AB Dynamics, Self-Driving Cars and Global Warming

AB Dynamics (ABDP) published some very positive interim results this morning. Revenue up 60%, pre-tax profit up 95% and it looks like it should easily meet analysts forecasts for the full year. The share price is up 9% so far today, at the time of writing. I hold the stock.

The company specialises in testing systems for major car manufacturers including a range of driving robots, soft vehicle and pedestrian targets and driving simulators. This is just what is needed to test the new Advanced Driver Assistance Systems (ADAS) and autonomous vehicles (“self-driving” vehicles) that all car manufacturers are now investing a large amount of money in developing.

For example Elon Musk of Tesla recently predicted that his cars will have self -driving capability by mid-2020 – they just need the software upgrading to achieve that he claims. He also promised a fleet of “robo-taxis” by the same date. These claims were greeted by a lot of skepticism and quite rightly. This is what ABDP had to say on the subject in today’s announcement: “There will be many phases to the development of fully autonomous vehicles and we foresee extended periods of time before they can satisfy a significant part of society’s mobility requirements.  There remain significant barriers to adoption including technical, ethical, legal, financial and infrastructure and these challenges will result in the incremental implementation of ADAS systems over many years to come. The ongoing regulatory environment and consumer demand for safety are also driving technological advancements in global mobility requirements and this provides a highly supportive market backdrop to the Group’s activities”.

As an active member of the Alliance of British Drivers, I can tell you that they are very wary of self-driving vehicles. None of the vehicles under test offer anything like the reliability needed for fully-automated operation and expecting human operators to take over occasionally (e.g. in emergencies where the vehicle software cannot cope), is totally unrealistic. In other words, even “level 3” operation for self-driving vehicles which requires drivers to take over when needed is fraught with difficulties and offers little advantage to the user because they have to remain awake and alert at all times, something not likely to happen in reality.

But even if that future is unrealistic, ABDP should still find a big market for testing of Autonomous Emergency Braking (“AEB”) and other ADAS systems.

Extinction Rebellion and their supporters who have been blocking London’s roads lately seem to want to remove all vehicles from our roads in the cause of reducing CO2 emissions which they claim is the cause of global warming (or “climate change”). I won’t even attempt to cover the latter claims although it’s worth stating that some dispute the connection and that climate change is driven by natural phenomena and cycles. But three things are certain:

  1. Reducing carbon emissions in the UK alone will have negligible impact on world CO2 emissions. China, the USA and other developing countries dominate the sources of such emissions and China’s are still growing strongly due to their heavy reliance on coal-fired power stations for electricity generation. China now produces more CO2 emissions than the USA and EU combined and is still building new coal-fired power stations. The UK now runs much of the time with no use of coal at all and rising energy contribution from wind-power and solar although gas still provides a major source.
  2. Environmental policies in the UK and Europe have actually caused many high energy consumption industries to move to China and other countries, thus enabling the UK to pretend we are whiter than white but not solving the world problem.
  3. A typical example of this approach is the promotion of electric vehicles. A recent article in the Brussels Times suggested that in Germany electric vehicles generate more CO2 over their lifespan than diesel vehicles. The reason is primarily the energy consumed in battery production – for example a Tesla Model 3 battery might require up to 15 tonnes of CO2 to manufacture. Electric car batteries are often manufactured in locations such as China although Tesla produces them in the USA.

In summary the UK and other western countries are being hypocrites and environmental campaigners are demonstrating in the wrong places and for the wrong reasons. The real problem is too many people in this world wanting to move to a high energy consumption lifestyle as we have long enjoyed in the western world. Population control is the only sure way to limit air pollution or CO2 emissions but nobody is willing to face up to that reality. In the meantime we get a lot of virtue signaling from politicians but a failure to tell the public the facts of energy consumption and production. Energy consumption is still growing world-wide and will continue to do so due to demographic changes and the desire for western lifestyles.

Finally just one comment on the Extinction Rebellion demand for a “people’s assembly” or “citizen’s assembly” as it is sometimes called. Is not the parliamentary democracy that we have at present such a system? Or is it simply a case that they want unelected people to decide on future policies? It has been suggested that such an assembly would be chosen at random from the population which hardly seems a very practical idea to me. This demand is a classic example of how muddled the thinking actually is of Extinction Rebellion supporters.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Construction Companies, Fixed Price Contracts and Galliford Try

Stockopedia last week published an article by Roland Head on his SIF Portfolio and the lessons from his biggest losers. He tries to steer clear of stocks that are likely to deliver big losses by a) Diversification by holding an evenly weighed portfolio of 20 stocks; and b) avoiding outliers with high or low P/E ratios, market caps of less than £50 million or those with large price spreads. But over the last three years there have still been seven stocks sold with a net loss of 20% or more, and two more still held that have a running loss of more than 20%.

The interesting aspect is that almost all of them are in sectors that I have developed a prejudice against from past experience and by learning from others. In my forthcoming book I rule out as investments such businesses as drug development companies, miners, oil/gas companies, banks, financial companies, morally dubious businesses, airlines, construction companies and several other sectors. In the SIF portfolio the losers include Plus500 (morally dubious), Easyjet (airline), Banco Santander (bank), Staffline (recruitment), Keller, Costain and Bilby – the last three operate in the construction or building services markets.

You’ll have to wait for an explanation of the others but here is why don’t I like construction companies. They have a great tendency to agree fixed price contracts with customers, or fixed delivery dates with onerous penalty clauses. Another example of the problems in this sector was the profit warning issued by Galliford Try (GFRD) on the 16th April. This company operates in both the housebuilding and construction sectors but have decided to downsize the latter and undertake a strategic review. To quote from the announcement: “The Board anticipates that this review will result in reduced profitability in the current year reflecting a reassessment of positions in legacy and some current contracts and the effect of some recent adverse settlements, as well as the costs of the restructure. The single largest element relates to the Queensferry Crossing joint venture, which has recently increased its estimated final costs on the project”. As usual with this kind of business, it seems that a number of projects are running over budget.

Now one thing I learned from my career as an IT consultant was never to write a fixed price contract for project development because there are always too many uncertainties. Technical problems can arise, the customer keeps changing their minds or delays the project through lack of focus, or resources thought to be available are not. The other difficulty is that the customers are commonly one-off relationships, so they have no motivation to sort out any problems amicably. In reality the customer’s management will always blame the third-party supplier for their own failings.

There are of course ways to write contracts so they look like a fixed price one but are not in reality. Contractors to the defence and rail industries seem pretty adept at this even if they cannot get customer to agree a “cost plus” deal. So for example, it looks like Transport for London, The Government and you and me are going to pick up the tab for the delays to Crossrail – now possibly delayed until 2021 according to the BBC.

One of the other dangers in construction companies is the attractiveness of up-front cash advances on many projects which means they have difficulty turning away future business as their cash flow would then turn negative.

Construction companies of most kinds are ones I have learned to avoid from experience. They may look cheap on the normal financial ratios that investors use, but they are never cheap enough to offset the major risks you run by investing in them.

You may say that with my prejudices I am ruling out as much as half the stock market’s listed companies. Perhaps that is so but that still leaves hundreds of companies to choose from for investment. So why bother with the dubious ones? The excluded companies will still find they get investors willing to buy the stock who like to track the indices and not make decisions about sectors and companies, but more fool them.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Audit Market Shake-Up, Ocado on TV, and Judges Scientific Presentation

The Competition and Markets Authority (CMA) have issued their final recommendations to improve competition in the audit market after an earlier public consultation. This follows widespread concerns over the dominance of the big four audit firms, the lack of apparent competition on price or quality, and repeated complaints about the quality of audits following several big and small company failures. Audit firms seem to have got off relatively lightly if the CMA’s recommendations are implemented by the Government. Here’s a brief summary of the proposed changes:

  1. Audit firms will have to operationally split their auditing operations from their consulting operations. This is not a requirement to totally split their businesses but to have separate management, accounts and remuneration.
  2. Mandatory joint audits are proposed for large companies where a big four firm is involved, with a few exceptions. This will enable smaller audit firms (“challengers” as they are referred to), to increase their capacity and credibility.
  3. Audit committees of companies will come under closer scrutiny with the audit regulator having powers to mandate standards, monitor those standards and issue public reprimands where appropriate. But the latter is surely going to be a somewhat ineffective remedy to incompetent audit committees. The CMA have rejected the idea of an independent body to select auditors as proposed by John Kingman due to legal barriers to that change, although they suggest it might be worth keeping under consideration.

One interesting statement in the CMA’s report is this: “In light of the consultation responses, we are recommending a combination of joint audits for most FTSE 350 companies and peer review for others”. That is important because previously it was suggested that only large companies be covered by either rule.

The key question is whether this will improve the quality of audits which is the major issue. I suspect not because more price competition might simply result in more bids at minimum cost with the result of cutting corners on the audit itself. Improved regulation is the key to improving audit quality. But improving competition by reducing the dominance of the big four is otherwise surely to be welcomed.

For more information on the CMAs report, go to https://www.gov.uk/cma-cases/statutory-audit-market-study#final-report . You can see what I said in my response to the original consultation here: https://www.roliscon.com/CMA-Audit-Market-Review-Response.pdf

There was an interesting glimpse into the operations of on-line supermarket operator Ocado (OCDO) on BBC television last night (programme entitled “Supermarket Secrets”). It showed their automated warehouse picking system although the final bagging up is still done manually – however that might change in future. Ocado is of course different to other on-line supermarket operations who mainly pick from in-store stock whereas Ocado have only central distribution operations with no physical retail outlets. Apparently most supermarkets have lower profits on their on-line sales as opposed to their in-store sales because the costs of delivery are not fully recovered in delivery charges. There are also more replacement items when delivery is from local supermarkets rather than from Ocado’s system.

There was an interesting review of Ocado’s business by Ian Smith in an FT supplement a month ago under the title “Pick of the Bunch”. It covered how Ocado moved from being a favourite of short-sellers to one of the best performing stocks in 2018. The change has been brought about because it is now perceived as more of a technology company than a simple retailer. That’s because it is selling its automated systems to other companies. That includes sales to Casino in France and Kroger in the USA.

Ocado lost money last year and is still forecast to lose money in the next two. But I bought a few shares regardless recently. It is interesting to see how the shopping habits in our family have changed. My wife does most of our food shopping and used to go to our local Sainsburys supermarket a couple of times per week. She started to occasionally use their on-line service when she was unwell. But now she uses it most of the time for her big weekly shop with only occasional visits to the store. If the habits of other families change in this way, one can see supermarkets adapting to the Ocado model.

A more long-standing holding of mine is Judges Scientific (JDG). This is a company that is an acquirer of small scientific instrument makers, and as with all good companies the management has a strong focus on return on capital. An interesting breakfast presentation after the results announcement can be seen here: https://www.piworld.co.uk/2019/03/26/judges-scientific-jdg-2018-full-year-results-presentation/ . It explains a lot about how the company operates.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Grant Thornton, Interserve and Arc Fund Management

The Financial Reporting Council (FRC) have announced an investigation into the audits by Grant Thornton of the accounts of Interserve (IRV) in the years 2015-2017. Interserve was a large outsourcing company with most of its business from Government contracts. It ran out of cash and went into administration on the 15th March with debts of £738 million. Readers will no doubt be aware that Grant Thornton were also the auditors of Patisserie Holdings and Globo, both cases where very substantial fraud took place.

I received a rather odd letter recently from a company called Investment Recovery Services Ltd. It suggested that I might have been mis-sold an investment in the Arc EIS 5 Growth Fund promoted by Arc Fund Management Ltd in 2006. The letter was odd for two reasons:

  1. I have never invested in that EIS fund or indeed with Arc Fund Management.
  2. Civil claims are time barred after 10 years so it seems unlikely that claims from 2006 could be pursued.

I know nothing about Investment Recovery Services Ltd although they seem to have been in existence for some years.

As regards Arc Fund Management Ltd the company itself was dissolved in 2017 but Arc Fund Management (Holdings) Plc changed its name to Consolidated Asset Management (Holdings) in 2008 and it subsequently delisted from AIM in late 2009. It again changed its name to SUSD Asset Management (Holdings) in 2011 and seems to be now a property development business with assets of £4.6 million.

I suggest anyone else who received such a letter and thinks they might have a potential claim should be very wary of such an approach. They key is never to pay money up-front on the basis that a claim will be pursued and it seems highly unlikely to me that such a claim could be pursued at this late date.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Debenhams PrePack, Dunelm Trading, ASOS and Privacy

Department store operator Debenhams (DEB) has been put through a pre-pack administration. It’s been bought by a new company formed by its secured lenders. Mike Ashley of Sports Direct is furious. His company invested £150 million in the shares of the company in the hope of taking it over, which will now be worthless. He had some choice words to say on the subject which included that it was an “underhand plan to steal from shareholders”, “as normal politicians and regulators fiddled while Rome burnt”, and that they “have proven to be as effective as a chocolate teapot”. I have much sympathy with Mike Ashley and the other shareholders as I have consistently criticised the use of pre-pack administrations in the past. It is an abuse of legal process. Why could it not have been put through an ordinary administration as the company appears to be a going concern, albeit with excessive debt, or Ashley’s offers considered?

Mike Ashley had previously made various offers to refinance the business including a pledge to underwrite a rights issue, but to no avail. It is not clear why his proposals were rejected, but as usual with pre-packs it is probably just a case of the lenders seeing the opportunity to make more money from a pre-pack. Ashley suggests he might try to challenge the pre-pack although that will be difficult now the deal is done.

What went wrong at Debenhams? Basically an old-fashioned retail format where sales were relatively stafic compounded by very high and onerous property leases and massive debt.

Contrast that with the trading statement from Dunelm (DNLM) this morning. This company sells home furnishings from out of town warehouse sites (not on the High Street like Debenhams) and have moved successfully into “multi-channel” operations with a growing on-line sales proportion. Overall like-for-like revenue in the third quarter is up by 9.8% with on-line sales up 32.1%.

Retailer ASOS (ASC) also announced their interim results this morning. Sales were up 14% but profits collapsed with margins declining and costs increasing while they invested heavily in technology and infrastructure. Competition in on-line fashion is increasing but you can see that such companies are taking a lot of business from High Street retailers, particularly in the younger customer age segment. The world has been changing and Debenhams has been an ex-growth business for many years. I do most of my clothes shopping, but not all, on the internet which shows even oldies are changing their shopping habits. I have never held Debenham shares although I do hold some Dunelm and have held ASOS in the past. But declining businesses with high debt are always ones to avoid however cheap the shares may appear.

Readers of my blog should be aware that after many years and growing amounts of spam I am changing all my email addresses. You can either contact me in future via the Contact page of my web site (see https://www.roliscon.com/contact.html ) or via the Contact tab on this blog.

It’s taking me some time to notify all the hundreds of organisations I am signed up with of my new email address. But that was almost frustrated when one of them sent out an email to all their clients using cc. rather than bcc. They have reported themselves to the Information Commissioner! But will they take any action? I doubt it. Thankfully the company in question used one of my older addresses which will soon be deleted. Such idiocy is not acceptable.

Another problem I am having of late is that if I mention a company or look at its web site, I then subsequently get bombarded with web advertising. So I am now seeing repeated advertisements for SuperDry products when I have absolutely no interest in such products. Despite removing cookies they still appeared. This is the kind of problem that is annoying people about the lack of privacy in the modern world and which needs tackling.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Brands Have Limits – Saga and AA

I have written before about the merits of strong brands. This is a paragraph from my new book soon to be published (entitled “Business Perspective Investing”): “Trade marks help customers to identify with the product, and make it easier for them to select the product on a new purchase. Brands are particularly effective when there is actually little difference between competitors’ products – for example, lager beer, gin or washing powder. Brands are exceedingly valuable if well maintained. Coca-Cola is a great example of a powerful brand, supported of course by a secret recipe”. But there are limits to how much a brand can be exploited in the face of aggressive price competition or where the company milks the customers too aggressively. Recent events at Saga (SAGA) and AA (AA.) demonstrate the problem.

Saga specialises in insurance and holidays for the over 50s. I certainly qualify in that regards and until a couple of years ago I actually had a car insurance policy through them. The policy was well structured and they dealt with the odd claim well. But I found they consistently increased the premiums on each renewal to the point where they became simply uncompetitive on price. That undermined my trust in the company. It seems other customers may have faced similar issues because their insured customers have been falling. The shares fell by 37% yesterday after a preliminary results announcement that showed reported profits had turned into a loss and the dividend is to be halved. This is what it said:

“Over recent years Saga has faced increasing challenges from the commoditisation of the markets in which we operate, especially in Insurance.  This has had an impact on both customer numbers and profitability.  Although Underlying Profit Before Tax for the 2018/19 financial year is in line with our expectations, the long-term challenges we face and the results demonstrate that Saga cannot grow without a clearly differentiated offering to its customers.

In response, today we are launching a fundamental change to the Group’s strategy to return the whole business to its heritage as an organisation that offers differentiated products and services.  This will give our customers and members a compelling reason to come to us and stay with us.”

I also had a Saga branded credit card until last month, a service run by Allied Irish Bank (AIB). But Saga abruptly cancelled the service with no explanation as to why, and no alternative offered. Those who only had one credit card, or significant outstanding balances owing would have had to scramble quickly for an alternative (Saga did not arrange any transfer to another provider). This is no way to treat loyal customers.

It would seem that Saga has been making very substantial profits in the last few years by exploiting its brand and loyal customers, but there is always a limit to how much that can be done. The over 50 age group is growing in size so the company should have been growing its customer base, not see it declining. I fear that it will take some time to rebuild brand loyalty. The over 50s are not stupid and uncompetitive pricing will be found out sooner or later, which is exactly what has happened.

Similar problems have been hitting car breakdown service and insurer, the AA. Here again we have a very strong brand but turnover has been flat for several years and there are cheaper breakdown services. They have been losing customers of late. They also seem to have had operational problems in extreme weather conditions last year which increased their costs and here again their insurance offering is now less profitable than it was.

Competitors have crept up on both Saga and the AA in recent years and there is no great differentiation from competitors any more. Car insurance has become commoditised in recent years because there is little to choose between suppliers. There is no advantage in being over 50 at Saga or a long-standing AA customer. They both need to rethink what their appeal is to their existing customer base, and prospective customers, so as to ensure better retention and to attract new customers.

Rather like Superdry (SDRY) which I commented on recently, the brands need reviving with new and differentiated products and services. But brands can only be of limited help when the pricing is uncompetitive and operational mistakes are being made.

I don’t rate any of these companies as good investment propositions however cheap they may appear to be until they show that they have solved these problems.

Roger Lawson (Twitter: htt ps://twitter.com/RogerWLawson )

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All Change at Superdry and Intercede – Perhaps

Readers are probably aware that founder Julian Dunkerton managed to win the votes yesterday at the EGM that he requisitioned at Superdry (SDRY). The votes to appoint him and Peter Williams were won by the narrowest of margins despite proxy advisors such as ISS recommending opposition. My previous comments on events at Superdry are here: https://roliscon.blog/2019/03/12/superdry-does-it-need-a-revolution/ . It did not seem clear cut to me how shareholders should vote, but I did suggest there was a need for change.

There will certainly be that because the incumbent directors (including the CEO and CFO although that does not necessarily mean they have quit their executive positions) have all resigned from the board although some of the non-executive directors are serving out their notice. Dunkerton has been appointed interim CEO.

Perhaps the most apposite comment on the outcome was by Paul Scott in his Stockopedia blog. He said “To my mind, the suits have made a mess of running this company, so bringing back the founder seems eminently sensible to me”. However, I suggest there is still some uncertainty as to whether the Superdry fashion brand can be revived – perhaps the world has moved on and it has gone out of fashion. But Dunkerton should be able to fix some of the operational problems at least. Retailing is still a difficult sector at present so I won’t personally be rushing in to buy the stock.

Another momentous change took place at Intercede (IGP) yesterday. This company provides secure digital identities and has some very interesting technology. But for many years it has failed to turn that into profits and revenue has been also remained flat. But yesterday the company announced a large US Government order and hence they expect a “return to profitability”. This certainly surprised the market as another loss was forecast. The share price jumped 60% yesterday after it had been in long decline for several years.

I have held a small holding in the stock since 2010 (very small prior to yesterday) but I was never convinced that the company knew how to sell its technology – a common failing in UK IT companies. The former CEO and founder Richard Parris who was there for 26 years was surely part of the problem but he departed in 2018. Has the company actually learned how to make money under the new management? Perhaps, but one deal does not totally convince. One swallow does not make a spring as the old saying goes.

Even after the jump yesterday, the market cap is still not much more than one times revenue which is a lowly valuation for such a company. But investors need to be aware that the company has £4.6 million of convertible loan notes which would substantially dilute shareholders if they were converted. A company to keep an eye on I suggest, to see if it has really changed its spots.

Another surprising change yesterday was the abrupt departure of Richard Kellett-Clarke from the boards of both DotDigital (DOTD) and IDOX (IDOX) “due to private matters in his other directorships” according to the announcement from DOTD. DOTD is looking for a new Chairman. I wonder what that is about? We may find out in due course.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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