Weekly Commentary: 06/01/20 – The Roaring 20’s

The Roaring 20’s

Nothing quite starts a new decade as reassuringly as Greggs Vegan Steak Bake causing late night queuing in Newcastle. With Pizza Hut’s vegan pepperoni pizza, Costa’s vegan ham and cheese toastie, KFC’s vegan chicken burger and M&S’ vegan chicken Kiev and Macdonald’s veggie dippers this could be a good decade to be a chicken.

I found myself wondering why Zulu is missing from the New Year’s day TV schedules while Sound of Music still gets its new year airing and suspect that a bunch of white males slaughtering some 4 thousand natives is not as much of a crowd pleaser as it used to be. This could be a very humane decade.

The opposing views of the vegan vs the meat eating populous is mirrored in the economist’s world. We have an incoming Bank of England governor fresh from the FCA, while the commentary from the chief economist at the Bank of England, Andy Haldane, is around the disappointing growth decade ahead. His tweets appeal for a debate over the poor rate of growth expected as opposed to the “over-optimism from the supporters of Brexit”. His concern is growth is expected to slow further from the 1.9% experienced in the 2010’s.


Yet as an investor I find myself interested in the fact that on the chart above the lowest GDP growth achieved in the last 200 years (according to the Bank of England) was in the 1920’s, an era that was known as the “roaring 20’s” which produced fantastic stock market returns culminating in the 1929 crash. In 1920 the Dow Jones index was trading at 100 and peaked in 1929 at 381. Apparently, it would seem, there was little correlation between economic growth and investor returns.

Yet on this chart the 1970’s looks like a good decade with GDP growth of 2.6% but for those that experienced it the reality was pretty awful. Inflation reached 12% The CPI (excluded fuel and food then) while the oil crisis caused the real cost of living to rise well above the CPI, while unemployment was also high and the stock market fell 40% over an 18-month period.


Compare that to the 1920’s when inflation started the decade at a deflationary -1.55%. In 1921 prices declined by 11% and by 1922 prices were basically flat. So, the 0.8% growth over the 1920’s made people feel wealthier. Those that invested did well. And it seems to me that with interest rates close to all time lows and benign inflation partly driven by technology driven structural changes we are more likely to be looking at a repeat of the roaring 20’s than a GDP slump that some economists are worrying about.

The building blocks are in place for a little bit of a party. Wage growth has been picking up for a few years now and is well ahead of inflation.

Ultimately of course the wage growth will cause inflation but at current levels there may be some time before we need to worry about that. There is a party to have first which ultimately may result in a hangover, which is beginning to look like a repeat of the roaring 20’s. Like the meat eaters and the vegetarian’s, economists are opposed as to whether to pay attention to low growth or increasing wealth.

In the 1920 the era of mass production was causing structural change. 12% of the UK’s working population was employed in Agriculture which had halved in the previous 40 years as mechanisation increased. Today 1.5% of the working population is involved in Agriculture. The structural change continues as mechanisation and mass production moves to technology today. The great stocks of the 1920’s were the consumer stocks such as Coca Cola, Gillette Safety Razor Company, and FW Woolworth. Today I can’t help but feel the consumer has more appetite for sustainability than consumption. During the last decade growth stocks have outperformed hugely as we have experienced the benefits of internet enabled connectivity in a low growth environment. I suspect going forwards we could have a decade when science once again comes to the fore and the emphasis in our spending is on ways to make the world more sustainable.

Sustainable Stocks

Perhaps this may be the decade when the holy grail of pollution reducers mobilising hydrogen fuel have a breakthrough. Ultimately combining hydrogen and oxygen to produce water is a zero emissions equation. But the infrastructure to commercialise this science doesn’t exist today. Quoted companies in this space include:

  • Ceres Power
  • AFC Energy Plc
  • ITM Power

All three of these companies remain loss making and are forecast to remain so for the three-year horizon that analysts typically take which to my mind makes the funding risk extreme. With 40% of the UK’s greenhouse emissions coming from boilers I can’t help but feel that investors may be better served looking at the solar and wind power solutions that have gained sufficient scale to make their power commercially viable.

The Problem with Solar and Wind

Many investors have been putting money into solar funds or wind power funds which I suspect in a few years’ time is going to end in disaster as investors realise that these assets are leveraged utilities. The underlying asset prices have become high driven by cheap debt that is now readily available to drive the prices of the assets up. In my view the high asset prices is more of a function of the cheap debt than of strong investor demand which is a dangerous situation. Using cheap leverage, the dividend yields can look acceptable but this is the equivalent of a highly leveraged bank paying a high yield. When something goes out of balance, such as the price of electricity or the price of debt, as is inevitable at some point, investors are likely to find that rather than buying socially responsible assets they have been buying toxic leverage. And the City is incentivised to hide this view from investors as the fees involved are material.

By way of example the Foresight Solar Fund, a closed end listed fund with a market cap of £765m trades at a 15% premium to NAV. Despite being in a growth industry the NAV at the most recent set of results decreased on account of a downward revision in power price forecasts offset by a reduction in the discount rate applied to the portfolio and improved financing terms. In other words, investors are actually betting their investment return on the arbitrage between power price forecasts, discount rates for projected future returns and financing terms. There is plenty of history available to tell us that at some point these leveraged arbitrage plays always fall out of kilter. The financial crisis is one such example that comes to mind.

Perversely I am reminded of my visit to Castings Plc foundry in the industrial heart of the west midlands where I saw the wind turbine blades being packaged up for dispatch. And so, this old midlands-based relic of the industrial revolution becomes a beneficiary of the green revolution. Another example of old industrial companies becoming green is the provider of steam pumps, Spirax-Sarco which is now providing green answers.

Castings Plc

Share Price 424p

Mkt Cap £185m

For capital intensive industries the investment cycles are highly influential and for that reason I prefer to use the cash return on capital than the ROE as a measure, because it replaces the depreciation in the profit and loss account with the capex. In this case the SharePad charts tell a story. One of generally good ROE but a disappointing share price over the past 5 years as the company has been undergoing a period of investment which has been depressing the returns thus impacting the rating.

And going forwards it appears that the free cash flow is expected to regain its historic highs and capex remains low resulting in increased cash return on capital.


Following a period of investment the shares trade on a sub market PE of 13.8X with a useful yield of 3.6%.

Spirax-Sarco Engineering

Share Price £90.40

Mkt Cap £6.6bn

Over the same 5-year time period this company has performed well, and the answer can be found in the same three charts around cash flow return on capital. The company has been investing heavily but the returns have also been accelerating such that the cash return on capital has also been maintained above 15%.


As a result of a strong performance over the last 5 years the company has been re rated to a forward PE of 34.9X with a yield of 1.2%.


Spirax-Sarco seems to be a growing cash generator which can reinvest its capital at similarly high returns. History suggests that companies such as this can be highly rated and remain so and therefore merit a long-term place in portfolios. The track record on dividends is exemplary:

However, the greater return may come from finding the next growing cash generator at an investment turning point. Which one we prefer is down to our individual risk profile. For me the curiosity is whether we are at a turning point in the CROCI for Castings. For this it is worth taking a look at recent results.


Results – H1 results to September 2019 were released on 8 November. Overall revenue was up 7% to £73.1m while PBT was up 27% to £7.34m. The foundry represents the vast majority of the profit (£7.1m) where the move to more machined parts drove higher margins. The commentary states that more productivity gains are expected to be delivered in 2020/2021. The machining division moved from a loss to a small profit as productivity improvements started to be realised. Capex also reduced from £1.3m to £0.6m which all seems to confirm the picture shown on the Sharepad charts above that the company is coming to the end of a period of investment and starting to deliver the benefits of the investment. The outlook however is subdued with commercial vehicles making up 70% of the revenues where they have seen a reduction in schedules. The sort of products made for commercial vehicles is exhaust manifolds and gear box casings etc. Against the reduction in demand the investment in automation will help productivity. The balance sheet is strong with net cash of £25m and there is a pension surplus of £24m.

Forecasts – have been coming down for two years and despite the subdued outlook statement it is notable that 8 November 2019 results delivered a modest upgrade as shown on the Sharepad chart below

This stock has the hall marks of benefitting from economic recovery and is likely to be cyclical. Vehicles is c.70% of revenues and car production has been cut over recent years. Of course, the threat medium term from the move to electric vehicles risks them being designed out. Electric vehicles don’t require cast iron engine blocks, but conversely electric vehicles may also need different, perhaps lighter aluminium castings. The company has strong relationships with the manufacturers and so is well positioned to be included on the suppliers for electric vehicles.

Forecasts are currently anticipating broadly flat revenue for the next two years and only 5% PBT growth in the year to March 2021, which given the productivity improvements expected in 2020 and 2021 appears conservative.

Culture – The traditional industry of operating a foundry may be the reason that 88% of the staff are male. The 51-year-old CEO joined the company in 2010 and became CEO in March 2017 having been in the foundry business all his working life. The previous CEO, Brian Cooke (aged 79), is now the chairman and joined the company in 1960 after attending foundry college. He owns 4.5% of the company while the new CEO owns 30,000 shares. The CEO base salary is £277k and unusually there is a company car benefit. The bonus is calculated as 1% of PBIT above a £10m threshold. There is no LTIP. A useful video on the website shows what the company actually does. http://www.castings.plc.uk/. It seems that the company breaks all sorts of corporate governance rules such as CEO moving to Chairman, but this is a traditional industry and the company is run conservatively, making it in my view suitable for a medium-term investment. The shareholders are traditional value investors such as Ruffer, Aberforth, Threadneedle, and Rathbone Income fund.


It is necessary perhaps to believe in a cyclical upturn to invest in Castings but given that my macro picture is one of renewed confidence in the economy I am happy on that basis. No revenue growth is anticipated over the next 2 years so there could be some upside risk to forecasts. The shares currently trade at 13.6X PE which compares to a range of 9X to 18X over the last 20 years. If forecast upgrades are delivered the shares are likely to re rate in my view which could put them on a multiple of 18X as the market starts to anticipate further upgrades. That suggests 30% upside over the next 12 months. But most of all I like the dividend chart:


In today’s bi-polar world where vegan’s and meat eaters have opposing views, so it seems economists are split between those focussed on low GDP growth and those looking at increasing wages. The experience of the 1920’s looks remarkably similar to this decade when despite low GDP growth they became known as the “roaring 20’s”. This time consumers may spend their newfound spending power on more sustainable products. Strangely some of the older industries are beneficiaries of the green revolution. Spirax-Sarco (steam pumps) looks set to continue to deliver superior returns but I suspect that Castings may have more upside for higher risk investors who are prepared to look at more cyclical businesses. I can see 30% on the shares over 12 months.

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