Dividends Slashed, Investing for Income, NMC Health and Finablr

Many companies are announcing cancelled, reduced or postponed dividends – two of the latest were Shell (RDSB) and Sainsburys (SBRY). This will hit investors hard who rely on dividends for retirement income. But should they be doing so?

Terry Smith of Fundsmith had an article published in the Financial Times today under the headline “Investors: never let a crisis go to waste” in which he attacks income funds. In particular he questions whether the Investment Association should allow funds with “income” in their name to only have a yield greater than 90% of the average fund yield, i.e. less than the average! Even that requirement has now been suspended for 12 months. Terry calls this a “ridiculous piece of deception” and I can only agree.

If you invest in individual shares, there is a strong temptation in times of stock market crises to run for the hills and start buying what are viewed as defensive businesses with high dividend payouts. You argue that the dividend yield will keep the share price up even if all other news is bad. But this is a fallacy. All you do is put yourself at risk of a sharp decline in the share price when the dividend is chopped.

As Terry Smith also pointed out in his article, dividend cover in many companies that are on high yields are inadequate. In reality they are not maintaining the businesses, or certainly not growing it, by not investing enough of their profits back into the business. Sometimes it indicates that they are operating in a declining sector and many have an abysmal return on capital. Should you really be investing in such companies is the question you should ask yourself?

The simple rule should be: Never invest in a company solely for the dividend. Invest in it because it is a quality company with positive prospects and management dedicated its long-term future for the benefit of all stakeholders.

I have mentioned NMC Health (NMC) and Finablr (FIN) in previous blog posts along with many other frauds. It’s not that I am trying to put off people from investing in the stock market which is one of the main sources of what little wealth I have. Likewise when I criticise those who invest in income funds or high yielding shares. But my desire is to educate people about how to get positive rather than negative results. NMC and Finablr have both been chaired by Dr B.R.Shetty and he made a rather surprising comment in a letter which was published by Finablr yesterday. He said: “The preliminary findings provided by my advisors from my own investigations indicate that serious fraud and wrongdoing appears to have taken place at NMC, Finablr PLC (‘Finablr’), as well as within some of my private companies, and against me personally. This fraud also appears to have been undertaken by a small group of current and former executives at these companies”. He goes on at some length on how the frauds were committed. This all sounds rather unlikely but we will no doubt see in due course whether what he says is true.

The shares of both companies are currently suspended and NMC is already in administration. Finablr also had this to say: “The results of this exercise currently indicate that the total net indebtedness of the Finablr Group may be approximately $1,300 million (excluding any liabilities of the Travelex business). This is materially above the last reported figure for the Group’s indebtedness position as at 30 June 2019 and the levels of indebtedness previously disclosed to the Board. The Board cannot exclude the possibility that some of the proceeds of these borrowings may have been used for purposes outside of the Finablr Group”.

The outlook for shareholders in both companies looks very bleak indeed. Let us hope that the investigation of these frauds is quicker than it normally is, but I doubt it will be. The larger and more complex the company, and the bigger the fraud, the longer it takes regulatory authorities to pin the tail on the donkey. Think of Polly Peck for example.

As I said in my previous blog post that mentioned false accounting at Lookers, “Such events totally undermine investor confidence in the accounts of public companies and suggest much tougher action is required to ensure accounts reported by companies are accurate and not subject to fraud or misrepresentation”.

For investors the motto must be ““Let’s Be Careful Out There” (as said by the sergeant in Hill Street Blues) because the financial world is full of shysters. You need to research companies as much as possible before investing in them, but even that is not fraud-proof unfortunately. Only improved regulation and accounting can really solve the problem of corruption in the financial scene.

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

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Bad News Rises as Market Does Also

Stock markets continue to rise when the economic news is generally bad. Is the market rise based on relief that it does not look like all our shares our going to become worthless, or relief that we have not yet caught the coronavirus personally? Although I know a few people who have – thankfully all recovering.

But companies continue to issue announcements of the kind that say “too early to tell the full impact” while reporting negative sales trends in the short term. Meanwhile the Bank of England is going to simply print money to finance government spending rather than raising debt in the gilt markets. If that is not a negative sign, I do not know what is.

A couple of companies are worth mentioning: 1) Speedy Hire (SDY), a company who rent out tools and equipment and hence are a good bellwether for the construction and maintenance sectors. They report “reduced activity levels” but they have “retained a substantial proportion of its revenues”. They are cutting costs, it is uncertain whether it will pay a final dividend in August and it “suspends all guidance until the position stabilises”. That does not sound very positive does it?

2) Diageo (DGE) also gave a trading update today. They give very little in the way of specifics about actual sales. They are reducing costs and are still paying the interim dividend this month, but have stopped the share buy-back programme. More information would have been helpful.

Those investors who rely on dividend income are being hard hit as many companies are cutting them out so as to protect their balance sheets due to the uncertainty of the economic impacts of the epidemic. Some of the big insurers are the latest to stop paying dividends and this has a very negative impact on their share prices as institutional investors who run income funds dump them for other shares. Private investors are probably doing the same.

But the really bad news yesterday, although not totally unexpected, was from NMC Health (NMC) who announced they expected to go into administration. The likely outcome for ordinary shareholders is zero. In normal times this would have been a headline story but almost all news is now being swamped by coronavirus stories.

NMC was valued at £2 billion when the shares were suspended but were worth four times that in 2018. So this will be one of the biggest stock market wipe outs in history, probably arising from some kind of financial fraud. I hope those responsible do not escape justice.

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

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Avoiding Another NMC Debacle

Yesterday the shares in NMC Health (NMC) were suspended and a formal investigation by the FCA was announced. The suspension announcement said that the company has requested the suspension of its shares and that the company is focused on providing additional clarity to the market as to its financial position.

The events at NMC are hardly the kind of thing one expects from a FTSE-100 company with reported revenue of $2.5 billion and profits of $320 million. The company operates hospitals and other healthcare facilities in the Middle East – hardly a sector that should be particularly volatile. The company has of course been the subject of an attack by Muddy Waters and the share price was already down by 80% from their peak in 2018, before they were suspended.

There now seems to be considerable doubts about the accounts (the finance director is on long-term sick leave which is never a good sign), there are doubts about who holds the shares, and questions about related party transactions and debt. The founder and CEO have departed from the board leaving the COO as interim CEO.

I recall NMC being tipped in numerous publications before all this bad news came out and it certainly looked a good proposition at a glance. Both revenue and profits were rising at 30% per year driven by rising wealth in the Arab states. So why did I avoid it?

The key point I would make is that “financial numbers are not important when picking shares” which is the subtitle of my book “Business Perspective Investing”. The numbers alone cannot be trusted even if they have been audited by a big firm such as Ernst & Young.

The company is registered in London and listed in the UK but the company had a peculiar governance structure with two joint Chairman and an Executive Vice-Chairman. They had a large number of directors otherwise and at the last AGM actually approved a resolution to increase the maximum number to 14. That is way too large for any company and results in board meetings being dysfunctional. The Muddy Waters financial analysis clearly raised some concerns and it is well worth reading. It also raised issues about the level of remuneration of the board and share sales. These might be considered warning signs and there is the key issue that it might be very difficult for UK based investors to monitor the operations of the company.

These are the kind of issues that I suggested investors need to look at in my book.

What do investors do if they find they have been suckered into a company with dubious accounts and when other negative facts have come to light? The simple answer is to study the evidence carefully and if in doubt sell the shares. It is never too late to sell is phrase to remember. You only have to look at the share price graph of NMC to see that investors with a trailing stop-loss of 20% would have exited long ago and hence avoided the worse outcome.

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

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NMC Health Attacked and Open-Ended Funds Holding Illiquid Assets

Yesterday Muddy Waters, the same organisation who recently attacked Burford Capital, published a highly negative report on NMC Health (NMC). The share price fell 33% on the day. Muddy Waters, and owner Carson Black, are effectively saying the accounts of NMC are fraudulent. A quick review of their report suggests the key issues are undisclosed related-party transactions, the purchase of assets at wildly inflated prices and the under-reporting of debt.

As with other similar “shorting attacks”, the dossier is long and complex enough to make any quick analysis of whether it is all true, or whether some of it is true, or whether the whole thing is a fiction, impossible to resolve. NMC published a fairly brief statement this morning saying the company had already responded in the past 12 months to many of the allegations but they suggest the claims are “unfounded, baseless and misleading, containing many errors of fact, and will respond in detail in due course”.

NMC run hospitals and other healthcare services in the United Arab Emirates (UAE) and elsewhere. It is registered in England and holds its AGMs in London.

This is what I had to say about such shorting attacks in a previous article: “One of the problems in most shorting attacks is the mixture of possibly true and false allegations, which the shorter has not even checked with the target company, along with unverifiable claims and innuendo. The shorter can make a lot of money by such tactics while it can take months for the truth or otherwise of the allegations to be researched and revealed. By which time the shorter has long moved on to other targets. Shorting is not wrong in essence, but combining it with questionable public announcements is surely market manipulation which is covered by the law on market abuse”.

I still think those who publish allegations that are likely to move share prices should at least give the company the opportunity to comment on the accuracy of the allegations before they publish. A few days grace should suffice with possible suspension of the shares until the allegations are investigated by the company and the FCA.

Readers will no doubt be aware of the problem of open-ended investment funds holding illiquid assets such as property or private equity shares. Investors of funds can sell their shares on a daily basis, but the fund manager who has to meet such redemptions cannot sell the assets of the fund to do so in any sensible time frame. They may hold some cash but if a stampede for the exit occurs then they cannot hope to meet the demand and hence have to close the fund to redemptions.

The Bank of England have published a Financial Stability Report that suggests such funds are creating a systemic risk and unfair outcomes for investors. They make various suggestions to solve the problem which includes making redemption notice periods reflect the time need to sell the required portion of a fund’s assets. For property funds this might mean many months delay. They also suggest a pricing mechanism to impose discounts on those investors who want a quick exit, but that might simply encourage investors to dump their holdings sooner rather than later, thus exacerbating a “run” on the fund.

Are these suggestions workable? I doubt it and they would certainly be confusing for retail investors. Why introduce such complexity when the answer is simply to ban open-ended funds from holding more than a very limited proportion of illiquid assets. Investors have a good alternative in investment trusts which have no such problems.

The Bank of England’s Report is present here: https://www.bankofengland.co.uk/-/media/boe/files/financial-stability-report/2019/december-2019.pdf (see page 75 for the coverage of open-ended funds).

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

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