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 )

You can “follow” this blog by clicking on the bottom right.

© Copyright. Disclaimer: Read the About page before relying on any information in this post.

 

 

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 )

You can “follow” this blog by clicking on the bottom right.

© Copyright. Disclaimer: Read the About page before relying on any information in this post.

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 )

You can “follow” this blog by clicking on the bottom right.

© Copyright. Disclaimer: Read the About page before relying on any information in this post.

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 )

You can “follow” this blog by clicking on the bottom right.

© Copyright. Disclaimer: Read the About page before relying on any information in this post.

 

 

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 )

You can “follow” this blog by clicking on the bottom right.

© Copyright. Disclaimer: Read the About page before relying on any information in this post.

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 )

You can “follow” this blog by clicking on the bottom right.

© Copyright. Disclaimer: Read the About page before relying on any information in this post.

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 )

You can “follow” this blog by clicking on the bottom right.

© Copyright. Disclaimer: Read the About page before relying on any information in this post.

 

 

Technology and Media Leads the Way, and the Renew Party

The Association of Investment Companies (AIC) have just issued an interesting press release. It gives the top performing investment companies and sectors for the year to date under the headline “Technology and Media Leads the Way”.

The Technology and Media Sector was up 34%, compared with an overall average of 14% for all investment companies (excluding VCTs) in share price total return. The top performing company was Blackrock Throgmorton Trust (THRG) which is a UK smaller and mid-cap companies focused trust. It is up 49%. A quick review of how they achieved their stellar performance indicates derivatives although several other smaller company trusts were listed in the top ten.  The Blackrock web site says this: “Derivatives may be used substantially for complex investment strategies. These include the creation of short positions where the Investment Manager artificially sells an investment it does not physically own. Derivatives can also be used to generate exposure to investments greater than the net asset value of the fund / investment trust. Investment Managers refer to this practice as obtaining market leverage or gearing”.

Dan Whitestone, Manager of BlackRock Throgmorton Trust, is quoted in the AIC press release as saying: “As we have long argued, stock and industry specific outcomes can triumph over the volatility created by macro, political and economic events. This certainly held true in 2019, which has been a strong year for the trust in absolute and relative terms, aided by positive contributions from both long and short positions. The management teams of the companies the trust invests in have played a key part in helping deliver value and wealth creation for shareholders, not just this year but over the course of many years.

The premium for genuine secular growth is high, as we remain within an era of low inflation, low interest rates and weaker growth. However, we see many companies with solid business models, that have enormous growth potential, are all too often dismissed by the market as expensive. Conversely, many so-called value shares are under significant pressure from the structural changes wrought by technological disruption, resulting in fundamental changes in distribution, manufacturing and customer behaviour.

Throgmorton aims to identify and own, for the long term, the exciting, fast-growing companies that we believe are truly differentiated and disruptive and taking full advantage of the structural changes reshaping industries. Our belief is that the stock market persistently undervalues these companies, which have strong balance sheets, and have been able to heavily invest ahead of their peers. Combined with solid management teams, dominant market positions, and a compelling product offering, investing in these companies can lead to years of dramatic compound growth, regardless of the wider political or economic environment.”

I can probably agree with most of what he says, but am not sure about the use of derivatives. I’m happier with the three other UK smaller companies trusts in the top ten list who all achieved more than 40% share price total return, one of which I hold. Does the cleverness of Throgmorton result in better long-term performance? It might do so if you look at the 10-year performance figures in the UK smaller companies AIC sector where it is beaten by only one other company – the Rights & Issues Investment Trust (RIII), although they seem to have a more variable performance. I may have a closer look at Throgmorton. This is definitely one where a read of their Annual Report will be essential (all 114 pages of it).

You can read the full AIC press release here: https://www.theaic.co.uk/aic/news/press-releases/top-performing-investment-company-sectors-over-2019

Investing in UK smaller companies rather than the rest of the world probably requires you to have confidence in the UK economy after Brexit. Which brings me onto the subject of politics.

The Renew Party

I was interested to receive a flyer through my door just now for the Renew Party. Bromley & Chislehurst is one of only four constituencies where they are putting up candidates. The Renew Party have an interesting manifesto including political reform.

This is what it says on their web site:  “Our system of politics rewards adversaries, not collaboration. These systems need radical reform to get the best, in candidates and in MPs. Whilst vigorous debate is critical to the evolution of our society, it does not need to become personal, crude and nasty…….. We support electoral reform to make representation in parliament proportional to the number of votes cast for each party. This means the abolition of the first-past-the-post voting system”.

That’s something I would vote for, but unfortunately their General Election platform also supports staying in the EU, which may be arguable, and delivering a “People’s Vote”, i.e. another referendum which is a profoundly daft idea. So they are not going to gain my vote this time.

Neither are the Labour Party who delivered a leaflet that referred to “Tory cuts” to the NHS. It’s simply not true – the real expenditure on the NHS has gone up. Indeed the service from the NHS has improved enormously over the 25 years I have been an active user of it. See https://fullfact.org/health/spending-english-nhs/ for the facts. I sent their candidate a complaint about her grossly misleading leaflet but she did not respond. Regrettably there seems no way to easily get such gross distortions by politicians stopped.

Other candidates are from the Christian People’s Alliance, the Green Party, the Liberal Democrats and the Conservative Party (no Brexit Party runner). It may not be a difficult choice.

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

You can “follow” this blog by clicking on the bottom right.

© Copyright. Disclaimer: Read the About page before relying on any information in this post.

De La Rue, Excessive Debt, Victoria and Link’s Debt Monitor

Link Asset Services have issued a note pointing out that De La Rue (DLAR) has net debt that now exceeds its market cap. The high debt in the company and recent falling revenue no doubt accounts for much of the recent fall in the share price, although the report of an investigation by the Serious Fraud Office (SFO) cannot have helped. But if you read the last interim report which was issued a couple of days ago, there are lots of other points that might put you off investing in the company. For example, it declares the business is in “turnaround” mode so restructuring is being accelerated, and that all of the Chairman, CEO, senior independent director and most of the executive team have left or resigned in the period.

How do you judge whether a company has excessive debt? There are two simple ratios which I look at for companies. The Current Ratio (current assets divided by current liabilities) and the interest cover (operating profits divided by net interest paid). For operating businesses I prefer to see a current ratio higher than 1.4 and interest cover of several times.

Why because companies go bust, or have to come to some accommodation with their bankers or raise urgent equity finance – all of which can be very damaging for equity shareholders, when they run out of cash. A low current ratio or low interest cover means that any sudden or unexpected decline in revenue and profitability can mean they get into financial difficulties. They simply have no buffer against unexpected adversity.

De La Rue’s Current Ratio is only 0.63 according to Stockopedia and as there were negative profits (i.e. losses) in the half year the Interest Cover is zero.

There are some exceptions to the Current Ratio rule so sometimes it is necessary to look more closely at the reasons for a low figure, but De La Rue just looks like a business in some difficulty.

Link Asset Services’ note also points readers to their Debt Monitor (see https://www.linkassetservices.com/our-thinking/uk-plc-debt-monitor ) which gives a comprehensive overview of the indebtedness of UK listed companies. They point out that it has risen by 5.8% to a new record of £433 billion. For comparison that’s only just higher than the Labour Party proposes to borrow for its “Infrastructure Fund”! But it’s worth pointing out that the FTSE is dominated by relatively few very large and traditional companies. They have probably been using financial engineering to enable them to maintain dividends and the result is higher debts. Or they are dedicated to the mantra of having an “efficient” balance sheet where there is significant debt so as to maximise shareholder returns, and have been buying back shares using debt.

Debt has become easier to obtain after the financial crisis of 2008/09 when banks were reluctant to lend at all. Interest rates have also come down making debt very cheap for those with good credit ratings and good security. It’s worth reading the Link Asset report to see which major companies and sectors have the most debt.

In smaller companies, particularly technology companies, there tends to be much less debt partly because they have few fixed assets against which to secure cheap debt. So they find equity less costly and more readily available. Or perhaps they just have more sense in realising that business is essentially uncertain so equity is preferable to debt.

There is relatively little debt in the companies in which I am invested (De La Rue is definitely not one of them) with one exception which is Victoria (VCP). If you wish to be convinced of the wonders of debt financing read the comments of Victoria’s CEO Geoff Wilding in their last Annual Report. In such companies one has to have faith in the management that they can control the risks that come with high debt levels. But most investors get very nervous in such circumstances which is probably why it’s only on a p/e of 10 (and my personal holding is relatively small). That’s so even though it has a Current Ratio of 1.8 and Interest Cover of 1.2 – the latter is too low for comfort in my view.

Of course it depends whether this is a temporary position (say after an acquisition) and how soon the debt is likely to be repaid. So you need to look at the cash flows. In the case of De La Rue it was minus £42 million in the half-year before investing/financing activities which is yet another negative sign, but it was a positive £38 million at Victoria in their half-year results announced on the same day. Clearly two very different businesses!

Note that there are some other financial ratios that you can look at to see the risk profile of a company but as always, a few simple things that you actually pay attention to plus getting an understanding of the business trends are to my mind more important.

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

You can “follow” this blog by clicking on the bottom right.

© Copyright. Disclaimer: Read the About page before relying on any information in this post.

 

The Political Manifestos and their Impacts on Investors

Here are some comments on the manifestos of the major political parties, now that they are all available. I cover specifically how they might affect investors, the impact of tax changes and the general economic impacts. However most readers will probably have already realised that political manifestos are about bribes to the electorate, or to put it more politely, attempts to meet their concerns and aspirations. However in this particular election, spending commitments certainly seem to be some of the most aggressive ever seen.

Labour Party: I won’t spend a lot of time on this one as most readers of this blog will have already realised that financially it is very negative for the UK economy and for investors. It’s introduced with the headline “It’s time for real change”, but that actually seems to be more a change to revert to 1960s socialism than changes to improve society as a whole. It includes extensive renationalisation of water/energy utility companies and Royal Mail, part nationalisation of BT Group and confiscating 10% of public company shares to give to employees. It also commits to wholesale intervention in the economy by creating a £400 billion “National Transformation Fund”. That appears to include a commitment to revive declining industries, i.e. bail-outs of steel making companies one presumes.  It includes promises to invest in three new electric battery gigafactories and four metal reprocessing plants for steel and a new plastics remanufacturing industry “thus creating thousands of jobs”. This is very much old school socialism which expected that direct intervention in the economy could create new industries and new jobs, but it never really worked as Governments are inept at identifying where money should best be invested. Companies can do that because they have a keen interest in the return that will be made while civil servants do not.

The best comment on the BT proposals was in a letter to the FT by the former head of regulator OFTEL Sir Bryan Carsberg. He said his memory was clear about the shortcomings of BT before privatisation even if many other people do not remember. The lack of competition meant that the company had no incentive to improve efficiency or take advantage of new technological developments. Monopolies are always poor performers in essence.

Trade union law will have the clock turned back with a new Ministry of Employment Rights established. Incredibly there is a commitment to “introducing a legal right to collective consultation on the implementation of new technology in workplaces”. Clearly there are some Luddites in the Labour Party. The more one reads their manifesto, the more it reminds you of years gone by. This writer is old enough to remember the Harold Wilson speech on the “white heat of a scientific revolution” by which he intended to revitalise the UK economy. It only partly happened and at enormous cost. In the same speech he also said that there was “no room for Luddites in the Socialist Party” but that has changed apparently. The manifesto includes a very clear commitment to “rewrite the rules of the economy”. A rise in the minimum wage might also damage companies.

The cost of financing all the commitments is truly enormous, and that is not even taking account of the £58 billion just promised to restore pension commitments lost to some women due to rises in their pension age which is not in the manifesto. Taxes will need to rise substantially to finance all the commitments – that means increases in corporation tax which may damage business, and rises in capital gains tax to equalise it with income tax plus higher rates of income tax for high earners.

But the real damage to UK investors will be the wholesale intervention in the economy in the attempt to create a socialist paradise. And I have not even covered the confusion and contradictions in Labour’s Brexit policy which is downplayed in their manifesto.

Conservative Party: The other main parties are all focusing on Brexit so the Conservative’s title headline in their manifesto is “Get Brexit Done – Unleash Britain’s Potential”.  In comparison with the other parties it is relatively fiscally conservative with no major changes to taxation but some commitments on spending.

Many of their commitments, such as on longer-term social care funding, are subject to consultation but there are some short term increases in that, and for education, for the Police and for the NHS.

Immigration will be restricted by introducing an Australian-style points-based system. This might impose extra costs on some sectors of the economy, but may result in more investment in education/training and more capital investment. This might well increase productivity which is a major problem in the UK.

There is a commitment to invest £100 billion in additional infrastructure such as roads and rail. That includes £28.8 billion on strategic and local roads and £1 billion on a fast-charging network for electric vehicles. Compare that though with the cost of £81 billion now forecast in the manifesto for HS2 a decision on which is left to the Oakervee review.

It is proposed to “review and reform” entrepreneurs tax relief as it is not apparently meeting objectives. There will be further clampdowns on tax evasion and implementation of a Digital Services Tax already planned for 2020.

Reforms are planned to insolvency rules and the audit regime which must be welcomed, but details of what is planned are minimal. They also plan to “improve incentives to attack the problem of excessive executive pay and rewards for failure”. It will be interesting to see how that is going to be done in reality.

There is a plan to create a new independent “Office for Environmental Protection” which will introduce legal targets including for air pollution. This could be very expensive for both companies and individuals. The Government has already committed to a “net zero” carbon target by 2050 but Cambridge Professor Michael Kelly has said that the cost of decarbonising the economy has been grossly underestimated. He has suggested the cost should run into trillions of pounds. But again there are few details in the manifesto on how these commitments will be implemented in practice. Nobody really knows what is the real cost of such a policy.

There are though firm commitments to review the Fixed Term Parliament Act, to retain the “first past the post” voting system, to improve voter identification and reduce fraud, and to avoid Judicial Reviews being used to undermine political democracy. They also commit to review the workings of Parliament – this might lead to a written constitution which this writer thinks is sorely needed to avoid a repeat of recent events which led to gridlock in Parliament and allegedly partisan decisions by both the Speaker and the Supreme Court.

With promises not to increase income tax, VAT or National Insurance (a “triple-tax lock” in addition to the expensive triple lock on pensions which will be retained) this is generally a positive manifesto for most investors and apart from the issues mentioned above should be positive for the economy. A Conservative Government might also restore confidence in overseas investors which may well account for the recent pick-up in the stock market indices as the Conservatives look like they are heading for a significant majority. Such an outcome will also remove some of the uncertainty, if not all, over Brexit which will give more confidence to UK businesses to invest in the future.

In summary the Conservative manifesto is likely to please many and displease few (apart from those opposed to Brexit) so it could be seen as a “safe bet” to avoid any last-minute popularity reversal as happened at the last general election.

The minority parties are losing votes in the polls as they always do when a general election looms and the public realise that there are only two likely candidates for Prime Minister – in this case Jeremy Corbyn and Boris Johnson. Is that a question of whom the public trusts? This was an issue raised in one of the recent panel debates but I think nobody trusts any politicians nowadays. It is more a question of whom the voters personally like as regrettably hardly anyone reads the manifestos.

But here’s a brief view of the minority parties’ platforms:

Brexit Party: Their manifesto (or “Contract with the People” as they prefer to call it), is definitely sketchy in comparison with the two main parties and is many fewer pages in length. They want, unsurprisingly, a “clean-break Brexit”, and they want a “political revolution” to reform the voting system.

They would raise £200 billion to invest in regional regeneration, the support of key sectors of the economy, the young, the High Street and families. Note the traditionally socialist commitment to support “strategic industries”. The £200 billion would be raised by scrapping HS2, saving the EU contribution, recovering money from the EIB and cutting the foreign aid budget, although I am not sure that adds up to £200 billion.

They would scrap Inheritance Tax and scrap interest on student loans and cut VAT on domestic fuel which will all be quite significant costs. They also promise more investment in the NHS but so do all the other parties – at least there is a consensus on that point.

The Liberal Democrat Party:  They have clearly decided their vote winning approach will be a commitment to stop Brexit, i.e. revoke Article 50. They have a strong endorsement of “green” policies and propose a new tax on “frequent-flyers”. That might include Jo Swinson herself it seems as she has taken 77 flights in 18 months according to the Daily Mail.

Two unusual commitments are to legalise cannabis and freeze all train fares (rather like the freeze in London on bus and Underground fares which has resulted in a £1 billion deficit in TfL finances, but even more expensive no doubt).

Corporation Tax would revert to 20% and Capital Gains tax will be unified with income tax with no separate allowances so private investors would certainly be hit.

The Scottish Nationalist Party (SNP) are focusing on another referendum for an independent Scotland as usual, an unrealistic proposition as no other party is supporting that and it would be make Scotland much poorer, plus a ragbag of populist commitments. They clearly oppose Brexit.  As most readers will not find an SNP candidate standing in their local constituency I shall say no more on the subject. You can also go and read their manifesto on the web where it is easy to find all the party manifestos. Likewise for the Welsh and Irish leaning parties.

In summary, this election is somewhat of a no-brainer for investors unless they feel that the Boris Johnson version of Brexit is going to be very damaging for the UK economy, in which case they have a simple choice – vote LibDem or SNP as Labour’s position is too confusing. Alternatively they can play at “tactical voting” to get the party they want info power. There is more than one tactical voting web site to advise you which is the best alternative option but be wary – they seem to be run by organisations with a preconceived preference.

If readers consider I have missed out anything important from this analysis, please let me know.

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

You can “follow” this blog by clicking on the bottom right.

© Copyright. Disclaimer: Read the About page before relying on any information in this post.