Population Growth Problem, Trump at Davos and More Bad News at Ted Baker

 

7.7 Billion and Growing. That was the subtitle of a BBC TV Horizon programme last night on population. Chris Packham was the presenter. He said the world’s population was 5 million 10,000 years ago but by 2050 it is forecast to be 10 billion. He showed the impact of excessive population on biodiversity and on rubbish generation with lots of other negative impacts on the environment. It is surely one of the most important things to think about at present, and will have major economic impacts if not tackled.

The big growth is coming in countries such as Brazil and Nigeria. Sao Paolo is now 5 times the size of London and it’s running out of water. So are many other major cities including London. The growth in population is being driven by better healthcare, people living longer but mainly via procreation. A stable population requires 2.1 babies per family, but it is currently 2.4. In Nigeria it’s 5!

In some countries it is lower than that. It’s 1.7 in the UK (but population is growing from immigration) and it’s 1.4 in Japan where an ageing population is creating social and economic problems.

The FT ran an editorial on the 14th of January suggesting population in Europe needed to be boosted but it received a good rebuke in a letter published today from Lord Hodgson. He said “Global warming comes about as a result of human activity, and the more humans the more activity.  This is before counting the additional costs of the destruction of the natural world and the depletion of the world’s resources. In these circumstances suggesting there is a need for more people seems irresponsible”.

I completely agree with Lord Hodgson and the concerns of Chris Packham. The latter is a patron of a campaigning charity to restrain the growth in population called Population Matters (see  https://populationmatters.org/ ). Making a donation or becoming a member might assist.

For a slightly different view in Davos President Trump made a speech decrying the alarmist climate views and saying “This is a time for optimism, to reject the perennial prophets of doom and their predictions of the apocalypse”. He was followed by a 17-year old with limited education who said just that and got more coverage in some of the media. I believe Trump and moderate environmental writers like Matt Ridley who suggest we can handle rises in world temperature and that the future is still rosy. But we surely do need to tackle the problem of a growing world population.

Chris Packham reported how this was done somewhat too aggressively in India and China but there are other ways to do it via education and financial incentives. Just ensuring enough economic growth in poorer countries will ensure population growth is minimised. Let’s get on with it!

On a more mundane matter, I have previously commented on the audit failure at Ted Baker (TED). The latest bad news today after an independent review it has been discovered that the inventory problem is twice as worse than previously reported. The company now states that inventory in January 2019 was overstated by £58 million. The share price has fallen by another 7% at the time of writing.

This is not just another example of a minor audit failure. Stock value in the Jan 2019 Annual Report was given as £225 million so that is a 22% shortfall. Auditors are supposed to check the stock and its valuation so this is a major error. It will reinforce the complaints of many investors that audit quality in the UK is simply not good enough and the Financial Reporting Council (FRC ) has been doing a rather inept job in regulating and supervising auditors. But will we see the proposed replacement by ARGA anytime soon, which will require some legislation? It seems this is not a high Government priority at present.

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

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FinTech Valuations, EU Harmonisation and Fundsmith Report

I received an interesting item from Sharepad/Sharescope by Jeremy Grime this morning. It was headlined “Culture in Payments” but the interesting part was the coverage of the valuations of Fintech companies. It listed some of the recent takeover transactions of such companies where the valuations ranged from multiples of 1.1 to 7.8 times revenue (Source: W.H.Ireland), but many of them were on more than 7 times. Profits are not even mentioned! One example was UK listed company Earthport, taken over at 7.3 times revenue by Visa when it had been consistently loss making.

The article also mentions three small such UK listed companies – Alpha FX (AFX), Argentex (AGFX) and Equals Group (EQLS) and explains how they seem to be evolving from being primarily suppliers of foreign exchange to evolving into banks. I have an interest in one of those companies and another in the sector, but some of  the valuations seem to be way too high to me. There are clearly a lot of share speculators betting on their future, but not all are likely to be successful. Maybe they are just looking further ahead than me (source of the word “speculator” is Latin “speculatus”, the past participle of the verb speculari, which means “to spy out” or “to examine” but it tends to now mean acting without looking).

Chancellor Sajid Javid has put the cat among the pigeons over the weekend by suggesting on Friday in an FT interview that UK businesses need to prepare for divergence from EU rules. He said “There will not be alignment, we will not be a rule taker, we will not be in the single market and we will not be in the customs union”. This may create potential difficulties for large importers/exporters from/to the EU, such as auto manufacturers, aerospace companies, pharmaceutical companies and food/drink suppliers. It is also somewhat inconsistent with the “political declaration” which was part of the Brexit Withdrawal Agreement.

Perhaps this is just a negotiating position. I hope so because some harmonisation on goods might surely be preferable to ease trade flows, even if we depart to some extent from EU financial regulations and other rules. However, just to give you one example where harmonisation might be objected to, the EU is mandating Intelligent Speed Adaptation (ISA) for all new cars from 2022. Many UK drivers consider this unreasonable as speed limits are often inappropriate and there are a number of technical objections to it. Exporting compliant vehicles to the EU should not be difficult for car manufacturers but for German manufacturers if the UK drops that rule then problems may arise. The devil is in the detail on harmonisation. The answer is surely to agree harmonisation on technical standards where there is an obvious benefit to both parties, but not where the regulations attempt to dictate policies in the UK, or how our citizens behave.

Lastly I covered the latest Fundsmith Equity Fund Annual Report in a previous blog post (see https://roliscon.blog/2020/01/18/another-good-year-for-fundsmith/ ). It’s now available from this web page: https://www.fundsmith.co.uk/docs/default-source/analysis—annual-letters/annual-letter-to-shareholders-2019.pdf? and is well worth reading.

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

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Slater Investments Warns on Pay, and Flybe Bail-Out

Slater Investments has issued a warning to companies of their “dissatisfaction with the framework of directors’ remuneration in most public companies”. Slater Investments run a number of funds managed by Mark Slater and others with a focus on growth companies.

The letter complains about a “relentless ratcheting of terms and conditions which have meant the interests of directors and investors have grown steadily further apart”. Specifically it complains about the award of nil-cost options which they see as a one-way bet and they also don’t like the hurdles that are set which are often simply e.p.s. rather than total return.

They also don’t like the quantum of pay awards and say: “It has become customary for executive directors to receive a handsome salary, plus the same again in cash bonus and a similar amount in nil cost options – year in, year out. Is a good salary not enough to get directors out of bed in the morning and to diligently work their allotted hours? A bonus should be determined by the return received by investors”. This is a similar complaint to my own made a week ago.

They plan to vote against remuneration reports which are longer than two pages [Comment: that means most of them at present], and vote against any schemes with nil cost options and against unresponsive members of the remuneration committee. Mark Slater and his firm are to be congratulated on taking a stand on this matter. I hope other fund managers will follow his example.

To read the letter sent to companies, go here: https://tinyurl.com/wu9jh9q

The UK Government is bailing out airline Flybe. It was obviously running out of cash and was saved from administration by the Government deferring passenger duty tax payable, a possible Government loan and more cash from the owners. Is this a good thing?

Flybe operates a number of short-haul flights in the UK and the rest of Europe. Some UK airports are apparently dependent on its operations. Is it really essential to maintain these operations when roads and rail links provide alternative transport options in most cases, albeit somewhat slower perhaps? State aid to failing companies has a very poor record in the UK – the motor industry was a good example of that. One of the few good things about the EU is its tough rules on state aid. I hope that the UK will not diverge from its principles now we are departing from the EU.

Why is bailing out failing companies a bad idea?  For several reasons. First because it effectively subsidizes poor companies which then compete with profitable companies to their disadvantage. Second, it rarely works because a bad business usually remains a bad business. For example, Flybe has been perennially unprofitable and had to be rescued via a takeover in March 2019 when it was delisted. You can see the financial track record of the company on this Wikipedia page: https://en.wikipedia.org/wiki/Flybe

Airlines are one of those businesses that I avoid. They suffer from the business model problem that they are always trying to maximise passenger loading as the economics of airlines means they need to fly the planes full to make money. This means they cut prices to fill volume when business is bad, but their competitors do the same (and their competitors can be other transport modes on short-haul flights such as buses or trains).

It has been suggested that the worlds’ airlines have never overall made money since the airplane was invented. I can quite believe it.

I see no good economic reason why the Government should bail out Flybe in the way proposed. If it owns some profitable routes, other airlines will take them on. There might be merit in reviewing air passenger duty in general which is a tax on travel that does not apply to other transport modes, or perhaps in providing some specific funding to unprofitable routes as suggested in the FT if there are good arguments for doing so and with onerous conditions attached. But the principle should be “no money unless the business is restructured forthwith with some certainty that it can be made profitable”.

Otherwise the danger is “moral hazard” as Lord King mentioned when refusing to bail out Northern Rock, not that I think he was particularly wise in that case. It is suggested that it just encourages the directors of companies to believe they will be rescued regardless of their incompetence. The threat of no more assistance ensures directors take more care it is argued and provides an example to others. Banks may be rescued with cash that the Government prints to shore up their balance sheet, but putting cash into airlines is typically just used to fund operating losses.

Businesses that are subject to Government regulation are always tricky to invest in. If they are not subsidising the competitors, they are restricting competition by regulation. Which one of my US contacts was explaining to me a couple of weeks ago as one reason for the demise of PanAm.

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

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Should Companies, their Investors and Bankers Adopt Some New Year Resolutions?

Environmental concerns are all the rage at present. Indeed it’s become a new religion verging on paranoia. Some people believe that the world is going to become impossible to live in after a few more years, or that seas will rise enough to submerge many major cities. They ascribe the cause to global warming caused by rising CO2 emissions from the activities of mankind. Even if we are not all wiped out, the impact on the economy could be devastating due to mass migration and the costs imposed by decarbonising all energy production, food production and transport.

This article is not going to attempt to analyse whether global warming is a major threat, or what its causes might be, but simply what the reaction of companies, their investors and their bankers should be. Should company directors adopt a New Year’s resolution to divest themselves of all activities that might result in CO2 generation? Should investors who hold shares in such companies sell them and invest in something else, and should bankers stop lending money for projects such as creating new oil production facilities.

Even outgoing Bank of England Governor Mark Carney gave some dire warnings in a BBC interview a couple of days ago.  He suggested that the world will face irreversible heating unless firms shift their priorities soon and that although the financial sector had begun to curb investment in fossil fuels the pace was far too slow.

What do oil companies or coal miners do if faced with such rhetoric?  There is clearly a demand for their products and if one company closes down its activities then other companies will simply move in to take advantage of the gap. There will be a large profit incentive to meet the demand as prices will likely rise if some producers exit the market.

Companies also have the problem that they cannot close down existing facilities, or move into new markets such as wind or tidal energy in the short term without incurring major costs.

Famous investor Warren Buffett does not think they should do much at all. He has suggested that even if Berkshire’s management did know what was right for the world, it would be wrong to invest on that basis because they were just the agents for the company’s shareholders. He said “this is the shareholders money” (see FT article on 30/12/2019).

So long as the law of the land says it is OK to exploit natural resources even if they generate CO2, and the shareholders support a company’s activities then company directors should not be holding back he suggests.

But I suggest shareholders have other things to consider whether they believe in global warming or not. Investors clearly face a risk that even if they are happy to invest in coal mines, the Government might legislate directly or indirectly to put them out of business. As a result of Government policies in the UK, the amount of coal produced and consumed in the country, particularly for power generation has been going down. It’s now only about 5% of electricity generation, largely replaced by natural gas usage (with lower CO2 emissions) and renewables such as wind-power and hydroelectricity. Forget trying to get planning permission for any new coal-fired power stations even if very cheap coal can be imported.

As an investor, clearly divestment from coal mining and coal consumption is a worldwide trend in most countries with a few exceptions such as China. So any wise investor might simply look a few years ahead and take into account this trend. Investing in declining industries is always a bad thing to do. However well managed they are, companies operating in such sectors ultimately decline in profitability as revenue falls and competitors do not exit as the management has only expertise in that sector and won’t quit.

Investment is also not about what you believe but about other people believe because other people set the share prices of companies, not you. You might think that global warming is simply not true, but if the majority of investors believe it then they will sell the shares in companies that are involved in CO2 generation and drive down the share price. This is surely already happening to some extent with major oil companies. Shell and BP are on low p/e ratios no doubt because they are seen as having little future growth potential. You can of course become a contrarian investor if they become cheap enough but that is a risky approach because clearly these companies are facing strategic challenges.

Investment managers are divesting themselves of holdings in oil companies so as to please their investors. Both the managers and the investors have been subject to propaganda that has told them for the last few years that oil is bad and consumption needs to be reduced. They are unlikely to take a contrary stance. Once a religion becomes widespread, you have to follow the believers or be branded a heretic, whether the religion has any basis in reality or not.

There are not trivial sums involved. The Daily Telegraph suggests that UK shareholders are some of the most vulnerable in the world with about £95 billion invested in fossil fuel producers. If you consider that CO2 needs to be reduced, and choose your investments accordingly, then you need to exclude not just coal, oil and gas producers but a very large segment of the economy. All miners and metal producers are big energy consumers mainly from fossil fuels, and engineering companies likewise. And then one has to consider the transport sector and the producers of trains, planes and automobiles. Even producers of electric vehicles actually use large amounts of energy to build them although much of that is consumed in other countries such as China. Food production and distribution also consume large amounts of energy, and building does also. For example cement production uses enormous amounts of fossil fuel and actually generates about 8% of global CO2 production for which there is no viable alternative.

There are actually very few things in the modern world that don’t consume energy to produce them. That production can be made more efficient but decarbonising the economy altogether is simply not viable.

For investors, it’s a minefield if they wish to be holier than thou and claim moral superiority. There may be some simple choices to be made – for example why support tobacco companies where their products clearly kill people? But as an ex-smoker, I am more concerned about future Government regulation that will kill off or substantially reduce their business which is why I am not invested in tobacco companies.

Company directors, investors and bankers do not need to make moral choices. New year resolutions are not required. They just need to look to the future and the evolving regulatory environment and the court of public opinion.

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

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Year End Review and Xmas Greetings

Xmas card

As the final blog post before Xmas, I thought it would be useful to do a quick review of the past year. I have not yet done a detailed review of my investment portfolio performance over the year as I do that after the 31st December, but on a quick look at my net worth, I think it’s been a good year. With the bounce in the stock market after the Conservative General Election victory, most investors should be well ahead this year. The FTSE All-Share is up 13% at the time of writing, with the FTSE-250 up 25%. AIM stocks had a relatively poor year, rising only 8% but ones I hold generally jumped up at the end of the year as UK small cap stocks were suddenly seen to be relatively cheap.

The focus this year though was certainly on technology stocks – internet and software companies, both small and large which continues the recent trend. Will that continue for the coming year?  I never like to predict market or economic trends, but there was an interesting article by Megan Boxall in the Investors Chronicle this week. It pointed out how the tech sector has outperformed the US market in 2019. Is this another dot.com bubble? She suggests not as companies such as Alphabet, Amazon, Netflix, Adobe, Apple and Microsoft are all highly profitable.

But she does warn that regulators are getting twitchy about the dominance of these companies. For example Google (Alphabet) is now so dominant in web advertising that the competitors are nowhere. They have become the gorilla in the marketplace as companies are bound to want to advertise with search engines that have the most users. Could some of these companies be broken up by US regulators or attacked by the EU as is already happening? Microsoft was of course the subject of an antitrust law suit alleging a monopoly and anti-competitive practices back in 2000, but escaped from any severe penalties or break-up and the case also took years to resolve so I doubt that other tech companies are likely to be badly damaged by any such law suits. But the settlement and some mis-steps by Microsoft did enable newer companies to grow into the size they now are.

Two areas that I am positive about are fintech and biotech, although the latter seems to have had rather a flat year as valuations became too optimistic and concerns grew about drug pricing regulation. Fintech, i.e. the enabling of innovative payment and banking systems, still looks a field where a lot of growth is likely and where there are a myriad of new or early-stage companies bidding to conquer the world. There is though a great danger in following such trends and accepting the hype that is given out by promoters of such companies – a lot of them will prove unsuccessful or never develop a profitable business model, and many of the shares in the good companies are wildly over-priced.

Housebuilding companies and estate agents have jumped up on hopes that the Conservative victory will lead to a recovery in confidence by house buyers. Even ULS Technology (ULS), one of my worse investments during the year and focused on property conveyancing, has risen by 50% since the low at the start of December. Does this mark a revival in the housing market and another golden era for housebuilders? I doubt it. The Government is undoubtedly keen to ensure more houses are built but house prices and the ability of buyers to afford them are driven by many other factors. With interest rates remaining at record lows, if the economy does pick up then interest rates might also rise. Readers need to be reminded that such low real interest rates are an exceptional phenomenon in historical terms. This anomaly surely cannot continue much longer.

Bearing that in mind, I won’t be investing in bonds or gilts in the near future as interest rates can surely only go one way and when rates rise, their prices fall.

Will the Conservative election victory and associated euphoria lead to a resurgence in business confidence, in more investment and hence in the growth in the UK economy? Perhaps, but there is still the potentially tricky issue of negotiating a free trade agreement with the EU over the coming year. That will likely mean the short-term euphoria will fade, as do most Santa Claus market bounces, in the New Year. But as with all market and economic forecasts, I could be wrong. So I will continue just to buy and hold well managed companies in growth sectors. That tends to mean small to mid-cap companies rather than mega-cap companies, although I do hold some investment trusts and funds that cover the latter. The managers of such funds are often closer to the market trends and the views of other investors than any private investor can hope to be.

It just remains for me to wish you a happy Christmas and a prosperous New Year.

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

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Euphoria All Around, But Platforms Not Keeping Up

The Conservative General Election Victory has generated large movements in stock prices with utility companies and banks some of the major beneficiaries. National Grid (NG.) rose 4% on Friday as the threat of nationalisation disappeared and Telecom Plus (TEP), which I hold, rose 11%. I sold the former some time ago as the business seemed challenged on a number of fronts and regulation of utilities in general in the UK and hence their likely return on capital seemed to becoming tougher. My view has not changed so although foreign investors might be mightily relieved, I am not rushing into buying utility companies today.

The euphoria seems to have spread to a very broad range of stocks. Even those you would think would be negatively affected by the rise in the pound, which will depress the value of dollar earnings, have risen. This may be because US markets have risen on the prospect of a US/China trade deal which was announced on December 13th.  This might roll back some of the imposed and proposed tariffs on Chinese products to the USA, and cause cancellation of retaliatory Chinese tariffs, but the details are yet to be settled. This may not be a long-term solution though as it will likely still leave the USA with a very large trade deficit with China.

One noticeable aspect of the euphoria infecting markets on Friday morning was the inability of some investment platforms to keep up. According to a report on Citywire, two of the largest operators were affected with AJ Bell suffering intermittent problems due to a four-fold rise in volumes and Hargreaves Lansdown also experiencing problems. Some of the issues apparently related to electronic prices not being quoted by market makers which was reported as a problem by Interactive Investor. This meant that trades had to be put through manually via dealers who became overloaded.

It is very disappointing to see that yet again a moderate rise in volumes caused an effective market meltdown. The Financial Conduct Authority (FCA) should surely be looking into this as it is their responsibility to ensure the markets and operators therein have robust systems in place. If there is a real market crash, as has happened in the past, retail investors could be severely prejudiced if platforms fail or market makers fail to quote prices.

Eurphoria also seems to have become prevalent in the market for VCT shares in the last couple of years with figures from HMRC showing that the number of new VCT investors claiming income tax relief reached a ten-year high in 2017-18, up 24% over the previous year. The amount invested increased by 33% and in 2018-19 the amount invested increased again by 1.6% to £716 million. The pension changes such as the reduction in the lifetime allowance and new pension freedoms are attributed as the causes. High earners have been flocking to VCTs to mitigate their tax bills it appears.

But the investment rules for VCTs have got a lot tougher so whether they will continue to achieve the high returns seen in the past remains to be seen.

The recently published HMRC report on VCT activity is present here: https://tinyurl.com/vuro5p8

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

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It’s a New Day and a New Era

It’s 7.30 on Friday morning and the Conservatives have won a very large overall majority. This is a seismic change with what one might expect to be solid working-class constituencies such as Blyth Valley, Workington, Grimsby and Leigh being won by the Tories. This was very clearly a Brexit election with the SNP winning more seats in Scotland where most people wanted to stay in the EU, but the rest of the country deciding otherwise it seems.

However the Brexit party has won no seats although they have undermined the Labour vote in some areas. This is disappointing because they might have provided some moderation in Parliament to an over-dominant Conservative Government. All the concerns of the other losing parties may be lost also which might increase social division. We might see even more street demonstrations.

The pound has already jumped up against the dollar and other currencies which might put a damper on some of the large UK listed companies with major dollar earnings. But market confidence and business confidence should now rise substantially now that some uncertainty is over. We will no doubt see in a few minutes when the market opens at 8.0 am.

Not that I have much cash in my portfolio to invest because I have been betting on a Conservative win and resolution of Brexit for some time. I did not like to mention it previously because I did not wish to encourage speculation on the outcome. Perhaps the market may have already discounted the likely outcome in the last few days but overseas investors in the UK market will now be reassured that financial stability and prudence will be in place for some time.

We are of course not totally out of the woods yet because Boris will still have to negotiate a trade deal with the EU and other aspects of the final separation. But I judge he is clever enough to do that.

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

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