IC Share Tips, National Grid, Brexit and the Audit Market

This week’s Investors Chronicle edition (dated 28/12/2018) provides lots of food for thought. One of the most educational is their review of the share tips they published as “tips of the week” in 2018. Unlike some investment publications, who simply forget about their past tips that go nowhere, while lauding their hits, the IC is open about their performance.

They issued 173 “BUY” tips and 24 “SELL” tips in the year. That is quite some achievement by itself as I rarely have more than a very few good new investment ideas in any one year and tend to hold most of my investments from year to year.

How did their tips perform? Overall the “BUYs” returned minus 11.5% which they calculate as being 0.9% better on average than the relevant index. Hardly worth the trouble of investing in them bearing in mind the need to monitor such individual share investments and the transaction costs. The “SELLs” did better at -18.0% versus an index return of -8.8%.

The BUYs were depressed by some real howlers. Such as tipping Conviviality shortly before it went into administration, although they did reverse that tip to a “SELL” before it did so. The result was only a reported 12% loss. As a consequence they are making some “fundamental changes to the way we recommend shares”.

But with so many share tips, the overall performance was not impacted by one or two failures and tended to approximate to the overall market performance. Which tells us that you cannot achieve significant over or under performance in a portfolio by holding hundreds of shares.

I don’t work out my overall portfolio performance for the year until after it ends on the 31st December so I may report on it thereafter. That’s if it’s not too embarrassing. With many small cap technology stocks in my portfolio, I suspect it won’t be good. I always look at my individual gains and losses on shares at the year end, as an educational process. As Chris Dillow said in the IC, “Investing like all our dealings with the real world, should be a learning experience: we must ask what we got wrong, what we got right, and what we can learn. The end of the year is as good a time as any for a round up…”.

One BUY tip they made was National Grid (NG.) in May 2018 on which they lost 11.8%. There is a separate article in this week’s IC edition on that company which makes for interesting reading as a former holder of the stock. I sold most of my holding in 2017 and the remainder in early 2018 – that was probably wise as you can see from the chart below (courtesy of Stockopedia).

National Grid Share Price Chart

National Grid has a partial monopoly on energy distribution and always seemed to be a well-managed business. Many investors purchase the shares for the dividend yield which is currently about 6%. But the IC article pointed out that proposals from OFGEM (their regulator) might limit allowed return on equity to 3%, which surely threatens the dividend in the long term. The share price fell 7% on the day that OFGEM announced their proposals. Bearing in mind the risks of running an electricity network, and the general business risks they face, that proposed return on equity seems to be completely inadequate to me. That’s even if one ignores the threat of nationalisation under a possible Labour Government.

Another IC article in the same edition was entitled “Brexit and the UK Economy”. That was an interesting analysis of the UK economy using various charts and tables. One particularly table worth studying was the balance of trade between the UK and our main trading partners. We have a big negative balance (i.e. import more than we export) to Germany, Spain, Belgium, Holland and Italy but positive balances with Ireland and the Rest of the World – particularly the USA. The article makes clear that our trade with EU countries has been declining – exports down from 55% in 1999 to 44% of all exports. But imports have not fallen as much so the trade gap has been widening. Meanwhile our exports to Latin America and China, which have been good economic growth areas, have remained relatively small.

The conclusions are simple. EU economies such as Germany would be severely hit by any trade disruption on Brexit. But opportunities in rapidly growing markets are currently being missed, perhaps hampered by inability to negotiate our own trade deals with them, and that might improve after Brexit.

Audit Market Review

The Competition and Markets Authority (CMA) have published an “Update Paper” on their review of the audit market. It contains specific recommendations on changes to improve competition and asks for comments. See https://assets.publishing.service.gov.uk/media/5c17cf2ae5274a4664fa777b/Audit_update_paper_S.pdf .

It mentions a long list of audit failings on pages 12 onwards including banks before the financial crisis of 2008, BHS, Carillion, Autonomy (covered in a previous blog post) and Conviviality which was mentioned above.

This paragraph in their executive summary is worth repeating: “Independent audits should ensure that company information can be trusted; they provide a service which is essential to shareholders and also serves the wider public interest. But recent events have brought back to the surface longstanding concerns that audits all too often fall short. And in a market where trust and confidence are crucial, even the perception that information cannot be trusted is a problem.”

One problem they identify is that “companies select and pay their own auditors” which they consider an impediment to high-quality audits. In addition choice is exceedingly limited for large FTSE companies, with the “big four” audit firms dominating that market.

Their proposals to improve matters are 1) More regulatory scrutiny of auditor appointment and management; 2) Breaking down barriers to challenger firms and mandatory joint audits; 3) A split between audit and advisory business within audit firms and 4) Peer reviews of audits.

Their review of FRC enforcement findings suggests that the most frequent findings of misconduct include:

(a) failure to exercise sufficient professional scepticism or to challenge management (most cases);

(b) failure to obtain sufficient appropriate audit evidence (most cases); and

(c) loss of independence (three out of a total of 11 cases).

That surely indicates a major problem with audit quality, and that is backed up by the FRC’s own analysis of audits that they have reviewed with only 73% being rated as “good or requiring limited improvement”.

Auditors are primarily selected via audit committees and there is a noticeable lack of engagement by shareholders in their selection. But that’s surely because large institutional shareholders have little ability to judge the merits of different audit firms.

Would more competition improve audit quality, or simply cause a focus on the lowest price tenders? The report does not provide any specific comment on that issue but clearly they believe more competition might assist. More competition does appear to drive more quality for a given expenditure in most markets however so it is surely sensible to support their recommendations in that regard. The report does emphasise that the selection and oversight of auditors would ensure that competition is focused on quality more than price which is surely the key issue.

A previous proposal was that auditors be appointed by an independent body but that has been dropped, partly due to shareholder opposition. The new proposal is for audit committees to report to a regulator with a representative even sitting as an observer on audit committees where justified. In essence it is proposing much more external scrutiny of audit committee activities in FTSE-350 companies and decisions taken by them.

The end result, at some cost no doubt, would be that both auditors and audit committees will be continually looking over their shoulders at what their regulators might think about their work. That might certainly improve audit quality so for that reason I suggest this proposal should be supported.

The requirement for “joint” audits where two audit firms including one smaller firm had to be engaged seemed to be opposed by many audit committee chairmen and by the big four accounting firms. Some of their objections seem well founded, but the riposte in the report is that evidence from France, where joint audits are compulsory, suggests they have a positive impact on audit quality. Moreover, it would clearly increase competition in the audit market.

In summary, the report does appear to provide some sound recommendations that might improve audit quality. But investors do need to respond to the consultation questions in the report as it would seem likely that the big audit firms will oppose many of them.

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

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Beaufort, OFGEM and National Grid

As a postscript to my last blog post on the administration of Beaufort, an interesting article was published by the FT this morning. They had clearly had a chat to administrators PWC. The article reports that the 14,000 investors affected will get no more than 85p in the £1 invested and that no money would be returned for at least a month.

PWC said that that Beaufort’s own funds were very limited and therefore clients will have to cover the cost of recouping their own money and assets. It seems it is a “complicated” administration and there are a number of challenges including assessing the accuracy of financial records. In other words, it’s a typical such mess where the administrators will run up enormous bills sorting it out. As I said in the last blog post, “past experience of similar situations does not inspire confidence”.

It will be months if not years before PWC can sort out who owns what and in the meantime the assets will be frozen. But anyone thinking of taking legal action over the alleged fraudulent practices of the company might find it not worth doing because the cupboard is bare, unless they can target individuals and their assets. Meanwhile there have already been 600 complaints to the Financial Ombudsman apparently but investors might find share dealing by “sophisticated” investors is not covered, and neither are they by the Financial Services Compensation Scheme.

The energy market regulator OFGEM issues a press release this morning. Here is some of what it said: “Ofgem proposes significantly lower range of returns for investors. Tougher approach would deliver savings of over £5 billion to consumers over five years.

Ofgem has today set out proposals for a new regulatory framework from 2021 which is expected to result in lower returns for energy network companies and significant savings for consumers.

This includes a cost of equity range (the amount network companies pay their shareholders) of between 3% and 5%, if we had to set the rates today. This is the lowest rate ever proposed for energy network price controls in Britain. Ofgem also proposes to refine how it sets the cost of debt so that consumers continue to benefit from the fall in interest rates.”

This is very negative news for National Grid (NG.), but surprisingly the share price has risen today. It is possible that analysts and institutional investors were expecting it to be worse, so it’s a “relief” rally. Meanwhile some chatter on twitter from private investors talks about how cheap the shares are on fundamentals. That may be one view, but just look at 2021, when Corbyn and John McDonnell might be in power and to me there look to be very substantial risks. If equity investors are getting less than 5% return, then in any nationalisation the valuation of the equity could be very low even if the Government pays a “fair” price – which no recent Government did on nationalisations. They used totally artificial valuation rules to come out with the figure the politicians wanted. Investors should not trust politicians, but I think we all know that.

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

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Running Out of Gas, and InvestorEase to Close

Media reports suggest that National Grid is running out of gas, and having to pay industrial users to stop consuming it. This is due to the exceptionally cold weather spell. But National Grid has also been running out of shareholders because of fears over possible nationalisation. The share price is down by 33% on its peak in 2016. As I have probably said before, the threat of nationalisation has undoubtedly spooked international investors who now dominate the holdings of UK public companies.

It seems Macquarie analysts have suggested that investors should encourage utility companies to move their domicile to another country. Shadow business secretary Rebecca Long-Bailey has said “Transferring asset holdings overseas in pursuit of higher compensation shows total contempt for the British Public”, but I think she complains too much. Surely moving the registration of a holding company would not be effective? The Government could just take control of the assets and bearing in mind principles set by other recent laws and legal judgements, just pay what they wanted. It would all be justified as being “in the national interest” even under EU law if that still applied.

One would have to pick the domicile carefully to gain much benefit. For example, National Grid has substantial assets in the USA so they could possibly keep those out of reach by demerging the relevant part of their business. But that only provides limited protection to current investors.

I have not personally held National Grid for some time because of the political risk and am not invested in other utility companies either. If those companies wish to avoid the risks of a Labour Government and their current policies, they might find it wise to look at other ways of thwarting damage to their shareholders interests.

InvestorEase

InvestorEase is a share portfolio management software product which I have used for the last 20 years. The current owner (Financial Express) has announced they are closing the service at the end of May on the basis that it is no longer economic to continue with it.

This is disappointing as although I also use ShareScope, there are some features in InvestorEase that are not easily replicated in the former. InvestorEase is also quicker and easier to use than ShareScope which has so many options that configuration is complex (SharePad from the same company is not a viable alternative either from my knowledge of it). But it’s hardly surprising that FE decided to close InvestorEase as the developer who maintains the software has clearly been having difficulty and losing interest of late.

I also have a portfolio in Stockopedia, but again I am not sure that will give a good solution. I need a product/service that enables maintenance of multiple portfolios with large numbers of holdings and transactions, plus a consolidated view on demand. The other reason I am running more than one such product is because I like to have a back-up in emergencies and by duplicating entries in the two products I can spot any obvious errors easily.

So any suggestions for good alternative solutions for the private but semi-professional investor would be welcomed.

Or perhaps anyone who might have an interest in taking on the product, which has suffered from total lack of marketing in recent years, should contact Financial Express.

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

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National Grid, Johnston Press, Crown Place VCT, Lloyds Bank, LoopUp and Brexit

I had a busy day yesterday, but let me first comment on the news today. National Grid (NG.) published their half year results this morning. They reported “Adjusted operating profit, excluding timing up 4%….” but statutory earnings per share were down by 12%. What exactly does “adjusted for timing” mean? I have no idea because the announcement does not explain it in any sensible way. For example, it says under “UK Timing”: “Revenues will be impacted by timing of recoveries including impacts from prior years”. Why are these revenues not being booked in the relevant period? Why are they not being recognised as revenues in the period concerned? Looks like a simple “fudge” to me as “adjustments” to reported figures in accounts often are. Many analysts seem to have a negative view of the stock, and I am coming to the same conclusion. I sold some of my holding in the company this morning.

I have previously mentioned the requisition of an EGM at Johnston Press (JPR), but the company has rejected this on the basis that it is “not valid”. It seems this is because the shareholder who requested it holds their shares in a nominee account (i.e. are not on the register). Yet another example of the obstruction caused by the use of nominee accounts. Changes to the law in this area are required to fully enfranchise all shareholders. See the ShareSoc Shareholder Rights campaign for more information: https://www.sharesoc.org/campaigns/shareholder-rights-campaign/

Yesterday morning I attended the AGM of Crown Place VCT, managed by Albion Capital. No excitement there. Just a competently managed VCT and a well run AGM with a presentation from one of their investee companies (PayAsUGym) who have developed an innovative business selling gym sessions. Crown Place made a total return of !4% last year and currently provide a tax free dividend yield of 6.9% which is covered twice by earnings. The expense ratio is 2.4% which is certainly better than many of the VCTs I hold. Previously this company had a strong focus on “asset-based” investments but they are now restricted by the new rules for VCTs so they are moving into more “exciting” fields. There are also concerns about further rule changes or removal of tax reliefs in the budget next Wednesday. Investors in tax incentivised vehicles seem to be getting nervous.

After lunch with representatives of AGMInfo, I filled an hour or so before the ShareSoc AGM by dropping into the Lloyds Bank legal action nearby which I have mentioned in previous blog posts. On the witness stand was former CEO of Lloyds TSB Eric Daniels being cross examined by the littigants QC. He gave a confident performance and was clearly well prepared. He said he was “bitterly disappointed” over the need to raise £7 billion in capital and was also disappointed that they would end up more highly capitalised than other banks. It was clear from his other comments that there was a certain momentum to go through with the deal (the acquisition of HBOS) and that they did not revisit the benefits of the transaction at every turn (e.g. as more information came out of the due diligence work for example).

He disclosed that in a conversation with the FSA there were real concerns that they could lose the vote of shareholders. This could be because there were views that HBOS could remain independent, although the Government had already indicated that it was promptly going to be nationalised if no rescue deal could be done; and because Lloyds TSB shareholders might vote against it.

The case continues. Lloyds Bank and the former directors continue to say that the claims have no merit of course.

It was then onto the ShareSoc AGM. Again no great excitement there. Mention was made of a possible merger with UKSA and as a former director of both I spoke in favour of that. Spreading the fixed costs over two organisations of a similar size makes a lot of sense. It should never have been necessary to set up a rival organisation to UKSA, but interesting to note that ShareSoc has more members now so my efforts in recent years were not in vain.

The ShareSoc AGM was followed by one of their company presentation seminars. Of interest to me (being current holders) were the two by LoopUp (LOOP) and Ideagen. I reported on Ideagen recently on coverage of their AGM so will only cover LoopUp herein. The presentation by their joint CEO Steve Flavell was slick but it was more a sales pitch for the product/service to customers than one to investors. The issue of them having two joint CEOs was raised in a question later.

The emphasis was on the simplicity of the service, so anyone could take it up easily and quickly. This is the major USP as there are lots of other conferencing products around. Most interesting was his explanation that they leapfrogged the “chasm” by ignoring the early adopters (who often like techy products) by aiming straight for the “mainstream majority”. His reference to “Crossing the Chasm” is from a book of that name by Geoffrey Moore which is essential reading for all sales/marketing executives in the software field, or investors in early stage technology companies likewise. Just had a chat with an Uber driver about this book – he has a degree in marketing – that’s the modern world for you. It will be a great shame if Sadiq Khan manages to put Uber out of business – might miss out on intelligent conversations with cab drivers. I read the book when it first came out back in the 1990s and Mr Flavell had read it also. I highly recommend the book. LoopUp is clearly a sales/marketing driven organisation but the technology is sophisticated enough to make it all look simple.

On the current valuation, the company has obviously a long way to go to grow into that valuation. Questions were raised about whether growth could be accelerated (revenue only up 39% in 2016m and 44% in the interims this year). But I expressed scepiticsm on attempts at a faster growth rate to Flavell after the meeting.

The Financial Times continue to publish anti-Brexit stories and editorial every day. My letter to the editor on the dubious bias, which they published, has obviously had no impact whatsoever. Tim Martin, CEO of JD Wetherspoon, had a lot to say about the subject of the impact of Brexit on food costs in his latest trading statement. He accused the media, and the Chairman of Sainsburys and that of Whitbread, and the head of the CBI, for completely distorting the facts. Rather than food prices rising after Brexit, he suggests they will fall. For his arguments see:

https://www.investegate.co.uk/wetherspoon–jd–plc–jdw-/rns/fy18-q1-trading-update/201711080700068513V/

My conclusion is quite simply that some foods might become more expensive, others might become cheaper, and home-produced products might also be cheaper; plus the Government might be able to save a lot of money on contributions to subsidising inefficient farmers. But that of course means that food buying habits might change as consumers react to price changes. Is that a bad thing? Readers can ponder that question.

Whether the Chairmen or CEOs of public companies should be making comments on essentially political issues, one way or the other, is also a question to consider. I suggest that might best be left to bloggers like me. Sainsburys and Whitbread (Costa, Premier Inns) might find they disaffect half their customers while having minimal impact on public opinion.

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

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