Abrdn UK Smaller Companies Trust and Property Companies

red apples on tree
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I took the time to read the Annual Report of Abrdn UK Smaller Companies Trust (AUSC) today. It makes for interesting reading for those of us who invest in small companies. The performance last year (to the end of June 2022) was dire. NAV Total Return down 27% and the share price even worse. This wiped out all the gains in the previous year.

This is the main explanation given by the Manager: “The period was a challenging one for performance for the Company, particularly during the second half of the financial year, with our style being out of favour in the market as “top down” global macro factors have taken the lead over “bottom up” stock picking. Smaller companies markets have been difficult, seeing dramatic falls during 2022 after having been relatively stable in the second half of 2021”.

Their best performing holdings were Telecom Plus (TEP), Safestore (SAFE) and Alpha Financial Markets (AFM) and I hold the first two directly also. But they have both fallen back sharply recently.

This is what they say about those two which is a good exposition of their merits:

· Telecom Plus 118bps* (shares +72%): supportive end market conditions given the exit of low-priced competitors from the industry, and the strong position the nPower contract has in Utility Warehouse’s pricing offering. Sales force fully engaged again post Covid-19. Strong cash generation and dividends. An investment case study for Telecom Plus is included on page 42.

· Safestore 90bps* (+12%): solid demand in the selfstorage industry with the constant of the 3Ds (divorce, death, dislocation). Rate increases and strong utilisation have ensured consistent earnings and dividend growth”.

One of the biggest fallers in the year was GB Group – down 52% which has been the subject of a takeover bid subsequent to the year end. They exited a number of holdings and it’s worth reading the Annual Report for details of the portfolio changes.

The company has no plans to change its investment style and processes and I agree with that although the company is surely going to come under pressure if underperformance continues (the discount to NAV is currently 15.6%).

Safestore is of course a property company although it does not just rent out space so should ideally be valued in a somewhat different way. But it has participated in the rout of property company prices which continued today. Safestore is also held in some property trusts which has compounded the problem.

There is an interesting article in this weeks Investor’s Chronicle headline “The Sorry State of the London Office Market”. It explains how landlords are concealing a surplus of space and declining rents by offering rent-free periods and other incentives. However average lease lengths have been falling and are now less than 7 years which is far cry from when I was looking for office space 20 years ago. The additional flexibility is surely to be welcomed.

This perceived poor market for offices in London seems to be affecting all property companies when they frequently have a very different customer bases. It’s a typical bear market in essence – the good is sold off with the bad.

But the market seems to be reaching a point in my view when it will be worth picking up the big fallers in property and small cap companies soon. Those sectors are irrationally out of favour. For example some small cap companies have a large proportion of US$ earnings so will benefit from the falling pound in due course.

A falling pound should stop the lunacy of importing apples from New Zealand which Sainsburys just delivered to our house in the peak of the English apple season. Making imports more expensive does have some benefits!

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

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TR Property and Telecom Plus AGMs

Today (26/07/2022) there were two Annual General Meetings for companies in which I hold shares – TR Property Investment Trust (TRY) and Telecom Plus (TEP), both of which are long-standing holdings. I didn’t manage to attend either physically because I had an appointment at Guy’s Hospital in the morning.

However I did manage to log in to watch most of the TRY meeting including the manager’s presentation by Marcus Phayre-Mudge which was very interesting. I’ll only cover a few points as you should be able to watch a recording via the company’s web site.

This was a hybrid meeting in the sense you could attend both physically or on-line but voting was done on a poll and questions had to be submitted in advance unless you attended physically. This is not an unreasonable compromise in my view. Combining a show of hands vote with an on-line vote is obviously very complex so for bigger companies it is not an unreasonable solution in my view.

Marcus reported that TRY NAV Total Return was up 21.4% last year (to March 2022) but it’s way down since then. There was a question to the board re the dividend not being covered by earnings – they have used some of the revenue reserves in the last two years to maintain and increase the dividend but expect coverage will improve in future. Do I have any concerns about this? No is the answer.

The cost of debt is rising and some holdings have been taken out by public to private deals – some at a premium. People are returning to work in offices in most major European cities due to relatively short commuting times, unlike in London. There is macro uncertainty at present which is affecting the property market.

There was an interesting discussion on the housing market in Germany where TRY is overweight and where there is some clamour for rental controls particularly in Berlin. With Germany facing economic problems from the disruption to gas supplies because of the war in Ukraine, it is worth listening to Marcus’s session for that alone.

The current discount to NAV is less than 2% so I think there may be better bets if you wish to invest in property trusts. For example Schroder REIT (SREI) is on 32%. But TRY has certainly been well managed over the last few years.

The other AGM I missed was Telecom Plus which was also run as a hybrid meeting. There was a resolution put to the meeting to revise the articles of the company so as to permit the company to hold wholly virtual meetings. The notice said “These changes are being introduced to provide the board with greater flexibility to align with technological advances and evolving best practice, particularly in light of the Covid pandemic….”. I voted to support the change but 45% of shareholders voted against it. Clearly there is strong opposition to holding a virtual only meeting and quite rightly. I hope that companies will not drop physical meetings altogether as they provide for much better engagement with shareholders. Telecom Plus need to take note of the vote.

Virtual meetings do save a lot of time, so long as the technology works well. Interesting to discover today that Guy’s Hospital IT systems had been down for the last week after their servers were fried in the heatwave last week. As a former IT manager I find it both astonishing and concerning that they had not a better back-up and recovery system for such a critical organisation. It’s just another example of how the NHS is not as competent as it should be, which is getting lots of media coverage of late.

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

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Annual Reports and Voting – HLMA, AUTO, PAY and TEP

It’s that time of year when many companies issue their annual reports and request that we vote on AGM resolutions. I pity our postman as I still receive most of the reports on paper (they are easier to read in that form) and they are getting to be very heavy. Here are some examples and brief comments:

Halma (HLMA): 248 pages.  Emphasises “sustainable growth over 50 years” and included a tribute to co-founder David Barber who died recently. Report is full of non-essential bumf which I doubt anyone reads. I voted against the Remuneration Report – total remuneration of CEO £3.5 million last year and against the Chair of the Remuneration Committee plus several other non-exec directors who either seemed superfluous or have too many jobs.

Auto Trader Group (AUTO): 170 pages. A clear description of the business and future developments but do we really need 20 pages of bumf on “Making a difference” (ESG etc). Interesting to note that the average price of a used car advertised on their web site rose by 22% last year. There is clearly a shortage of second-hand vehicles as new car sales have been depressed for a number of reasons. People are holding on to their cars for longer it seems. Again I voted against the Remuneration Report and the Chair of the Remuneration Committee (single figure of pay for the CEO last year was £1.7 million). Cannot see any reason for such generous pay for directors. Also as with Halma I voted against share buy-backs and calling General Meetings on 14 days notice.

Paypoint (PAY): 162 pages. This is a complex business providing payment and other services to retailers and SMEs. Their markets have been changing as mobile top-ups have declined and bill payments in cash also. Romanian business was disposed of and a settlement with Ofgem re competition infringements of £12.5 million has been booked as a prior-year adjustment. You can spend a long time reading this Report without getting a very clear understanding of where the profits came from and their future prospects.

Total pay of the CEO last year was £911k which is down on the previous year. Does that reflect the Ofgem settlement? I have no idea as the 11-page Remuneration Report does not explain. Again lots of ESG bumf under the heading “Responsible Business”.

Telecom Plus (TEP) also published their Final Results last week. This company is clearly going to benefit from the failure of numerous energy suppliers. The National Audit Office has blamed the Ofgem regulator for light touch regulation and allowing businesses to be set up with poor financial resources. Gareth Davies, head of the NAO, said: “Consumers have borne the brunt of supplier failures at a time when many households are already under significant financial strain having seen their bills go up to record levels. A supplier market must be developed that truly works for consumers”. Certainly regulation has been lax but the setting of price caps that stopped world market gas prices from being passed on to customers was also quite irrational.

With a lot of the competition to Telecom Plus being removed from the market their prospects are looking up and the share price has zoomed upwards.

Needless to point out that I hold shares in all the aforementioned companies. They have many things in common – high levels of repeat revenue, have high returns on capital and appear to be well managed. But they have not been immune to the general bearish view of the stock market by investors at present.

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

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Bulb Collapse, Telecom Plus Results and FCA Globo Action

Yesterday energy supplier Bulb collapsed and was put into Special Administration. Bulb has 1.7 million customers and is the largest of 20 alternative energy suppliers to go bust recently. Most of their customers have been taken on by other suppliers but apparently nobody was willing to take on Bulb’s so effectively the company has been nationalised.

These companies have all been hit by the rapid rise in gas prices while the price cap imposed by Ofgem meant they could not raise their prices to their customers. Established suppliers such as Telecom Plus (TEP) consistently complained that the newer energy suppliers were building a customer base by selling at less than cost and the irrational price cap proved to be their undoing. Forcing businesses to fix their customer prices when input prices are based on market whims is a recipe for financial disaster in any market.

Coincidentally Telecom Plus, which I hold, published their half-year results this morning. They are a likely beneficiary from suppliers disappearing from the market. They reported “Net customer growth in October of over 15,000 and they are expecting around 10% growth in customer base during H2 with double-digit annual percentage growth thereafter”. There is always someone who benefits from financial disasters.

They also made these comments: “Over twenty energy companies have ceased trading since the summer, leaving over two million customers dependent on the safety net provided by the market regulator, Ofgem, to maintain their supplies and protect their credit balances through the Supplier of Last Resort (SOLR) mechanism.  These corporate failures take the total number of suppliers that have exited the market in the past five years to over 50, with further failures expected over the coming months.

Whilst primarily blamed on rising wholesale prices, this catalogue of failures, and the associated billions of pounds of costs that will ultimately be borne by consumers, reflect a regulatory regime that encouraged a clearly unsustainable ‘race-to-the-bottom’ approach to competition.  The resultant price war has eroded consumer trust and caused significant financial detriment, as the cost of these failures will need to be recouped through higher energy bills over the coming years.

Ofgem’s recent open letter to energy suppliers is therefore a welcome statement of intent to reform the regulatory framework towards one that genuinely fosters sustainability, investment, good service and fair competition amongst properly resourced and differentiated suppliers.

It is clear that the retail energy market has undergone a paradigm shift, bringing an end to the unsustainable practices which had become widespread over the last seven years of selling energy below cost to attract new customers, using customer credit balances as working capital, and failing to accrue for regulated renewable obligation payments.

In that environment, it stands to reason that an established, well-capitalised energy supplier benefiting from a sustainable cost advantage that is derived from bringing consumers a highly differentiated ‘all your home services in one’ proposition, should thrive.   As the dust settles on the prolonged energy market price war, we believe we are better positioned than ever to grow our market share significantly over the coming months and years”.

Other news today is a report in the Financial Times that the FCA have filed an action in the High Court against the former CEO and CFO of Globo (GBO). That company collapsed in 2015 after the accounts were shown to be a complete work of fiction with the claimed cash on the balance sheet non-existent and revenue also fictitious. It was a similar case to the more recent one of Patisserie Valerie also audited by Grant Thornton. The FRC declined to take action over the audit of Globo but it is good to hear that after so many years the FCA is finally taking some action.

As a former shareholder in Globo I have an interest in this matter and did provide some information to the FCA but there has been no contact from them since 2019. I am trying to find out more about the nature of the legal action now pursued (there is nothing on the FCA web site).  

Globo well demonstrates the weakness of UK audits, the poor enforcement by the FRC and FCA, the lack of transparency over what they are doing and the length of time it takes for those bodies to take action.

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

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Gas Prices, Price Caps, Reckless Pricing and Telecom Plus

There was a lot of coverage of the impact of rising gas prices in the media this morning, particularly on retail consumers. The wholesale price of natural gas has been shooting up for a number of reasons – up 17% alone on Monday for example.

The Government imposed “price cap” has protected consumers to some extent, but it has meant that many companies that supply consumers have been losing money. There are as many as 55 companies that supply gas to retail consumers but a number have already entered administration and the forecast is that only 10 might survive.

The price cap is only reviewed every six months and that is clearly insufficient to keep up with the rapid change to open market prices. The price cap was introduced to protect consumers from big companies who had many long-standing customers on fixed expensive tariffs. Many were reluctant to switch to other suppliers which is now very easy. Government action might have been laudable to protect the most vulnerable from exploitation but when you start interfering in markets, the outcome is usually perverse.

As a shareholder in Telecom Plus (TEP) I have some interest in this issue. They have repeatedly complained about new entrants to the market who were promoting prices so low that they were bound to lose money. But they were doing this to build a customer base.

This is what TEP said in their last Annual Report in June: “The level of the energy price cap increased by almost £100 at the start of April, a substantial rise that reflects both rising wholesale prices and higher covid-related costs. Since then, wholesale costs have remained at an elevated level, which makes the switching market particularly challenging for all market participants.

Despite this, many independent suppliers are still setting their retail prices at whatever level is required to attract new customers on price comparison sites, irrespective of the impact it will inevitably have on their profitability and cashflow; as a result, we continue to see them reporting significant and unsustainable losses in their latest published accounts. A number of further suppliers have left the market over the last 12 months, with further insolvencies likely in the event that the current Ofgem consultation (designed to prevent suppliers using customer deposits as a substitute for shareholder capital) becomes effective”.

Business Secretary Kwasi Kwarteng has said that the Government “will not be bailing out failed companies” which is good to hear because it is the companies own fault that they have got into this parlous situation. Gas prices are always volatile and companies that had not hedged the price nor had long-term supply contracts were very likely to come unstuck.

A meeting of supply company leaders with Mr Kwarteng apparently encouraged dropping of the price cap, but he was adamant in retaining it. That is a great pity because this problem would never have arisen if a free market was allowed to operate.

There are other possible ways to protect vulnerable consumers and nobody ever has their gas cut off because their supplier goes bust.  

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

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Electronic AGMs and Voting

Several companies in which I hold shares are proposing to adopt new Articles of Association at their Annual General Meetings. These typically are amended to enable the holding of “virtual”, i.e. electronic ones, or “hybrid” meetings where a physical venue (or multiple ones) are also used. They can do that legally at present under the emergency regulations put in place by the Government but they are clearly anticipating a more common use of such capabilities now that everyone is more practised in using video conferencing.

But finding out what the proposed new Articles actually are is often not easy. I simply could not find the one for JPM European Smaller Companies Trust anywhere so I sent them an email. No response to date.

In the case of Telecom Plus, the AGM notice points you to their investor web site for the new articles, but they were difficult to find there and the changes were not clear. This is where they can be found if you scroll down far enough: https://uw.co.uk/investor-relations

You will find the changes very unclear and convoluted. They look like they were written in a hurry. This paragraph is particularly problematic: “59.1 Each Director shall be entitled to attend and speak at any general meeting of the Company. The chairman of the meeting may invite any person to attend and speak at any general meeting of the Company where he considers that this will assist in the deliberations of the meeting.”

This does not give shareholders the absolute right to speak at a General Meeting as is the current position in Company Law so far as I understand it. The Chairman clearly has the right under the proposed new Articles to invite shareholders to speak, or not. That is not the same thing.

So I will be voting against the new Articles.

You might think the wording of a company’s Articles is a very technical matter of little concern. But in reality it can be a quite critical issue when important votes are required or a company is in difficulties.

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

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Euphoria All Around, But Platforms Not Keeping Up

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

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

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

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

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

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

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

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

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Dunelm Trading, Abrupt Share Price Moves and Volatility

It’s a good job I am not an emotional person. This morning Dunelm (DNLM) issued what I considered a very positive trading statement for the last quarter. The share price promptly dropped 6% after the market opened.

Total group sales were up 5.8%, with like-for-like sales up 6.4%. In addition this is a company that is clearly making a successful transition from being a retail store business to a hybrid on-line/store model. On-line business was up 34.7% while store business was still up 2.9%. On a prospective p/e of less than 15 and a yield of over 4% this is starting to look attractive. The company says year-end expectations remain unchanged as it continues to win market share. The only slight negative was that “September trading was mixed in part reflecting a softer homewares market”. But should a retailer be judged on one month’s trading alone?

This is the third of my holdings to suffer abrupt falls in the last couple of days. The others were 4Imprint (FOUR) and Telecom Plus (TEP), neither for any very obvious reason although there were some large trades put through on the former. But the UK market has been falling driven by the nervousness over resolution of the Brexit situation no doubt. That looks even more problematic at present with it being clear that the EU thinks they can force Brexit to be cancelled by sitting on their hands and dictating another referendum or general election before they will negotiate a withdrawal agreement. Conspiring with Speaker John Bercow is the latest attack on the democratic constitution of the UK by the EU in furtherance of this objective. What’s the motivation for the position of the EU Commission on all of this? I would suggest as usual it’s about money which always drives politics and the actions of individuals. The departure of the UK from the EU will leave a massive hole in the EU budget which they have not even attempted to solve as yet.

These events mean of course that foreign investors, who hold the majority of UK listed companies, are spooked and the risk of a future Labour Government rises as the leavers vote is split between Conservatives and Brexit party supporters. The only positive aspect is that the falling pound, driven by the same emotions, is improving the potential profits of many of my holdings which have large overseas revenues. 4Imprint comes into that category of course so the recent falls are difficult to explain except on the basis of recent past irrational exuberance. Smaller cap stocks are particularly vulnerable because just a few trades can move the share price substantially.

When markets and investors get nervous, volatility does increase and sharp share price falls can happen for no great reason. This is the time to pick up some bargains perhaps?

Postscript: Commentators on the Dunelm results after the share price fell further focused on the threat to margins from a falling pound, but the company announcement indicated that they expect gross margin for the full year to be consistent with last year despite currency headwinds towards the end of the year.

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

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