Drink yourself wealthy

Small cap commentator Investor’s Champion, a business associated with our firm, has recently issued a Blog on the Beverages sector.

Investor’s Champion comments how the Beverages sector offers compelling defensive attributes, with the likes of Diageo (DGE) and Ireland’s C&C Group (CCR), owner of the popular Magners and Bulmers cider brands, seen as relative safe havens during turbulent times.

The AIM and ISDX junior markets have a number of interesting beverage stocks, with one in particular being the out-and-out star performer over the past 12 months. Investor’s Champion considers some of the more interesting players including a number of stocks held in our client portfolios.



“These moves in the market are like a tale told by an idiot: full of sound and fury, signalling nothing”

The quotation is attributed to Jack Bogle (paraphrasing Macbeth, although he never mentioned markets!) the octogenarian founder of Vanguard Group, the world’s second largest asset management group. Jack has a habit of bringing a good degree of common sense during times of stock market stress and in his 86 years has seen a great deal. Furthermore, with US$3 trillion of passive funds under management at Vanguard, he is well placed to assess markets more objectively than the active funds that are causing the current upheaval with their manic trading.

Jack urged investors thinking of selling amid the current market turmoil to sit tight commenting “This is speculation that we’re seeing out there, and you can’t respond to it.”

While the share prices of some stocks had clearly risen too high, corporate balance sheets are, for the most part, in excellent shape with plenty of cash. The exception is the beleaguered oil and gas sector which has been a primary beneficiary of cheap money over the past few years and is now paying the price. However, even in oil and gas world there are plenty of well capitalised businesses that will exit the current maelstrom in terrific shape.

The recent fall in stocks and commodities, particularly oil, has raised questions as to whether or not the economy is at risk of entering a recession. In the short term this market mayhem has been for the most part about the oil price which permeates all aspects of the global economy. Until the oil price displays a degree of stability we foresee the speculators will continue to run riot. Saudi Arabia is intent on breaking the back of US oil and gas production to secure its own market share and place at the head of the global oil and gas table. With the price now below US$30 per barrel, and no doubt set to fall further still, we sense that the time approaches when US production will fall materially as higher cost US producers throw in the towel. Up to now technological advances have helped the US producers drive down costs and improve production, but geography will ultimately win.

Returning to the 86 year old Bogle he concludes that:  “In the short run, listen to the economy; don’t listen to the stock market,” he said. “These moves in the market are like a tale told by an idiot: full of sound and fury, signalling nothing.”

On home soil, fund manager Gresham House Asset Management (‘GH’) recently published an excellent article on its Investing Strategy. The full article can be found here.

GH commented how value investing has been out of favour with investors for a number of years, effectively since the financial crisis, and that the material underperformance of “value” stocks versus “growth” companies is comparable to levels last seen at the peak of the TMT boom in 1999.

With investors focusing on growth and momentum companies over the past few years the recent market activity reflects a reality check for the momentum trade.

We are now hopefully returning to a time when the proper analysis of fundamentals will be rewarded and with this in mind it is worth casting a glance at US technology giant International Business Machines (IBM).  As was the case with Microsoft several years ago, many commentators appear to be doubting the long term prospects for this previous bellwether of the technology sector. Over the past few years shares in IBM have tumbled 43% on fears that the group has lost its way in the fast moving technology world, with momentum firmly to the downside. While earnings have indeed stumbled, as the giant group goes through one of its periodic transformations, ‘real’ cash returns to shareholders have actually been rather good, to say the least. Over the past 5 years IBM has generated average ‘annual’ free cash of an eye popping US$14bn. It has used this cash to pay substantial annual dividends (Dividend yield is just over 4%) and buy back a colossal US$65bn+ of shares over 6 years.  In its recently reported results ‘accounting’ earnings fell again but the total ‘real’ capital return to shareholders during the year was still US$9.5bn, consisting of dividends of US$4.9bn and gross share repurchases of US$4.6bn. Shares in this high quality business, which still generates operating margins of 20% and returns on equity of over 90%,  trade at modest 9x forecast earnings for 2016. Transforming a business of this size is bound to take time and in the interim patient shareholders are being rewarded. More positively for the technocrats out there, its expansion into cloud services looks quite encouraging

Investors have also questioned the business prospects of UK listed WH Smith with its dull portfolio of high street stores. WH Smith has also been going through a transformation with the high street operation essentially being run for cash which is subsequently being reinvested in a growing portfolio of ‘Travel’ venues. It’s hard to visit an airport or train station without coming into contact with WH Smith. Much like IBM, the UK group has been returning cash to shareholders through dividends and share buy backs. WH Smith is a much smaller business than IBM and its metamorphosis has taken less time with the share price reacting very positively over the past few years as the transformation starts to deliver.

We anticipate investors will need to pay greater interest to ‘value’ investments like IBM in the coming years and focus on real cash returns, high returns on equity and capital and sustainable dividends.

So what does it mean for our client portfolios?

Small caps
Many of the small caps we follow have benefited from the momentum trade with valuations becoming more stretched; although quite a few are also substantially less expensive following the falls of the past few days! However, unlike their blue chip peers, these businesses are also demonstrating real growth, generating plenty of cash and possessing the desired balance sheet strength. While large well established businesses have been the major beneficiaries of quantitative easing and low cost debt, UK small caps have, for the most part had to tread more carefully with debt less freely available. Don’t be put off by the violent share price swings of small caps during heightened periods of market volatility such as the one we are currently experiencing; that’s the nature of small cap investing and its important not be sucked in Mr Market’s dark mood!.

Blended portfolios
We have maintained a generally defensive stance over the past year or so with a strong weighting in Pharma, Tobacco and Telcos and higher yielding equities with limited exposure to financials.  We remain on the look-out for real value and businesses that are able to demonstrate an ability to generate meaningful free cash and a willingness to return this to shareholders in some form.

AIM News
Real news from AIM quoted companies since the start of 2016 (it’s a busy period for AIM results) has been overwhelmingly positive. News from AIM can also be a good gauge of the state of the UK economy with the majority of AIM companies more reliant on the UK economy than blue chips. We summarise below recent news from some of the companies we follow, across a vast array of sectors and industries:

Majestic Wine (wine retailer)
Encouraging Christmas Trading Statement
Majestic Retail like for like sales grew 7.3% in the Period (versus decline of 1.7% in comparator period)

Breedon Aggregates (Quarrying of aggregates and the production of added value products)
Largest ever contract award

KBC Advanced Technology (Software technology and consultancy for hydrocarbon industry)
Takeover at a 50% premium, look out for more like this in the oil and gas sector

Shoe Zone (Low cost footwear)
Results in line with an additional proposed Special dividend bringing yield to 6.8% at current share price

Quartix Holdings (Subscription-based vehicle tracking systems)
Trading statement confirms revenue and profits are anticipated to be ahead of market expectations.

Smart Metering Systems (Integrated metering services company)
New domestic smart meter contract wins as part of the UK Government programme, requiring domestic energy supply companies to provide all of their customers with a smart meter in homes and small businesses across the UK by 2020.

XLMedia (Provider of digital performance marketing services)
Trading update confirms that the Company expects to exceed current market expectations with the dividend materially increased

Plexus Holdings (Oil and gas equipment provider)
New customer contract and region win worth approximately USD$0.6m.

Quixant (Specialised computing platforms for gaming and slot machines)
Trading update confirms profitability over the 12 months ended 31 December 2015 was comfortably in line with market expectations. The Company has started 2016 well, with a healthy order book which underpins their confidence in achieving market expectations for 2016.

We would urge investors to focus on real news and the real economy and ignore the market noise and actions of speculators. Long term investors (and real investment is all about the long term!) should view the current sell-off as a potential buying opportunity to acquire interests in good businesses at much fairer prices.


RWS Holdings (AIM:RWS) – whopping acquisition significantly earnings enhancing

The world’s leading provider of patent translations, international patent filing solutions and searches has announced a significant acquisition that is expected to be immediately and significantly earnings enhancing.

 The AIM quoted Group has acquired Corporate Translations Inc (“CTi”) for a cash consideration of US$70 million. Based in Connecticut, USA, with 140 employees, CTi is the world’s leading life sciences translation and linguistic validation provider. The Company was founded in 1990 specifically to cater for the growing demand for high quality translation services in the life sciences sector and is now a recognised leader in successfully managing complex translation projects on behalf of the world’s top pharmaceutical and biotech companies and their Clinical Research Organisation (CRO) partners. It enjoys a preferred supplier relationship with many of its key customers, with extraordinary penetration of the blue chip life science community.

As CTi’s customers operate in highly regulated and audited industries, they place a premium on high quality translations being delivered to specific deadlines, which in turn underpins CTi’s attractive margins. RWS already focuses on the life sciences sector both through its patent translation and filing solutions and with its separate Medical Translation Division which includes the linguistic validation specialist PharmaQuest, a company acquired in 2013. The greater scale of CTi, combined with the existing specialist RWS divisions will immediately transform the Group to a world leading position in life sciences translations and linguistic validation and further enhance its competitive standing amongst the largest specialist translation companies in the world, especially in IP support services.

The acquisition of CTi is expected to be immediately and significantly earnings enhancing, with the US$70m consideration to be paid based on CTi reporting an EBITDA of not less than US$7m for the year ended 31 December 2015. CTI’s latest audited financial statements, for the year ended 31 December 2014, showed revenues of $23m and adjusted EBITDA of $4.8m.

The acquisition will be funded by $25m from internal cash resources (RWS had net cash of £30m at 30th Sept 2015) and US$45m through a five year loan provided by Barclays. The co-founders of CTi, will retain their current positions for up to a year, to allow the enlarged Group to benefit from their significant knowledge and experience as they integrate the business into the enlarged Group.

They are certainly paying what looks like a hefty price for CTI but many have been concerned how the Group’s growing cash pile could be best utilised and this acquisition appears to deliver on many fronts.

Forecasts for the year ending September 2016 were previously for pre-tax profit of £22.1m and eps of 8.0p. One senses a minimum 10% earnings upgrade is probably anticipated following the acquisition moving the earnings number closer to 9p.

UPDATE – Broker forecasts

The house broker has actually raised their EPS forecasts by 20%.
Financial Year moves to 9.6p from 8.0p, with 2017 raised to 10.1p from 8.4p.

– See more at:


Solid State (AIM:SOLI) – a ‘not so Solid’ trading update

The AIM listed supplier of specialist industrial/ruggedised computers and electronic components has issued a profit warning with suggestions that not all is going to plan with their large Ministry of Justice contract!

The update starts brightly enough and “despite some softening in Solid State’s markets as widely reported by industry peers, the Company has made a satisfactory start to the year.” However, the fact that for the six months to 30 September 2015 turnover of approximately £21m (2014: £17.13m), being 22% higher than the comparable period, is only set to deliver pre-tax profit of £1.50m (2014: £1.55m), being marginally lower, suggests problems!

The big issue surrounds the ‘material contract’ which we assumes means the contract with the Ministry of Justice for the supply of monitoring hardware for GPS offender tagging. Following a customer meeting on 27 October 2015, delivery expectations for a material contract have apparently been “varied” which will impact the second half of the year. The statement continues how “The contract is high profile and a high priority for the customer and Solid State is confident that it is fulfilling its obligations to the customer.” It is hard to gauge exactly what is meant by this but the defensive nature of this statement suggests some differences of opinion between SOLI and customer!

We arrive at the usual ‘second half weighting’ warning with revenues and profits in the second half now anticipated to be significantly lower than expected and, as a result, revenues and profits for the year as a whole will be below market expectations.

With pre-tax profits for the full year previously forecast to be £5.23m, only £1.5m delivered in the first half and the second half now anticipated to be significantly lower than expected, surely this suggests full year profit will also be significantly below expectations.

Revised broker estimates

The house broker has now reduced PBT and EPS forecasts to show a broadly flat y-o-y outcome. Revenue forecasts for the year ending March 2016 are reduced from £57.0m to £44.0m with pre-tax profit reducing from £5.3m to £3.2m.and eps coming back to 36p (from 56p). The dividend is also reduced to 12p resulting in a yield of 2.5% at the current share price. The broker has withdrawn estimates for March 2017.

SOLI has been progressing quite serenely over the past few years boosted by the material MoJ contract so this is clearly disappointing news, let’s hope it’s only a minor blip!


Our view on the recent market madness and how it affects AIM

With global stock markets experiencing a volatile summer, and this week in particular witnessing some bizarre movements from leading indices, we thought it an appropriate time to offer our thoughts.

The start of the week saw the largest ever intra-day points move from the Dow Jones Industrial average. This bizarre short term move saw shares in solid blue chip companies such as Apple, General Electric and Microsoft down more than 10% in the space of a few minutes. Contagion spread to other stock markets all of which followed the US lead and tumbled.

At times like these, when trading frenzy takes hold, our usual course of action, which has served us in good stead over the past decade, is….to do nothing!

While the sell-off was initiated by the stock market rout in China and mounting concern over the state of the Chinese economy, a short term move of this magnitude has little to do with worries over economies or company fundamentals. Rather, it has more had more to do with computer trading programmes triggering vast sell orders as so called index ‘support levels’ were breached and the share prices of the 3 US giants above swiftly bounced.

Addressing the China issue first, it is evident there are concerns over slowing Chinese growth and the seeming inability of the authorities over there to control their tumbling stock market. While the Shanghai Composite index has tumbled a whopping 45% since hitting its high on 12 June 2015, it still remains up over the 12 month period and only 10% below the level at the start of 2015.

To put things into perspective, a stock market that rises well over 100% in the space of 12 months and sees many of its constituent companies trade at ridiculously high valuations is bound to experience a reality check at some time. In response, Chinese authorities have already devalued the Yuan, cut interest rates by 0.25 percentage points and also announced plans for its main state pension fund to be able invest in the stock market for the first time. They will clearly be prepared to do more to stabilise matters and support the hopes of their vast population.

There are indeed mounting concerns surrounding global growth prospects, reflected in the decline in commodity prices, and the era of low interest rates has boosted the share prices of many companies, sometimes to unsustainable levels.

However it’s not all gloom with plenty of excellent businesses with good growth prospects (notwithstanding China and global growth concerns) trading at fairer valuations. The UK market recovered strongly following the financial crisis.

The current stock market correction that we are now experiencing should therefore be viewed as a healthy development in the normal cycle of things offering, if anything, opportunities for the patient long term investor.

During such volatile times the share prices of smaller quoted companies on AIM often tumble more precipitously than their larger brethren, simply due to reasons of illiquidity, notwithstanding the merits of the business, their financial strength or prospects. With many AIM stocks having experienced a good run over the past few months it shouldn’t come as surprise that many investors decided to take their profit at the first sign of trouble.

The result of this is that several of our portfolio companies have seen their share prices fall from recent highs. We have seen this sort of irrational behaviour on several occasions over the past decade or so, following which our client portfolios have thankfully benefited handsomely. Our diversified approach to investing in smaller quoted companies also serves us well during such times and, with no single stock having a material influence on individual portfolios, overall returns on portfolios remains strong.

Sharp corrections in the AIM arena for no fundamental stock specific reason often present excellent buying opportunities for the patient long term investor that is willing to ignore the short term noise. AIM stocks (even the lower growth variety) are generally much higher growth propositions than their main market counterparts, accordingly the global growth concerns prevalent in main market stocks with their big international exposure are of less relevance to the lower end of the market.

We look forward to the irrational behaviour continuing this week and we sense that the beginning of September could offer an excellent buying opportunity.