Private Investor Diary: On the look-out for a certain type of company
August was a good month for equities, helped by a more stable bond market. The market stabilised after the fall in the US Treasury 10 Year yield from April’s 2021 peak of 1.75 per cent to 1.2 per cent in early August. There is still a vast gulf between those who believe the current uptick in inflation is transitory and those who worry that it’s only just the start of something more sinister. The spread of the COVID delta variant seems to have suppressed the rate of global growth over the summer. The optimists believe we are through the worst, and growth will accelerate into Q4. The pessimists, however, think that growth will continue to disappoint and that deflation will rear its ugly head again. Worse still, some predict a return to the stagflation, low growth and inflation, of the 1970s.
Thus far, the Chairman of the Federal Reserve seems to be playing his cards well. His Jackson Hole speech at the end of August managed to satisfy both camps in the short term. He opened the way for tapering the Fed’s monthly quantitative easing whilst convincing the markets that he would not take risks with growth.
Over the month, technology stocks performed well, with the NASDAQ 100 (up 4.2 per cent) achieving new highs. The S&P 500 was up 2.9 per cent, extending its gain this year to 20.4 per cent. The Nikkei 225 was up 4.3 per cent but remains one of the worse performing major indices this year, up just 3.7 per cent. The German DAX was up 1.9 per cent, the French CAC 1.0 per cent and Italian MIB 3.2 per cent. Smaller and mid-cap companies led the way in the UK, helped by a record number of takeovers. The FTSE 250 was up 5.0 per cent, FTSE Small Cap 3.6 per cent and AIM All-Share 3.4 per cent. The FTSE 100 gained just 1.2 per cent, with its exposure to mining stocks proving a drag.
Commodities were friendless for most of the month before staging a recovery in the last week of August. Nevertheless, most were still down on the month and some way below April/May’s highs. Brent crude fell 4.7 per cent to $71.71 per barrel, platinum -4.1 per cent, copper -2.4 per cent, zinc -1.0 per cent and nickel flat. Gold continued to trend sideways, down just 0.8 per cent to $1813 per oz.
By the skin of its teeth, the JIC Portfolio was in the black, up just 0.1 per cent. I’ll take that, given that it was down 4.0 per cent on the 20 August! There is no room for complacency, though – year-to-date, the JIC Portfolio is up 10.6 per cent, lagging the 14.7 per cent for the FTSE All-Share and the 15.4 per cent for the FTSE All-World. Since inception in January 2012, it is up 352.6 per cent (16.9 per cent annualised) comparing favourably with the 104.2 per cent (7.7 per cent annualised for the All-Share and 256.4 per cent (14.0 per cent annualised) for the All-World. My principal aim is to make money, but it’s also important for me to beat the index; otherwise, I might as well buy an index tracker!
The highest returns came from Calnex Solutions up 16.5 per cent and SigmaRoc 15.5 per cent. Calnex produced a robust update four months through its financial year. It is one of my smallest positions, and there was not enough reassurance in the results for me to add to the position yet. Earnings are still forecast to fall this year due to last year being an exceptional year helped by COVID. There is no doubting the company’s quality with operating margins in the 20s and return on equity in the high twenties. Still, without upgrades, the valuation looks rich. The jury is out, but I’m still hopeful that I will find the opportunity to add at some stage. SigmaRoc continued its tremendous run. Only just over a year ago, I added to my position at 28.5p. It ended August at 112p after a favourable reaction to its recent acquisition of Nordkalk, which received clearance from the Polish competition authorities. Half-year results reported on a robust 2021 H1, leading to upgrades to full-year earnings of around 6.0 per cent to 5.5p earnings per share. Back in April, forecasts for 2021 earnings were only 3.8p.
Other noteworthy positives were K3 Capital up 6.9 per cent, Bioventix, which I added to in July, up 6.8 per cent and WisdomTree Cloud Computing ETF 5.4 per cent.
Venture Life was the one big negative in August, costing the portfolio around 1.2 per cent of performance. It was down 24.2 per cent following a poor H1, leading to downgrades to full-year earnings. In last month’s column, I mentioned I had reduced my position. I had a hunch that the delay in updating the market was down to bad news travelling slower than good news. That proved correct. In hindsight, my mistake was not to reduce further than I did. My trust in the management has been knocked. It must have known months ago about the depressed sanitiser sales and the poor uptake from its Chinese distributor of Dentyl. Why not an update in Q2 as it did last year? Where to from here? Although there is a risk of further bad news, I think it looks like an attractive proposition. In a rush for the exit, investors risked throwing the baby out with the bathwater.
Outside the two problem areas, organic growth was 9.0 per cent. As my fellow columnist Simon Thompson points out, Cenkos has upgraded 2021 earnings per share from 3.79p to 4.53p. In 2022 it expects earnings to grow a further 37 per cent to 6.21p as it benefits from the full-year contribution from recent acquisitions. If those numbers prove correct, then the shares are valued at only 10.8x next year’s earnings for 37 per cent growth. I agree with Thompson that while disappointing, the numbers are not a disaster. The disaster lies in the hit to confidence in the management. If management can rebuild credibility with investors, there is scope for a substantial re-rating. Before I add, I’ll be interested in seeing what Mark Slater does with the 15 per cent stake he has built in the company. I would also like to see management put their hands in their pockets and reinvest some of the cash they raised from substantial share sales last December at 90p.
Sylvania Platinum proved a rocky ride. Down 22 per cent at one stage, it ended the month down just 5.6 per cent. A case of the summer wobbles also hit SDI Group. By the 26 August, it was off 25 per cent before rallying to close the month down just 5.5 per cent. These smaller stocks can move quite violently in thin markets as weak holders think someone knows something they don’t! Blackrock World Mining Trust succumbed to the malaise affecting the broader commodity sector. The fall was despite a 37 per cent increase in the Q2 dividend, with many of its constituents reporting bumper cash flow, substantial dividend increases, special dividends and buybacks.
Apart from Blackrock World Mining Trust, all the JIC Funds’ Portfolio funds were up with nine of the seventeen, more than the FTSE All-World. Baillie Gifford Positive Change topped the table with a gain of 7.8 per cent, closely followed by JP Morgan Emerging Markets’ 6.5 per cent and Blackrock Throgmorton 6.2 per cent.
Members of my website, jicuk.com, will know there were just two trades during the month, both in the JIC Portfolio. I reduced the number of positions to 20 by selling JP Morgan Emerging Markets Trust. My main reason for selling was to free up cash with which to increase my position in Supreme. In May, I added Supreme to the portfolio with a High risk, High reward rating. For me, that points to a 2.5 per cent position. Results published at the end of July gave me the confidence to lower my Risk rating from High to Medium. Coupled with a High reward rating, that points to a 5.0 per cent position. It is achieving rapid growth in its Vaping segment and the less critical Sports Nutrition & Wellness segment.
Along with other shareholders such as Slater Investments and Gervais Williams at Premier Miton, its robust free cash flow generation attracts me. Combined with a return on equity of 86 per cent and a return on assets in the low 20s, it can reinvest very profitably. On current forecasts, value the shares at only 15.2x March 2020 earnings. For 44.9 per cent growth, that looks tremendous value to me, hence my High reward rating.
Before landing its bombshell on the market, Venture Life announced the acquisition of three brands used in oncology support. Gelclair, for instance, is a mucoadhesive oral rinse gel used to manage painful symptoms of oral mucositis (a side effect of some cancer therapies). Gelclair is a registered medical device currently partnered in 40 countries. Venture Life has manufactured it under contract manufacturer since 2000. The three brands generated a gross profit of £1.3m from revenue of £2.5m in 2020. Given that it is paying £4.75m, it is not surprising that it will immediately enhance earnings.
Surface Transforms announced a contract from a new OEM (original equipment manufacturer), a mainstream US auto manufacturer. It also primed the market for more contract news in the coming months. Surface Transforms is my most minor position as it is still a bit of a “blue sky” story. Still, thus far, it is delivering on the news front. If other contracts are forthcoming, it should be making handsome returns in 2025/2026. As it is, a valuation, based on current forecasts, of 26.5x 2023 earnings is not as outlandish as it could be.
Nearly through the summer fallow period, I’m looking forward to a solid end to the year. Little has changed since last month’s outlook. There is perhaps a little more clarity on the Federal Reserve’s plans regarding the tapering of its bond-buying programme. Meanwhile, I expect corporate activity to continue apace. Companies with solid balance sheets and private equity firms flush with cash will continue to chase cheap British assets. As far as the JIC Portfolio is concerned, I’m happy with my position in commodities for all the reasons regularly rehearsed over the last year. I could probably do with another couple of mid or small-cap companies which are exposed to the continued recovery in the UK economy. That will be my focus over the next few months—valuation as ever being the key.