Watch Your SIPP REIT Dividends, RPI Change and Brexit

Many shareholders hold Real Estate Investment Trusts (REITs) as they provide a high level of dividends, partly because they have an obligation to distribute most of their income to shareholders as Property Income Dividends (PIDs). These are taxed in a different way to other dividends. They incur a tax charge of 20% which is like a withholding tax. But if you hold the shares in a SIPP then the SIPP can reclaim the 20% tax from HMRC.

I hold two SIPPs. One operator routinely refunds the REIT tax but the other one (operated by Curtis Banks) appears to have no system to do so. I have had to chase them more than once about outstanding refunds going back several years. Currently they are saying that they have to wait until the year end before they can submit a reclaim because they cannot submit claims of less than £5,000 during the year.

Shareholders who have REITs in their SIPP portfolios need to keep an eye on such refunds otherwise you could be losing hundreds if not thousands of pounds in missing tax claims.

Yesterday, among other activity by the Chancellor of the Exchequer, he issued a letter indicating that despite demands to revise the calculation of the Retail Price Index (RPI) he is putting off consent for any change until at least 2025 with consultation on when it might be implemented. See the letter here: https://tinyurl.com/y3muwr3g

There is of course strong opposition from some people to any change in the calculation of RPI. For example it might impact the returns on Index Linked Gilts that use it as it is generally seen as giving slightly higher figures than other inflation indices. But other people would welcome a change because it affects the cost of rail fares for example. It does appear wise to me to have extensive consultation on such a change before it is implemented, particularly where it affects people who have purchased investments such as index linked gilts or national savings certificates on the basis of the current formula.

The Chancellor, Savid Javid, did of course deliver a Spending Round review document to the Commons yesterday – you may have missed it among all the Brexit debates. In summary it commits to higher expenditure on schools, the NHS, the police, on social care, on defence and on other crowd-pleasing measures – a total of £13.8 billion. This should help to boost the economy, and might be seen as a typical pre-election attempt to win votes.

I watched the debates in Parliament yesterday and am baffled by what MPs have decided to do. One Bill (the European Union (Withdrawal) (No.6) Bill if you wish to read it) which seems likely to be approved demands that the Prime Minister sends a letter to the European Council requesting a further extension past October for Brexit. The proposed letter is specifically worded.

But under the UK’s, albeit unwritten, constitution the Prime Minister’s powers include: “Relationships with other heads of government” – see https://tinyurl.com/y3wneo9s for more on the Prime Minister’s powers. In effect MPs seem to want to take over executive powers in our relationship with foreign powers such as the EU. But the Prime Minister can surely contradict any such letter or undermine it in other ways because he alone has the powers to negotiate with the EU (as Mrs May negotiated the proposed Withdrawal Agreement”). This just gets us into a constitutional and political crisis.

The second decision by MPs was not to support the Prime Minister’s request for a General Election which would be one way out of the impasse. That leaves the Prime Minister and his Government in an impossible situation, particularly as now the Government has no overall majority in Parliament. In effect they may find it impossible to get any business through. This can surely not continue for long.

Whether you are a Brexiteer or a Remainer, surely you should be concerned by this turn of events which seems to be driven more by emotions about Brexit and opinions on the merits of the Prime Minister than any rational consideration of the constitutional crisis that is being created and the overall wishes of the electorate.

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

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Victoria AGM, Dunelm Results and Brexit Impacts

I attended the Annual General Meeting of Victoria (VCP) in central London yesterday. I have held a few shares in this producer of carpets and tiles since the revolution that installed Geoff Wilding as Executive Chairman a few years ago. He did a great job of turning the business around but the share price fell back sharply last October over concerns about the level of debt and a failed bond issue to replace bank debt which cost £7.3 million As Mr Wilding says in the Annual Report: “There is no way to view the majority of these costs other than, with the benefit of hindsight, a waste of money”. The Annual Report is certainly worth reading as it is a good example of the Chairman and CEO revealing their thoughts on many issues rather than the polished and anodyne statements you see in most such reports.

The company has subsequently issued some loan notes with a five-year term and fixed rate of interest to replace some of the bank debt. These were described as “covenant light” in the meeting. The company has adopted the use of high debt levels (net debt/EBITDA ratio of 3.2) to finance acquisitions and to finance substantial restructuring of its operations. There is extensive justification of this policy in the Annual Report but there are clearly still concerns among investors.

Last year the company reported a loss of £7.9 million despite reporting an operating profit of £24 million because of the exceptional finance costs, restructuring costs and amortisation of acquired intangibles. This is one of those companies where it is best to look at the cash flow statement to see what is going on as the accounts are otherwise quite confusing. The company did generate £52 million in cash from operations last year.

An announcement from the company on the morning of the AGM contained positive comments and they expect to meet market expectations for the full year. They are also continuing to look at further acquisitions although it states “mindful of financial leverage levels, the Board is proceeding cautiously”. I would certainly like to see some reduction in debt levels with fewer exceptional costs for a period of time.

There were less than a dozen shareholders at the AGM. There were only a few questions. One was on the attributes of new non-executive director Zachary Sternberg, and what he will be contributing. Apparently he is the investment manager of a US fund who have a 15% stake in Victoria. It was said he is very good at financial analysis but is not a flooring expert.

I asked about the breakdown of sales. Turf (i.e. artificial grass) is now 4% and growing. Otherwise it’s about two thirds tiles to one third carpet. In Europe hard flooring (not just tiles but wood/laminates) is growing but the demand varies between countries. That surely is has been a long-term but slow trend in recent years in the UK for example. Even my wife wants to replace our hall carpet with something else because she is tired of cleaning it but other areas are likely to remain carpet.

I also asked about the impact of Brexit, hard or otherwise. Earlier in the year they built up stock in case of disruption and are now doing this again. But the CEO said they might be able to take advantage by increasing prices. He did not appear too concerned about the prospects.

In summary a useful meeting, but investing in this company is very much dependent on one’s trust in Geoff Wilding to manage the debt levels and its business operations wisely. Mr Wilding has a beneficial interest in 18% of the shares although he did dispose of some shares last year.

Another company I hold is Dunelm (DNLM). The company issued preliminary results this morning and at the time of writing the share price is down about 8%. That may be surprising because the earnings were slightly better than forecast and a special dividend was also declared. Like-for-like revenue was up 10.7% and market share is increasing in the homewares sector. The company appears to have been successful in moving into “multi-channel” operations with internet sales rapidly increasing. So why would shareholders be concerned about the announcement?

One comment in the announcement was “Whilst trading performance has continued to be strong, we remain cautious about the full year outlook due to ongoing Brexit uncertainty and specifically the impact it may have on consumer spending as we enter out peak period”. They go into more detail on the impact of Brexit, especially a “no-deal” version which might disrupt imports after the possible Oct 31st date. But if Boris Johnson loses his fight against the “remainers” this evening then it could be put off yet again, even into “never-never” land. Comment: What a shambles and the House of Commons is descending into anarchy. I hope Mr Johnson manages to call a General Election to get this matter settled finally. But at least a Scottish Court has rejected the challenge to the Government’s ability to prorogue Parliament which was surely misconceived. Legal cases driven by emotion are never a good idea.

As regards Dunelm, perhaps another issue that rattled investors was the adoption of IFRS16 which will apparently reduce group pre-tax profit by approximately £3 million (i.e. by about 2.3%) but with no impact on cash flows. However EBITDA will increase. IFRS16 concerns accounting for leases and has surely been well known about for some time so it is odd if this was the cause of the share price fall.

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

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Edge Performance VCT Sorted

The Edge Performance VCT (EDGH and EDGI) I have long considered to be a basket case of the first order. VCTs are typically owned only by private shareholders but I am always astonished by how those shareholders put up with dire performance and excessive management costs over many years. But in the case of Edge they have finally taken action – namely removed all but one of the directors at the AGM and voted down other resolutions. It was not even apparently necessary to call a poll as the resolutions were defeated on a show of hands vote according to the RNS announcement of the result, but the proxy votes were clearly of the same mind.

The sole remaining director is now apparently considering what to do next. See this report by ShareSoc on the meeting: https://www.sharesoc.org/blog/vcts/edge-another-vct-problem-case/

I would suggest the answer is simple: ask for volunteers with relevant experience from the shareholders to serve as directors before deciding on any future plans.

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

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CentralNic, Photo-Me and Nationalisations

Firstly lets talk about a couple of companies in which I hold no shares. CentralNic (CNIC) published interim results this morning. This company sells internet domain names and web services. It states that both revenues and adjusted EBITDA have tripled year on year. The share price has not moved at the time of writing.

This company is surely operating in a growth sector but the company’s share price is less than it was 5 years ago. The company has been growing via acquisitions, but the key problem appears to be that the dilution of shareholders from the issue of new shares means that reported earnings and cash flow per share have bounced around a bit but not consistently grown even though revenue has. The reported loss after tax at the half year was £3.3 million and it generated negative cash flow from operations of £1.4 million.

The CEO comments on “these outstanding results” and he is “confident in continuing our trajectory towards joining the ranks of the global leaders in our industry”. But shareholders might prefer that the company simply generates some profits and cash from the capital raised.

PI World interviewed John Lee last week – see https://tinyurl.com/y6z9zwa8 and he is always worth listening to. Lord Lee is a well known private investor and writer on stock market investment. As he has realised some cash from a takeover he is looking at new investments and one he has been considering is Photo-Me (PHTM). Photo-Me has traditionally been an operator of photo booths, but as that market is strategically challenged it has moved into self-service laundry units and launderettes. It has now also acquired a fresh fruit juice vending operation in France. In effect it is focused on several “vending” type operations. A quick look at the financials gives a historic p/e of 12.9 dropping to a forecast 10.6 next year and dividend yield of 8.2%. In other words, it looks very cheap on the normal fundamental ratios.

But on Friday the Investors Chronicle published a “SELL” tip on the company. It suggested returns on capital were falling, that the photo business which still represents a major proportion of revenue was becoming more difficult as passport photos are easy to produce on any smartphone or camera, and the dividend is barely covered.

This is a business that is highly profitable with a good track record but faces some business challenges. This is why the share price has been drifting over the last few years as investors have become nervous about the future. With investors now focusing on “growth” stocks it may remain out of fashion. John Lee is not a follower of fashion though.

The Financial Times ran with a headline story of the Labour Party’s plans to confiscate £300 billion of UK company shares to give them to workers. Over 10 years all companies with more than 250 staff would be required to transfer 10% of their shares to workers over a period of ten years. The article also covered the party’s nationalisation plans including apparently perhaps even travel agents which the article suggests one in four people would support. That of course means most do not, but a Labour Government might not take much notice of the latter. Why travel agents? It appears some people think that the answer to any concerns about the cost of a service and the way it is provided justifies nationalisation. Have they learned nothing from history?

Many companies and investors might simply choose to move their assets from the UK if a Labour Government was elected but the reaction might be to impose capital controls to stop that. In other words, shadow chancellor John McDonnell might put us back into the 1960s – exchange control was not lifted until 1979.

The last time Labour was in power they nationalised Northern Rock and Bradford & Bingley banks. The original shareholders are still very disgruntled and they continue to fight for fair compensation after more than ten years. See this article for the latest on Northern Rock: https://tinyurl.com/yxpvk8sl , or the latest on Bradford & Bingley here: http://www.bbactiongroup.org/News.htm . The fact that the leaders of these campaigns continue to fight after so many years tells you how strongly they feel that their assets were confiscated at less than fair value.

Unfortunately there is a lot of irrationality in the political scene of late which may undermine our financial prosperity unless people come to their senses.

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

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Burford, Channel Island Registrations and Brexit

Firstly lets talk about Burford Capital (BUR). Tom Winnifrith, who has been complaining about the accounts and other issues at that company for a long time, sent a letter of complaint to the FCA and FRC (the Financial Reporting Council) asking them to investigate the allegations of Muddy Waters. The FRC have responded with this comment: “Burford Capital is incorporated under the Companies (Guernsey) Law 2008 and is accordingly not subject to the requirements of the Companies Act 2006”. They also said that the shares are traded on AIM which is not a regulated market. The FRC’s Corporate Reporting Review Team therefore does not have powers to make enquiries about the matters raised.

In summary, although the FCA and the FRC have some powers relating to the company’s directors and its auditor, Mr Winnifrith will have to complain to the Guernsey Financial Services Commission who are the regulatory authority.

As I said in my recently published book, company domicile does matter and is definitely worth checking before investing in a company. I specifically said: “In general for UK listed companies, any domicile outside the UK adds to the risk of investing in a company. Domicile in the Channel Islands or Isle of Man is also not ideal [see Chapter 7]”. So that’s yet another reason why I would not have invested in Burford, apart from my doubts about the prudence of their accounting.

Brexit

At the risk of offending half (approximately) of my readers, here are a few comments on the latest political situation and the prorogation of Parliament. Speaker John Bercow has said that “shutting down parliament would be an offence against the democratic process and the rights of parliamentarians….” while there was an editorial in the Financial Times today that said “it was an affront to democracy” and that Mr Johnson had “detonated a bomb under the constitutional apparatus of the United Kingdom”. But I tend to side with Leader of the House Jacob Rees-Mogg who called it “completely constitutional and proper”. Suspension after a near record long parliamentary session to allow the Government to put forward its programme in a new Queen’s Speech is entirely appropriate and not unusual. There is also time before the suspension, and after, for Parliament to debate whatever they want before Brexit date on October 31st. Also Parliament is often closed down in September for the party conferences so this is not unusual.

It’s simply a case of sour grapes from remainers who realise they may not be able to stop Brexit or cause further trouble in resolving the impasse in Parliament. John Bercow is particularly to be criticised because he is supposed to be independent and should not be making such comments on a well-established procedure supported by precedent.

Parliament has been debating Brexit for many months and it is time to draw such debates to a conclusion because it gives the false hope to the EU that the UK will change its mind over leaving. The UK voted to leave and we should get on it with, preferably with some kind of Withdrawal Agreement, or otherwise none. Business is damaged by the on-going uncertainty which is why the pound has been falling. Boris Johnson is simply forcing the pace which is quite right.

If the opposition parties or remainers in the Conservative party do not like what is happening they can call for a vote of no confidence. It that was passed then a general election would no doubt be called, which the Conservatives might actually win, or the election might take place after the Brexit date which would put the remainers in a very difficult position. That is why they are so clamorous. They simply don’t like the position they find themselves in which has actually been caused by those in Parliament who have wanted to debate the matter endlessly without coming to a conclusion.

There are some possible legal challenges but should, or will, the judiciary interfere in what is happening in Parliament? I don’t think they should and I doubt they will. Are Scottish judges, where one challenge is being heard, really going to attempt to rule on a matter of UK wide importance? This seems unlikely in the extreme.

In summary, I think everyone should calm down and let the matter take its course. Those who are not happy with the turn of events can challenge it in Parliament via their elected representatives if they wish. But Brexit needs to be resolved on Oct 31st, one way or another. Not delayed yet again. There are so many other issues that Parliament needs to deal with that more debate on the matter is simply unacceptable.

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

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Book Review: 100 Baggers

100 Baggers is a book by Christopher Mayer on those companies that have returned more than 100 times the original investment cost to shareholders. Having got some 10-baggers in my portfolio, and with the summer lull in business and the markets, I was interested in reading how to spot the ones that could generate an even bigger return.

The author credits a book by Thomas Phelps called “100 to 1 in the Stock Market” first published in 1972 as the inspiration for his own title and quotes extensively from it. Mr Phelps died in 1992 and his book was out of print for a long time but is now available as a reprint at some considerable cost. It’s also rather archaic in references to companies. Mr Mayer’s volume is therefore a useful update on the subject and also covers many areas of investment practice from his own experience.

One interesting quote from Phelp’s book he supplies is this: “There is a Wall Street saying that a situation is better than a statistic” and also says that “Relying only on published growth trends, profit margins and price-earnings ratios is not as important as understanding how a company could create value in the years ahead”. That accords very much with my thinking as espoused in my own recent book.

Christopher Mayer is obviously a widely read investor as he includes numerous pithy and apposite quotations from other authors. But this tends to make his book rather episodic and unstructured in nature. It’s full of parables and apocryphal or true stories to reinforce the points he is making.

What are some of the key points he makes? Firstly to have a 100-bagger means you need to a) invest in companies at a reasonable price; b) start with a relatively small company; c) have them grow at 20% or more per year; and d) hold them for a long time. Diving in and out of companies, or reacting to overall trends in the economy or the markets should be avoided, i.e. you need to “buy and hold”.

Who are some of the 100-baggers in the US market on which the author concentrates as at 2014 when this book was published? Amazon, Microsoft, Electronic Arts, Amgen, Nike, Union Pacific, Pepsi, Equifax, Walgreens Boots, Hershey, Intel, State Street, Southwest Airlines, Wal-Mart and Sunoco are just a few of the 365 and many of them you will not have heard of before. The key point is that they come from a wide variety of industries and sectors but the book does cover what are the defining characteristics of these companies. That includes high and consistent growth in revenue and high return on invested capital.

Longevity is important. Many of the 100-baggers in 2014 took more than 30 years to get there, although some such as EMC and Charles Schwab took less than 10. But the author tends to skip over the problem that even if you pick a company with the right profile in its early days, the chances are that you will be taken out by a takeover bid, by changes to the market for its products/services, by changes in technology or other vicissitudes. Companies have shorter and shorter lives in the modern era so the chance of a company reaching the age of 30 as a listed vehicle is quite low. It may be mostly chance that enables them to reach 100-bagger status. But that does not undermine the basic thesis that it is best to aim for those companies that have the potential to do so.

There is much to be learned from this book. But it does conclude with the statement that “there is no magic formula” so bear that in mind when reading it.

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

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Eddie Stobart Logistics and Reasons to be Fearful

No sooner had I published a book that says investors cannot trust the accounts of companies when making investment decisions (“Business Perspective Investing”) than we have yet another case of dubious financial reporting. The latest example is that of Eddie Stobart Logistics (ESL) which has announced that “the Board is applying a more prudent approach to revenue recognition, re-assessing the recoverability of certain receivables, as well as considering the appropriateness of certain provisions”. CEO Alex Laffey is leaving with immediate effect, profits seem to now be uncertain, the dividend is being reviewed and the shares have been suspended. In other words, it’s one of those shock announcements that undermines investor confidence in company accounts and in the stock market in general.

That follows on from the case of Burford Capital where revenue recognition has also come into question and I personally doubt the accounts are prudent. We seem to be getting about one case per week recently of accounts that are called into question or where significant restatements are required. I may need to revise my book sooner than expected because it contains a list of examples of dubious and fraudulent accounts in companies which is rapidly becoming out of date!

ESL is of course one of Neil Woodford’s largest investment holdings – he holds 22% of the company. Mr Woodford has also suffered from a write down in the value of his holding via Woodford Patient Capital Trust in Industrial Heat due to slow business progress. This is a company focused on “cold fusion” technology. Mr Woodford seems to be adept at picking risky investments of late which is not how he built his former reputation. Even the Sunday Times is now attacking Neil Woodford with an article today headlined “Neil Woodford’s worthless tech bets” which covers his investments in Precision Biopsy and SciFluor Life Sciences and which are now alleged to be almost worthless. I feel it’s going to be a very long time before his reputation recovers.

As regards more wider issues, there was a very good article by Merryn Somerset Webb in Saturday’s Financial Times under the headline “So many reasons to be fearful”. She points out that due to low interest rates making it seem irrelevant how long it might be before exciting companies actually produce returns, value stocks are trading lower relative to growth stocks than they have for 44 years. The pound is also at a 35-year low against the dollar and US stock prices at a 50-year high relative to US GDP.

Bond yields are so low that even in nominal terms they are negative in many parts of Europe. What should investors do? She comes up with some suggestions such as investing in commodities such as gold or silver, or even oil because there is a risk that with Governments running out of options to stimulate their economies, they may start printing money which will drive up inflation.

She also comments on a likely new “cold war” to be fought by the USA and China over trade which will may profoundly affect many of our investments. She argues that the next 30 years may be very different to the last 30.

Altogether an interesting article well worth reading if just to remind ourselves that the world is rapidly changing and that we live in very unusual times.

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

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