Weekly Commentary 12/07/21: Beware the prudent man rule

Just as I thought the FTSE 100 was breaking out of its trading range 7000-7200 markets dipped at the end of last week to leave the FTSE at 7084. The US 10 year Government bond yield fell to 1.33%, down from a peak of 1.74% at the end of March, suggesting that bond markets have become less concerned about inflation. That’s despite the price of oil continuing to climb to finish the week at $75 per barrel, +45% since the start of the year, after OPEC+ failed to reach an agreement on how much they’d raise production by. Normally when commodity markets and bond yields disagree, it tends to be the bond market which is right. This was certainly true when Brent was over $100 a barrel in the second half of 2008: the price collapsed to below $40 a barrel as the extent of the banking crisis became clear.

Last week I asked the question: who is buying UK Government bonds yielding 0.82% when Andy Haldane, ex Bank of England, expects inflation to approach 4% in the second half of this year?

This isn’t just a UK phenomenon. Globally there’s $12bn of debt trading at negative yields currently, down from $18 trillion at the start of the year. Though Central Bank Quantitative Easing plays a large part, the long bond yield decline predates the financial crisis. Government borrowing has been increasing rapidly in recent years, a trend which will accelerate due to the costs of Covid-19. As the chart on the next page shows it reached 113% of UK GDP.

Normally when you have increased supply of an asset (in this case Government debt) the price of that asset falls and yield rises. So why are bond prices so high and yields so low? What’s going on?

The answer I think is demographics (ageing populations) and the way corporate pension funds are managed. Pension fund trustees have a contradictory duty, to avoid risk and generate the best possible returns. This gave rise to the “Prudent Man” rule which dates back almost 150 years:

“A trustee ought to conduct business of the trust in the same manner that an ordinary prudent man of business would conduct his own, and that beyond that there is no liability or obligation on the trustee.”

UK public sector debt as a percentage of GDP, back to 1975. Source: SharePad

While most “ordinary prudent” retail investors wouldn’t think of holding a large proportion of their portfolio in negative yielding Govt bonds, pension trustees as a group have become more risk averse than individuals. What we are seeing is not just Central Bank buying, or demographics, but also a distortion from the institutionalisation of retirement savings.

Institutions have different biases to retail investors, they want to avoid blame: currently a pension fund manager can’t be blamed for buying “risk free” Government bonds. At the same time the value of pension obligations has been driven up, due to a lower discount rate of future obligations caused by… falling bond yields. This is George Soros’ idea of reflexivity: asset prices create feedback loops.

The trend can continue for a long time, but not forever. Once bond yields do start to rise, we may see a sudden nonlinear increase in funding costs for Governments. We don’t need pension funds or annuity holders to become “forced sellers” of bonds. All we need is for pension funds to question their allocation toward bonds and whether bonds really are “risk free” in an inflationary environment. A 1% rise in interest rates leads to an increased £28bn Government debt service cost, according to research by Hardman&Co.*

What this means from a portfolio perspective is that equities are likely to do better than bonds. But that’s a relative call, I can imagine a scenario where both equities and bonds fall in value. It might be a good idea to have some cash to hand to take advantage of that scenario. It probably also explains why Berkshire Hathaway has $145bn of cash on its balance sheet.

This week I look at cybersecurity firm Intercede, which in the past has struggled to grow the top line, but has an attractive gross margin if it can scale. Plus disruptive estate agent Purplebricks reported FY results to April and Somero (concrete screed) and Equals (foreign exchange and payments) announced positive H1 trading updates.


This cyber security and digital identity company announced strong progress with their “Connect Partner Programme” which was launched in February 2020. The company has a March year end, and in early June reported revenue +6% to £11m and statutory PBT +51% to £1.1m. Then last week they announced £600K of orders received from new customers in their Q1 (ie April to end of June). 5% of FY revenue doesn’t sound particularly exciting, but annualising would mean a 20% revenue uplift so the shares responded by rising +12% on the morning of the RNS.

In addition SharePad shows a gross profit margin of 98%, so it looks like Intercede is very scaleable if they can grow revenue on a fixed cost base. 83% of revenue comes from the US, presumably they ought to be able to grow in less technologically sophisticated markets.

History Despite operating in the hot sectors of cyber security and digital identity, this company has been around for a surprisingly long time. Founded in 1992 by Richard Parris, then floated on AIM in 2001, raising just under £3m at 60p, valuing the company at £10m. The founder Richard Parris still owns 5.1%. SharePad’s “financial” tab shows that it took 15 years (that is till 2016) for the company to achieve revenues greater than £10m.

FY March 2021 revenues were £11m; this is a company with an attractive gross margin, and high quality 27.9% RoCE and 81% CRoCI, but which struggles to grow the top line.

Broker forecasts FinnCap, Intercede’s broker did not raise FY 2022F forecasts following the RNS, and are forecasting c. +5% growth in revenue to £11.5m. The following year this accelerates to +10% revenue growth.

Ownership Jacques Tredoux, a South African corporate financier and Non Exec on Intercede’s board since 2006, owns 16.4m shares or 29% of the company. Plus his family Trust called Azalia owns 26% of the shares.

Anjar International own 5.7%, Palm Ltd 5.5%. Herald Investment Management is the largest holder whose name I recognise on the shareholder register with 5.5%. Miton on Liontrust both hold stakes below 4%.

Valuation PER of 44.6x 2022F feels very expensive for a company that is struggling to grow. Quite possibly the Solar Winds and Colonial Pipeline hacks give cybersecurity some more momentum. SharePad shows the forecast EPS growth next year as +38% so 2023F PER drops to 32x.

I don’t have a high conviction about that forecast though, there always seems to be hacking going on, Hilary Clinton’s emails for instance, O2 and Yahoo come to mind. Those data breaches don’t seem to have helped Intercede’s top line significantly. Maybe after all these years the company has finally hit its stride, in which case a few years of top line growth would make it very attractive.

Purplebricks FY to April 2021

This disruptive estate agent announced FY to April 2021 results with revenue up +13% to £90.9m and statutory PBT of £3.9m from continuing operations, versus an £8.2m loss last year. The group has done reasonably well in the UK, but international expansion has caused problems. They sold their Canadian business July last year for £36m, strengthening their cash position to £74m at end of April. The gain on disposal was a mere £2.3m. They’ve also discontinued operations in the US and Australia.

Despite the revenue growth, the company reports market share by volume down from 5.1% to 4.6%. The previous expansion was clearly not sustainable, and the business seems now being run with a greater focus on the bottom line returns, rather than market share. The gross margin fell 60bp, but is still an attractive 63.5%.

History The company was founded by Kenny and Michael Bruce, the latter was a qualified solicitor who had run a high street estate agent and spotted an opportunity. He was Chief Exec at the time of the IPO in December 2015, when Purplebricks raised £25m at 100p per share, valuing the business at £250m. The IPO was backed by Neil Woodford who owned over 30% of the shares.

The shares increased 5x to over 500p in August 2017, despite the business continuing to make losses. From that point onwards investors began to worry about the group over reaching. Presumably worries were not helped by Neil Woodford’s well publicised problems with fund outflows.

In May 2019 Purplebricks announced a disappointing trading statement, saying that they would close their Australian business and cut back the US expansion. At the same time Michael Bruce stepped down, to be replaced by Vic Darvey the Group’s Chief Operating Officer. Then the pandemic hit 6 months later. The share price fell by 95% from the peak in August 2017 to below 25p at the March 2020 low. The shares have now recovered to 78p.

Ownership Neil Woodford has long since departed from the shareholder register. Axel Springer, the German publisher which has a portfolio of tech investments owns 26.5%. They have a Board seat and a 50% holding in a joint venture called “Homeday” which is headquartered in Berlin and trying to replicate the Purplebricks model across Germany. Property transaction fees are much higher in Germany. Estate agents charge up to 6%, then there’s 6% stamp duty (depending on the region) and a further 2-4% notary fee. Adding all those together it’s not unusual for property transaction costs to reach 15% in Germany.

Other shareholders include Jupiter which owns 16.4%. JNE Partners owns 7.4% and Senecca owns 4.8%.

Outlook The new leadership team has introduced a Money Back Guarantee (MBG) and simplified two tier service, which will launch this month. Because of the new customer proposition management highlight uncertainty around forecasts, but for now they are happy with market expectations which is for flat EBITDA. Medium term they are hoping for +20% y-o-y revenue growth. I’m impressed with the management commentary; Vic Darvey, the new-ish Chief Exec writes well. He explains the challenges Purplebricks faces to wider adoption, and why they are making changes.

Valuation With £74m of cash the company is not in any financial difficulty. Probably an EV/EBITDA multiple of 9x is a better ratio to use than the PER 34x 2023F because cash represents a third of the market cap. The investment in the Berlin-based Homeday has been reclassified from a JV to an Associate and is currently recorded on the balance sheet at a value of £11.5m. The value is unlikely to be correct, either the business is a success and worth multiples of that figure, or it’s a write off. Axel Springer has been providing funding through convertible loans, most recently in February 2021 which (despite having lots of cash) Purplebricks chose not to match.

Opinion The story is that Purplebricks can take market share from traditional estate agents. However as the company has become more focused on the bottom line, market share has fallen back below 5%. Medium term they hope to double this to 10% market share, which I think is realistic. I own ULS Technology, which competes with Purplebricks on the conveyancing side. Both companies have the potential to disrupt estate agents and conveyancing, but I think that with ULS, which reports later this month, valuation is more attractive.

Somero Trading Update FY Dec 2021

This US-headquartered concrete screed company has raised FY Dec 2021 guidance. I particularly like that they give what the previous guidance was (revenues were expected to be c. $100m, adjusted EBITDA $31m) and they also say when they gave the previous guidance (6th May). It makes life easier for investors, and I think signals that management are helping investors to gauge progress.

H1 has continued to be strong, particularly in North America (80% of sales), and they expect momentum to continue into H2. The Board now expects FY 2021F annual revenues will be $ 110m (ie a +10% increase on previous guidance and +24% y-o-y growth) adjusted EBITDA should be $35m, and year end net cash is expected to exceed $33m.

Broker forecasts FinnCap, their broker, have increased EPS by 13.6% in both FY2021F and FY2022F to $c45.4 and $c48.7 respectively. Assuming an exchange rate of 1.38 that puts the shares on a PER ratio of 14.3 and 13.3x this year and next year. That seems good value for such a profitable company (38% RoCE and 42% CRoCI).

Opinion This is a cyclical stock, but we are currently in the right part of the cycle. The cash on balance sheet should protect investors when the cycle turns. I’ve owned the shares since 2015, and like Impax AM, feeling fortunate that I didn’t sell in March 2020 when the shares fell below 160p and it generally felt like the world was falling apart.

Equals H1 Trading Update

This foreign exchange and payments’ company with a December year end released an H1 trading update to end of June. If you remember, in January I crowd sourced some suggestions from readers on Twitter and Equals was @Glasshalfull’s suggestion. So far the shares are up +56% since the first of January, so I’ll try to remember to ask him for more picks! Other ideas were from @Carcosa who went for Cenkos +42% and @fundhunter_co who went for Gooch & Housego up +27%. It’s been a helpful market, but good to see that readers are doing well.

Equals revenues were up +21% to £16.7m y-o-y. H1 last year was clearly a very volatile half, but the company also points out they’re up +11% compared to H2 last year. In a normal year just under a third of their revenue comes from travel related activity, but this has fallen to just 5% in their most recent quarter. The implication is that as travel resumes, revenue should increase further.

Valuation The last couple of years have been tough for Equals, as they converted from their original business model FairFX, they lost £8m in 2019 and £9m in 2020. Even before last week’s update forecasts were for £4m of PBT this year, so it looks to have turned the corner. Equals is now trading on 21x 2022F PER, but feels like management set expectations low because they don’t want to risk disappointing again, so we may see them exceed forecasts.

Opinion I can remember I nearly bought this at the start of the year, but was concerned about competition, not from clunky old banks, but from deep pocketed FinTechs like Wise (previously TransferWise). The latter listed last week, achieving a valuation of £8bn. There’s a fascinating write up of Wise by Marc Rubinstein here.

I’ve used SharePad’s “compare” tool to look at the various companies in this space (see next page). SharePad’s quantitative approach thinks that Record followed by Argentex are more attractive than Equals. That could be right, but much will come down to which management team are the most agile, so investors may also want to listen to management present before making up their mind.

Bruce Packard


The author owns shares in ULS Technology and Somero.

* Public Sector Debt doesn’t include unfunded public sector pension obligations. If Governments were corporates they’d be required to show their unfunded pension obligations on the liability side of their balance sheet. But the same rules don’t apply. The Govt debt figure rises to £4 trillion (or 2x GDP) if you include the unfunded pensions. https://www.hardmanandco.com/research/corporate-research/the-monthly-july-2021/

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