus forecast is for earnings to rise 12% this year and 9% in 2021. Some increased activity does seem likely given the new government’s talk of oven-ready spending.

There were no material detractors in the year.

Purchases and sales

During the year we sold Charles Taylor (bid), Close Brothers, Entertainment One (bid), First Derivatives, On the Beach, Quiz, Safecharge International (bid), Telford Homes (bid), WYG (bid) and XLMedia. We reduced the holdings in Arbuthnot Banking, Ergomed, Future and River & Mercantile. We bought Arrow Global, Frasers, Kin + Carta, Ten Entertainment, Tesco and Simplybiz. We added to Applegreen, Clinigen, CVS, Gamesys and IWG.

Outlook

2019 ended strongly, wrapping up a year of sharp recovery from the near-panic conditions of late 2018. The plunge of 2018 was triggered by aggressive monetary tightening, prompting fears of recession, though central banks relented and boosted the supply of money. Valuations were extremely depressed at the beginning of 2019, leaving significant scope for re-rating. However, the UK stockmarket continued to see outflows from retail and overseas investors owing to concerns about Brexit and the prospect of a Corbyn-led government. The election result in December 2019 has removed the risk of a Marxist government and means that, for many investors, UK equities are suddenly investable again. The likelihood of a satisfactory resolution of Brexit has also been materially enhanced now that the EU is no longer able to arbitrage a minority government. The UK market remains 10% below its average value of the last 10 years relative to the US and 20% below where it was just before the 2016 referendum. We remain optimistic for 2020.

Slater Investments

January 2020