Weekly Commentary 16/08/21: The S&P494

FAMANG share price over past 10 years. Source: SharePad multigraph

Bruce looks at how stock market indices can be skewed by a few large winners.  The same goes for portfolio returns.  Stocks covered this week are BOTB’s profit warning, plus H1 results from Clarkson, Ocean Wilsons and Georgia Capital. 

The FTSE was up +1.0% to 7,193 last week, outperforming the S&P500 which was up 0.5% and Nasdaq 100 which was flat to slightly down. China Evergrande’s shares were up +25% as Hui Ka Yan, the company’s founder suggested selling assets in order to confront the falling share price and “many confusing news”. The Shanghai Stock Exchange changed the eligibility of investors who were allowed to hold Evergrande’s onshore bonds to “qualified institutional investors”, which an analyst quoted in the FT suggested might be to prepare for a potential restructuring in troubled property developer’s debt.

Though this weekly normally starts with a paragraph or two about the S&P500, Nasdaq and FTSE100 etc, I’m conscious that this may be the wrong way to look at stocks. There’s an interesting piece by Drew Dickinson at Albert Bridge Capital, pointing out that when we look at the performance of US markets we should remember that Google, Facebook, Apple, and Netflix headquarters are all within 40 miles of each other. The performance of the S&P500 (+253% since start of 2012) doesn’t tell us much about the US, it reveals something exceptional about Silicon Valley (unless you are trying to buy a house there).

The reason why US markets have strongly outperformed European indices is nothing to do with linguistic barriers, cultural differences, government bureaucracy, Central Banks, BREXIT or Donald Trump. Instead, the market cap of six companies, the FAMANGs (Facebook, Apple, Microsoft, Amazon, Netflix, Google) now constitute a quarter of the value of the S&P500, up from less than 10% in 2014. These S&P6 are up +721% since the start of 2012, versus the S&P494 which is up a less impressive +148% according to Ed Yardeni.

That 10 year +148% increase for the S&P494 is still better than the FTSE Allshare +83%, the Cac 40 +116% but less impressive than the German DAX +168%. Rather than frame the performance in terms of US vs UK or Europe, we could equally frame the performance as Silicon Valley plus Seattle, versus the rest of the USA. Interestingly too, FAMANGs make up a quarter of the market cap, but because tech companies trade on high price/sales multiples reflecting good margins, the FAMANGs are below 2% of the index revenues, according to the same presentation by Yardeni. Or put another way, Ford’s revenues were $127bn FY 2020, almost 50% higher than Facebook’s $86bn. Yet the car company has a market cap of just $127bn, 13% of the $1trillion value investors put on Facebook’s revenue.

So when people say “the FTSE is cheap, or the Nasdaq is expensive” it’s worth asking whether they mean most stocks in the index are expensive or a few outsized high performing companies have skewed the average. Assuming your holding period is measured in years, rather than months, I’d expect a similar pareto distribution for your own portfolio with c. 80% of gains coming from c. 20% of winners. That seems to me a good argument for using SharePad’s screening tools, to help identify companies with the growth and return prospects to generate the high returns.

Last week Paul Hall, held an interactive ‘Learn Stock Screening in SharePad’ webinar, with time for Q&A afterwards. Screens and filters are a great way identify companies that fit your process, and hopefully improve your returns. The system is fairly intuitive, so if you’re patient you can figure out these features yourself. But learning from an expert saves time and frustration, so I recommend checking out the SharePad YouTube channel.

Portfolio activity: many people on Twitter make a lot of noise when they buy a share, less so when they sell. BOTB profit warning on Friday last week (share price down -44% on the morning of the RNS) shows that when a high performing share disappoints the reaction is normally savage. I’ve sold some of my Impax AM shares. This is as much about “regret avoidance” for me rather than the expensive valuation.

Impax has been one of my better investments, but still I’d suggest a couple of mistakes: 1) Position sizing. I should have bought with much higher conviction when Impax reported +16% inflows in the first 3 months of 2016. 2) Too focused on the entry price. I’d followed the company for many years, and as it happened I was able to buy at below 50p when the company started reporting those strong inflows, but I almost missed out on one of the best performing companies over the last 5 years. Maynard has also written about Impax screening for his next long term winner here.

Obviously not all of my investments increase in value 30x in c. 5 years; I’ve recently sold some Hostelworld for a 20% loss.

This week I look at H1 results for a couple of businesses that have been driven by global trade flows, a decade ago both were multi baggers, but have struggled more recently. Clarkson, the shipbroker and Ocean Wilsons, the Brazilian ports business. I also look at Georgia Capital, but start with a comment on BOTB’s profit warning last week.

Best of the Best profit warning

The online “spot the ball” company put out a disappointing trading update for the 15 weeks ended 8 August 2021, with the shares reacting by falling -44% on the morning of the RNS. The management did a placing in March, selling at £24 per share generating proceeds of £41m for William Hindmarsh and family and £12m for Rupert Garton. Then on 16th June the share price fell -30% when they announced a weaker outlook in their FY results to April 30th.

In last week’s RNS the company splits their customers into three cohorts. 1) Existing customers prior to May 2020 remain loyal and engaged but revenues c.6% lower than during the final 15 weeks of the FY to 30 April 2021. Despite this, revenues generated by these existing customers remain higher than in the 12 months pre-pandemic, and now form c.50% of the total. 2) Customers signed up between May 2020 and Apr 2021 representing c.40% of total revenue have performed well and in line with our normal models and expected behaviour. 3) But the problem seems to lie with the third cohort registered within the last 15 weeks. The cost of acquiring these customers have risen, so these new customer revenues are c.40% lower (accounting for a 9% fall in total revenue) than during the final 15 weeks of the prior financial year.

Broker forecasts FinnCap, their broker, cut their EPS forecast by 63% to 53p from 142p for FY2022F and by 61% to 64p from 165p for FY2023F, which assumes current trading levels persist for the rest of the year. Assuming a share price of 850p (where the shares traded Friday morning), that implies a PER of 16x for next year, and 13x 2023F.

Opinion I’m sorry for holders here. In June I suggested that “The shares have risen +40% in the last year, and in contradiction to what you’d expect from the Bored Market Hypothesis have participated in the vaccine rally. I think this is a case of expectations getting ahead of themselves, the longer term investment case remains unchanged in my view.” Expectations had got ahead of themselves, but were still far too high. That said BOTB has disappointed before and then recovered strongly. In 2012 BOTB lost 48% of revenue from physical sites when they failed to agree an extension to their contract with British Airports Authority (BAA). I’d steer clear for now, but revisit the investment case in 3 to 6 months.

Georgia Capital H1 to June results

This Tbilisi based Bank of Georgia spin off (containing a hodgepodge of assets: a hospitals business, a pharmacy chain, a water utility, insurance, renewable energy, education, a property developer, a brewery and my favourite, the Teliani Valley vineyard) reported H1 results to June. Previously these businesses were part of Bank of Georgia, but they have been listed on the London Stock Exchange (not AIM) since May 2018, because the Georgian Central Bank was unhappy with the conglomerate structure. We saw in the financial crisis that diversification is not an effective way for banks to reduce risk, much better is regulating leverage. Bank of Georgia, will report their H1 results this Tuesday, on 17th August.

CGEO’s NAV per share was +13.2% from December 20 to £13.18 at today’s exchange rate (4.3 £/GEL so NAV in Georgian Lari is 56.55). Around 17.7% of that NAV is a cross shareholding in Bank of Georgia, whose share price is up +29% since the start of the year. There’s a fun “discount map” on the company’s website, where investors can play with the underlying multiples of each business to generate their own valuation assumptions.

Net debt at the end of June was 714m GEL (26% of the gross portfolio value 2,921 GEL), or £166m versus gross portfolio value of £680m at today’s exchange rate. The company has a target for net debt / total portfolio value of less than 30%.

Excluding Bank of Georgia, the group’s revenues were up +26.5% v H1 last year. They were also up +37.1% versus H1 2019, which would have been a more normal year. However, I don’t think that +37.1% growth figure is comparing apples with apples, because they bought out a minority stake in their Healthcare business last year. Nevertheless these results look impressive and NAV should continue to grow, underpinned by the fundamentals in each of the diverse businesses. They are expecting dividend income from their companies of 60-70m GEL this year (or c. £15m).

The company announced a $10m buyback. Despite the +16% increase in the CGEO share price since the start of the year to 651p, the current discount of c.50% to NAV per share 1318p remains high. Due to this large discount management believe that they are better to spend excess cash on share buybacks rather than new investments. Presumably if Berkshire Hathaway shares were trading at 50% NAV (rather than 1.47x premium that they currently do), Buffett would be using more of his $140bn of excess cash to buy back his own shares.

Georgian Economy Despite Georgia’s reliance on tourism and remittance flows (ie Georgians working overseas sending money home to their families) the economy has held up remarkably well. Fitch, the rating agency, has reiterated Georgia’s sovereign credit rating at BB, and revised up the outlook to Stable from Negative. I am extremely sceptical of rating agency’s ability to flag problems early, share prices react much more quickly than rating agencies (China Evergrande being the most recent example, but the financial crisis starting in 2007 and Enron’s investment grade credit rating are embarrassing at best.) However, as a backward looking indicator rating agencies can be useful, so conditions probably did improve in Georgia in H1. Fitch also revised up their 2021F real GDP estimate to 7.8% (versus a 6.2% fall in 2020), implying that output will exceed its 2019 level this year. If anything there are some signs of overheating, and on the 4th August the National Bank of Georgia (the country’s Central Bank) increased interest rates by 50bp to 10%.

Ownership Eaton Vance (the Boston based wealth manager now owned by Morgan Stanley) owns 6% and M&G 5%. Other than that, at £300m market cap, CGEO is too small and too complicated for large institutional investors to spend much time understanding the business. I believe that could present an opportunity for retail investors who are prepared to spend time understanding the risks and potential returns.

Voluntary Disclosure I’ve owned this stock as part of my investment in Bank of Georgia, receiving shares in the May 2018 spin off. I like the story and Irakli Gilauri, the Chief Exec, but I do struggle with the voluntary disclosure. There’s huge amounts of detail (the H1 results presentation is 165 slides) and I’m sure the management aren’t trying to hide anything, but it’s hard to work out what’s going well and what isn’t. That means the discount to NAV is likely to stay, until management sell one of their businesses (hopefully at a premium to book value) which could then drive a re-rating as CGEO i) becomes easier to understand and ii) investors have confidence that the NAV has been valued correctly.

Clarksons H1 to June results

This shipping services company is a long term multi-bagger, up from £1 in 2000 to a peak of £34 in March 2018. The share price is trading below that £34 previous high, but has participated in the vaccine rally with a +62% rise since November last year. CKN announced revenue +5% to £190.1m H1 to June 2021 and reported PBT up +31% to £27.3m. They had net cash of £87m on the balance sheet at the end of June. Management are paying a 27p interim dividend, which is the 18th consecutive year of progressive (ie increasing) dividend policy.

That’s a good recovery because the company had a difficult second half, with revenues falling -9% H2 v H2 2019. Shipping is a cyclical industry, and the company complains about a “decade long malaise” in freight rates. But in last week’s RNS the Chief Executive’s sounds very positive, implying that we are at the start of a new cycle which favours Clarkson.

“As we have been predicting for some years now, the demand/supply dynamics of the shipping market have turned positive, aided by the green transition, its impact on the global shipping fleet and the beginnings of economic recovery from the pandemic. The Group’s first half performance reflected the early days of these changing trends and we have positioned the business to capitalise on these dynamics.”75% of revenue comes from shipbroking, and well publicised supply chain disruptions and rising freight rates have helped Clarkson. Disruption from the Ever Given, wedged in the Suez canal saw rates in the container shipping markets pushed further up.

Despite all the bullish commentary and impressive charts, PBT in the shipbroking division was up less than £1m to £30m v H1 last year. The disconnect between a favourable environment and the lack of PBT growth in the shipbroking division isn’t well explained by management.

Instead group profit growth was driven by the much smaller division, called “Financial” or “Clarkson Platou Securities” which rebounded to a profit of £5.3m v a loss of £1.6m H1 last year. Clarkson’s specialist financial business (both debt and equity capital markets) raised $2bn for clients. Both shipbroking and financial division have EBIT margins (in good times) of over 20%, but the latter has operational gearing and more volatile PBT.

Cash flow It’s also notable that though PBT was £27.3m, cash flows from operating activities were minus £12.2m on a pre tax basis. The two large negatives were an increase in trade and other receivables (£17.4m) and a bonus accrual programme (£31.3m). They say that the increase in trade debtors is a timing issue, due to a particularly busy Q2, and the figure should convert to cash in Q3. Trade debtors were £74m or 39% of H1 2021F revenue of £190m (the FY 2020 figure was £161m of trade and other payables, which included £120m of accruals, including bonus accruals).

Bonus accrual The £31.3m H1 bonus accrual figure in the cashflow statement looks very significant in the context of PBT of £27.3m. Assuming the bonus is paid in cash to employees, then I would expect a cost accrued in the p&l through the year, and then that cost added back (ie positive number) appearing in the cashflow statement. Whereas at the H1 stage CKN cashflow statement has a large negative number (£31.3m H1 2020 and £36.8m H1 2019) representing a decrease in the bonus accrual. I’m flagging this as something I don’t understand and which I’d ask for clarification on, rather than implying there’s anything untoward going on. Maybe “decrease in bonus accrual” actually means “bonus cash paid out” but they don’t want to highlight that they’ve paid out £31m in cash bonuses in H1, when the business reported a FY 2020 loss of £16.4m?

As a general observation, I think that companies could improve their discussion of movements in the cash flow statement – I noted a couple of weeks ago that Sylvania Platinum’s “sales adjustment” is also hard to understand.

Ownership Clarkson is in the FTSE 250. There are some institutions with disclosable interests: Invesco 5.2%, Heronbridge 4.99%, Royce & Associates 4.9%, Franklin Templeton 4.9%, Kames Capital 3.6%.

Forecasts FY 2020 revenue fell last versus the previous year. That figure is now forecast to grow by +4% in 2021F, and by c. 5% CAGR to £416m in 2023F. That puts the shares on EPS of 140p 2023F and a PER of 26x.

Opinion I’ve never really understood how Clarkson has done so well, relative to Braemar which is in the same sector. I’ve used the multigraph feature in SharePad to compare the performance of both shares back 10 years, rebased to 100. Clarkson is up +340% and Braemar shareholders have had a torrid decade, with the shares down -80% before recovering in the last 12 months.

It’s clearly been a tough environment for both companies. Clarkson’s RoCE peaked at 25.7% in 2011, and has been on a declining trend since then (minus 3.3% RoCE in FY 2020). Despite the declining profitability CKN’s share price has done much better than Braemar, and CKN commentary sounds upbeat, so perhaps we are about to see not just revenue growth, but improving RoCE?

Ocean Wilsons H1 to June results

This company listed on the LSE (not AIM) has two subsidiaries: i) it owns a 57% stake in Wilson Sons, a ports (Salvador and Rio Grand) business in Brazil that includes towage, container terminals, offshore oil and gas support services, small vessel construction, logistics and ship agency. Wilson Sons has just completed a restructuring, so that its shares now trade on the Brazilian stock exchange, the Novo Mercado, in an effort to improve liquidity. ii) Ocean Wilsons (Investments) Limited or OWIL, which had $336m of investments at 30th June and backs a number of hedge funds that have underperformed the S&P500 over the last 10 years. I wrote about the company last November.

Wilson Sons The ports business had a strong H1, with revenues up+8.4% to $189m and up +19% in Brazilian Real. The currency has been weak against the US dollar, depreciating 26%. In terms of business units Logistics +8.4% and towage +12% were strong, but offshore which supports the oil & gas industry remained weak. Operating profit was +83% H1 v H1 20 to $51m, showing the benefits operational gearing working in the right direction.

OWIL The portfolio is up +9.1% per annum in the last 5 years, or +53%. This is outperformance versus management’s chosen performance benchmark (+5.4% per annum). Their chosen benchmark is US CPI Urban Consumer index. I’d suggest that Consumer Price Inflation is a pathetically easy benchmark for an $330m equity portfolio to beat over the long term. The S&P is up +104% in the last 5 years, around double that of OWIL’s stable of hedge funds.

Valuation The share price of Wilson Sons is 62BRL per share trading on the Novo Mercado, which is 14.4x 2021F earnings. That is a market cap of 4.5bn BRL. Multiply that 4.5bn by 0.57x for the majority stake that the Holding company owns and translate into GBP gives £350m versus a current market cap of £357m. But that ignores the $336m of OWIL investments, so effectively investors can buy at the mark to market price (quoted on the Brazilian Stock Exchange and liquid holdings in hedge funds) and receive $336m (or £240m) of diversified and liquid hedge fund investments for free.

Opinion I bought the shares in 2016, because I liked the idea of owning a Brazilian ports business with exposure to global trade flows and rising commodity prices. Edison, the paid-for research publisher, are forecasting OCN’s PBT to rise by +44% in FY21 and by +20% in FY22 as business recovers to normal.

On the downside I’m not impressed by OCN management investing in a collection of hedge funds that have underperformed the S&P500 by a considerable margin. This is unlikely to change because Hansa Investment Company Ltd own 26%, and Victualia LP 12.5% of the group, these are investment vehicles of William Salomon, Deputy Chairman of Ocean Wilsons Holdings, who appears to prefer lunches in Mayfair rather than long term shareholder returns.


The author owns shares in Impax, Georgia Capital and Ocean Wilsons

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