Taylor Wimpey 2016 Trading Results Unpicked

Disclaimer: Shareinvestors is not authorised by the Financial Conduct Authority to give investment advice. Terms such as ‘Buy’, ‘Sell’ and ‘Hold’ are not recommendations to buy, sell or hold securities, these statements and other statements made by the author have the meaning only to express the author’s personal views on the quality of a security. Independent financial advice from an authorised investment professional should always be sought before making investments. CAPITAL AT RISK. Full Disclaimer here.


Taylor Wimpey (TW.) perhaps needs limited introduction, it is one of the larger players in the housing development sector. TW’s focus is almost entirely on the UK market, of which 25% of its revenues come from London and the South East. It was no surprise then that following the BREXIT vote that the shares were marked down almost 40% in the immediate aftermath. The shares have recovered 27% since trading around 170p, but after this week’s trading results can we expect a further recovery?

The Trading Statement Unpicked

The full RNS is here, i’ll go through the highlights below but for those who want to skip the detail I have translated the release into hard numbers in Figure 1.

In 2016 total home completions increased by 4% to 13,881, including our share of joint venture completions (2015:13,341).

Our net private reservation rate for 2016 was 0.72 homes per outlet per week (2015: 0.73). Cancellation rates remained low at 13% (2015: 12%).

Taylor Wimpey informs us that demand continues to look strong. Cancellation rates have increased slightly by 1%, although some of that may be attributed to the immediate uncertainty post the BREXIT vote. The management team confirmed this hypothesis in the analyst call.

The mix impact of better quality locations continued to have a positive impact with average selling prices on private completions increasing by 13% to £286k (2015: £254k). Our overall average selling price increased by 11% to £255k (2015: £230k).

The average prices of the sales continue to increase, this is good news for TW clearly. However, whilst the locations may be of higher quality much of this increase will also be around the general increase in house prices. This growth in house prices continue to be far outpacing the real earnings growth, which is around 1.5% according to the Labour Costs Index. Many market commentators question whether this is sustainable and it doesn’t take a genius to understand why. So is it feasible for TW to post further increases in selling prices for 2017? I would suggest not, I’ll discuss the outlook later in the article.

We ended 2016 with a year end order book valued at £1,682 million as at 31 December 2016 (31 December 2015:£1,779 million), excluding joint ventures, with a small fall in the average selling price largely due to a number of high value Central London completions in December 2016. This order book represents 7,567 homes (31 December 2015:7,484 homes). We enter 2017 with 285 outlets (31 December 2015: 297)

This gives an indicator of the prospects going into 2017, the value of the book has fallen by 5% from £1,779m to £1,682m year on year. The total number of orders though has increased by 83 homes, i.e. 1% year on year. This starts to give a picture at the slow down in the London market, which Taylor Wimpey attributes this to. This again reinforces the point that the selling price is likely to be static at best for 2017.

As at the end of December 2016, our short term landbank stood at c.76k plots (2015: c.76k plots), having successfully converted over 9k plots from the strategic pipeline into the short term landbank (2015: c.9k). Looking ahead, we remain mindful of the wider macroeconomic uncertainty created by the outcome of the EU Referendum. In line with our disciplined strategy and with the benefit of a long landbank and underpin of strategic pipeline, we will continue to be selective in further land investment.

The landbank provides the inventory for future developments, at the interim results in June this land bank was recorded at £2.8bn, stated at the lower of cost and Net Realisable Value. It is by far the biggest balance sheet item and thus sensitive to impairment in downturns. The company quite rightly sounds caution over future investments in land, which is sensible given a potential overheat in land prices. The company thought as plenty of inventory here assuming the demand continues, with 76,000 plots at current average selling price of £0.255m the landbank provides for around £19.38bn of potential future revenue. I think it is fair to comment we should not be worried about the pipeline, management can afford to be overly prudent on replenishment for a while it seems. Next…

The Spanish market continued to be positive. We completed 304 homes in 2016 (2015: 251) at an average selling price of €358k (2015: €315k)

Encouraging, but the Spanish market represented just 2% of the total revenue in 2015, so I won’t spend any time on. Marching on further…

In 2016, the first year of operating towards our enhanced medium term targets, the Group expects to report an improved operating profit margin of c.20.8% (2015: 20.3%) and a return on net operating assets of over 30% (2015:27.1%).

Operating margins have improved slightly by 0.5%, this is positive and with prices increasing quicker than costs in the UK market this results in an increase in the profitability per completion of 14%. It is encouraging that Taylor Wimpey have retained some of the additional revenue and this hasn’t been lost in the supply chain.

We ended the year in a strong position with net cash of c.£365 million (31 December 2015: £223.3 million net cash), due to the strength in underlying trading and after the payment of £355.9 million of dividends to shareholders in 2016 (2015: £308.4 million).

There is no denying that Taylor Wimpey has thrown off the cash this year, when you add back the dividend it seems the company has generated around £0.5bn of free cashflow (FCF). With a market capitalisation of £5.6bn, this looks very favorable indeed and places my favorite metric of FCF/Earnings ratio of just over 10 – well in the value range

We remain confident in our ability to pay significant dividends through the cycle, and are focused on our medium term target for dividends which is to pay a total of £1.3 billion of dividends in cash to shareholders over the period 2016-2018.

The company retains it’s dividend guidance of dishing out on average £400m per year over the next three years, which puts the company on an estimated dividend yield of 7.9% at the current share price. This dividend was covered by 1.4 times by free cashflow so fairly safe for at least the next two years (2016 and 2017 payments).

We expect to deliver full year profitability at the upper end of market consensus [EBITDA £706m-£755m]. Looking ahead, we remain confident that our disciplined strategy will enable us to continue to deliver value over the long term.”

The company finally states it is likely to come in at the upper end of market expectations.  I calculate it will hit £755m bang on, perhaps even a little higher. The company even helps us mere mortal shareholders out by stating what that guidance was in the footnote. Bonus Point to the management.

So in summary 2016 was an exceptional year but what about the future?

Can Taylor Wimpey keep this performance up going into an uncertain environment?

I am far from an expert on the sector, but here are my views for what they are worth. I am a long term investor and my long term view is that we are still short of housing in the UK, which is backed up by the ONS, the long term fundamentals are therefore positive.

The house price has though increased on average by 7% year on year since 1980, I don’t deny this is making it very difficult for the younger generations to get on the housing ladder which means we are seeing some of the lowest first time buying rates in a very long time. I also don’t deny that house price increases by 7% each year against real wage growth of 1-2% is also not sustainable. We may well be due a large correction in prices and we start to see this in London now as evidenced by the trading statement. Let’s for a moment though take a fairly bearish scenario, reducing Operating Margin, completions and the average selling price by 20% (see figure 1). I calculate that this would still give a PE ratio of 20, not exactly great value but far from a disaster. Taylor Wimpey also has a strong balance sheet, unlike the last time the housing market suffered a correction in 2008/2009. The company at present is carrying just £100m of debt and even in the bear case it would still likely to be able to throw off around £300m of cash each year, not enough to sustain an 8% dividend yield but perhaps still 3% or so.

It is true we don’t know the effects of BREXIT, but in my view it would take a long and deep recession rather than just a correction in the housing cycle for Taylor Wimpey to be a long term sell.

Summary

Author Recommendation – Buy, Target 230 / 35% upside

A price of 230p would still give a dividend yield of around 6% and a PE ratio of 13 on 2016 numbers. This even at that level would give an appealing dividend yield, but discounts in some risk for a downturn in the housing cycle.

Appendix

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Figure 1 – ShareInvestors.co.uk 2016 projections and ‘bear case’

 

Disclaimer – I have long positions in TW. equal to 2% of my NAV. ShareInvestors.co.uk requires me not to deal in this stock in the next two trading days from the date of the post being published. This post is purely my opinion and should not be taken as financial advice. I welcome any alternative comments and will consider adjusting posts based on information made available to me.

December 2016 – Running Trading P&L

Disclaimer: Shareinvestors is not authorised by the Financial Conduct Authority to give investment advice. Terms such as ‘Buy’, ‘Sell’ and ‘Hold’ are not recommendations to buy, sell or hold securities, these statements and other statements made by the author have the meaning only to express the author’s personal views on the quality of a security. Independent financial advice from an authorised investment professional should always be sought before making investments. CAPITAL AT RISK. Full Disclaimer here.


In the interests of absolute transparency I record all my trades and produce a P&L of all of my share tips.

I will also continue to state my positions at the end of all company specific articles too.

December 2016 ROLLING P&L

Here is the P&L as at 30th December 2016, which assumes you had taken a long/short position on my recommendation on the date of the article with £1,000 capital at risk. I do not always take exposures in all of the stocks I tip due to risk management purposes, i.e. not placing too much capital in one area. I may also have higher or lower exposure to individual stocks so this is not my actual gain/loss.

dec-track

Click Here to Download Full Trading Overview 

The average stock tip is 24% Inception to Date, with 86% of my 18 tips in profit.

Prospect for Gold in 2017

Disclaimer: Shareinvestors is not authorised by the Financial Conduct Authority to give investment advice. Terms such as ‘Buy’, ‘Sell’ and ‘Hold’ are not recommendations to buy, sell or hold securities, these statements and other statements made by the author have the meaning only to express the author’s personal views on the quality of a security. Independent financial advice from an authorised investment professional should always be sought before making investments. CAPITAL AT RISK. Full Disclaimer here.


In continuation with my macro themes for 2017, today I look at Gold and what I consider to be the best way to get exposure to the sector. Gold had an explosive start to 2016, up 30% to $1,372 from $1,061 the start of the year in $ terms to its peak just after the BREXIT vote in the summer. Since then Gold has given up much of the gains, ending 2016 at $1,173 just 7% higher than where it started. The price action has been unpredictable of late, gold traditionally does well in times of uncertainty/adversity and hence many gold analysts thought the prospect of Donald Trump in the white house would rally the yellow stuff, but no such joy.  So what are the prospects for gold in 2017, will it be a year for the gold bugs or the gold bears?

Gold, back to basics

Gold is pretty useless compared to most other commodities, it has very limited industrial application, with its key industrial use being as a conductor in precision electronic appliances. Gold’s industrial demand is very limited compared to for example copper, oil or iron. Theoretically therefore demand should be limited and the price pretty cheap, but it isn’t, Warren Buffett once famously summed up the paradox as follows:

“Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”

Gold though is a) pretty and b) relatively rare. Demand historically was driven by the very nature of these two factors. Gold also doesn’t corrode and has just one grade, adding practicalities to its repertoire, i.e. gold doesn’t lose its value and is very simplistic to value. These factors meant gold became the global standard store of value and thus used as Currency for thousands of years. For at least the first millennia this was as a physical currency, but latterly as a backing to paper currency, known as the ‘gold standard’.

The Gold Standard met its demise in the 70s though, this was largely to allow flexibility, i.e. so the growth of the money supply wasn’t restricted by how much gold could be physically dug out of the ground. This all meant that today’s modern currency is no longer backed by gold, but it is worth noting that most countries still hold some stores of gold, albeit the amounts in their vaults generally accounts for a small % of the total money supply in issue.

So whilst the role of gold in monetary policy is reduced, one thing that hasn’t changed though is gold’s cultural significance. Gold is still considered a luxury item and thus it remains a key input to expensive jewelry. So theoretically then this should be the only factor that really drives the gold price? Not so simple, even though gold is not official currency anymore, it still is a store of tangible value. Fundamentally paper is very common and thus worthless if the system is removed, this is exactly why gold does well in times of great uncertainty, as we will go on to see.

So what drives the gold price today?

One of the theoretical drivers and frequently cited reasons for gold price increases is a decline in the interest rates, since gold has no yield then theoretically an increase in base rates should decrease the appeal of gold and hence gold prices should decline. Figure 1 shows the link between US interest rates and the gold price is US$.

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Figure 1 – Gold price vs. Real Interest Rates. Source: Merk Investments

There is clearly some inverse correlation between US interest rates and gold prices, but the relationship does not always hold true. Interest rate decreases are also likely to weaken the US$ and hence make the price of gold relatively cheaper to non US buyers.

This leads me nicely on to the next driver; the strength of the US$ which is another key factor which influences the gold price, whether driven by interest rates or otherwise. The US has the largest gold reserves, over 8,000 metric tons, double the next largest holder Germany so a lot of gold buying may have been historically domestically led. However, China and Russia have been more recently been heavy buyers of gold and they would all benefit from any weakening in the US$. It is also worth noting though that a strengthening US$ provides some protection for existing overseas gold holders, in that a stronger US$ also increases the value of the holding when converted back to local currency.

Inflation is another factor than is often cited as a driver for the gold price. As inflation reduces the real value of currency then gold is seen as a way of protecting wealth. Be careful what you wish for though, periods of high inflation are usually correlated with periods of high interest rates, which as discussed above theoretically dampen the gold price.  As expected therefore there is some but not a strong correlation between the gold price and inflation.

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Figure 2 – US Inflation rates vs. Gold Price

For example, inflation rocketed to 18% in the late 70s/early 80s, but interest rates also rocketed to 20% to attempt to control the inflation. Interest rates stayed above 10% into the early 80s with the gold price collapsing over the same period!

As you can see with all of the first three factors mentioned, i.e. interest rates, inflation and US$ strength, they are all very much linked in that they all drive each other. The final economic factor I look at it is semi ‘delinked’ from the others, I use the word delinked extremely loosely, as clearly the macro drives the micro, i.e. individual stocks. The performance of the stock market is though probably the most inversely correlated to the gold price, but hold your horses! In figure 3 below you can see the performance of the S&P over the past 5 years against the performance of a physical gold ETF. The S&P500 index has risen 100% whilst the return of physical gold has been 0%. This is far from perfect inverse correlation, which would be -1, i.e. gold declining 100% (impossible). Taking a shorter time frame looking at this year though, the S&P500 has risen 18% and our physical Gold ETF has risen 6%, i.e. a somewhat positive correlation, which isn’t what it is in the textbook!

It is clear there is no perfect relationship here, in fact the longer term correlation is just -0.14, so only slightly inverse. This might not seem a lot, but when you leverage this onto producing companies the share price performance of these can potentially vastly outperform, but more on this later.

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Figure 3 – S&P500 Index vs. Physical Gold ETF. Source: Google Finance

As a final analysis let’s take a look in Figure 4 at how gold performed in the last financial crisis, overall gold rose 60% during 2008-2010 against a 20% decline in the S&P500. In this crash gold did provide some protection, but perhaps not just as a result of the general fear and uncertainty. Over the same period interest rates also declined, which as we discussed earlier make holding gold more attractive.

Another observation to note is that a popular ETF which tracks the major gold miners only rose 30% against the gold price rise of 60%. This goes against the common advice of ‘buy the miners not the commodity’. At the peak of the crisis, late 2008 the gold miner sell off was actually even more intense than the broader S&P500. One of the key reasons for this was indiscriminate selling in an environment of extreme fear. However, if you had bought the ETF gold miner index in late 2008 you would have returned around 80% to the close of 2010. Timing was key in this period!

gold-in-financial-crisis
Figure 4 – S&P500 vs Physical Gold vs Gold Miners. Source: Google Finance

In summary, there are many drivers to the gold price and it is not as simple as looking at one variable and buying gold on that basis. It is not even sound advice to blindly load up on gold to protect against stock market declines. I am still of the view that gold does have a place in a balanced portfolio, but one should broadly consider the environment and carefully consider the weighting.

So what are the prospects for gold in 2017?

The following chart shows real gold prices over the last 100 years, we are some way off the two most recent peaks but even further from the recent trough.

historical-gold-prices-100-year-chart-2016-12-27-macrotrends
Figure 4 – Real (inflation adjusted) Gold Prices. Source MacroTrends.Net

I’m not going to perform any detailed analysis here, a) I’m not qualified to do so and b) you can find predictions from so called experts from around $200 to $10,000. The truth is that given the number of variables it is very complicated. However, looking at the drivers, some very quick thoughts.

  1. Inflation – picking up in many core economies.
  2. Interest Rates – picking up in USA and we may see this trend continue among other major economies later in 2017.
  3. US$ – Likely to continue strength.
  4. Stock Market – Markets are fairly fully valued but global growth prospects looks reasonable. But where is the next black swan?

All in all, I believe the strong US$, Interest Rates and Inflation are already priced in to gold and thus the key drivers may be driven more by geopolitics. There is also the European Union and how Trump settles into the White house to consider. My personal view is that gold can offer some downside protection against these events. There is also a potential major new demand source for gold. I won’t go into that here but take a look here at the Sharia Gold Standard over at ZeroHedge.com

How can I get exposure to gold?

There are many funds and ETFs which allow exposure to gold, these include through physical holdings, derivatives and the underlying producers. As a general rule I never invest in physical commodities or the derivative methods, the former is expensive and the later you need to deal with Contango (I’ll cover this in a separate piece). I prefer holding the underlying miners, i.e. investing in real businesses. In times of high gold prices, much of any price increase goes to the bottom line and producers can theoretically also work to minimise costs thus increasing the margins. You can see in figure 5 below that during the peak bull run of 2016 the gold price had increased 30% since the start of the year and hence the ETFS physical Gold ETF delivered a similar increase, however one ETF tracking the gold miners  increased 160% during the same period. However, as mentioned above this didn’t hold true in 2008/2009 stock market crash, initially at least.

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Figure 5 – Performance of Gold Vehicles 2015/2016. Source: Google Finance


Should I go Active or Passive?

There are limited fund/trust options for active management. The most obvious active fund is the BlackRock Gold and General (BRGG) Unit trust, this performs well but the broker management fees are not included in the above chart (0.45% per annum for Hargreaves Lansdown) and the performance differential is not enough for me to give up the instant liquidity that come with exchange traded products.  That said BRGG remains an excellent choice for those investing in smaller tranches.

The two ETFs I like in the sector are the Vaneck Junior Gold ETF (GDXJ) which fully replicates the Market Vectors Global Junior Gold Miners Index and the Vaneck Gold Miners ETF (GDX) which replicates the NYSE Arca Gold Miners Index, an index representing the larger gold miners. The performance has been interesting this year, with the junior miner index, represented by the green line in figure 5 outperforming in 2015 during a period of weakness in gold price but also in 2016 during a period of better prices. The other lines on the chart are the performance of Physical Gold ETF (yellow) and the popular BlackRock Gold and General Unit Trust (brown).

Let’s take a look at the fundamentals, the Price Earnings (PE) ratio of GDX is 44, which is expensive. After a good year for many miners the forward PE drops though, for Randgold the 2017 PE is expected to be 23. Further it is important to note the effect of even modest increaes on the gold price, ‘GDX’s top 17 component gold miners had average All in Sustainable Cost [AISCs] of $936, while the next 17 looked even better averaging $857.’ According to Analyst Adam Hamilton. This gives a margin of around 17% against a current gold price of $1,100. If the gold price hits a sustainable level of $1,300 then the margin is 38%. Major miners would be on P/E ratios at current share price of less than 10. A very attractive prospect. Moving on to the junior index ETF, the P/E of GDXJ is -24, this is mainly as the companies tracked are at an earlier stage of their life and may be explorers as well as smaller producers. The Price/Book ratio is just 1.24 though which is reasonable and suggests plenty of room for growth.

The key risk is a lower gold price throughout 17, a fall of the gold price towards $900 would wipe out earnings and some miners would be loss making. The pain in the junior miners may be more significant with some exploration/appraisal prospects likely to be canned.

SUMMARY

Authors opinion – Buy Gold, on balance I see more bullish indicators than bearish.

Overall I like to have between 5%-20% of my portfolio in Gold depending on my view of the world. I’m currently planning on going into 2017 around about 7% and may look to increase this on weakness and/or geopolitical concerns and a bearish stock market.

GDX/GDXJ are both good ways to get exposure to the sector and you could consider a holding in each.

Disclaimer – I have no positions in any of the stocks mentioned. ShareInvestors.co.uk requires me not to deal in this stock in the next two trading days from the date of the post being published.

This post is purely my opinion and should not be taken as financial advice. I welcome any alternative comments and will consider adjusting posts based on information made available to me.

Are UK Smaller Companies still investable?

Disclaimer: Shareinvestors is not authorised by the Financial Conduct Authority to give investment advice. Terms such as ‘Buy’, ‘Sell’ and ‘Hold’ are not recommendations to buy, sell or hold securities, these statements and other statements made by the author have the meaning only to express the author’s personal views on the quality of a security. Independent financial advice from an authorised investment professional should always be sought before making investments. CAPITAL AT RISK. Full Disclaimer here.


I continue today with my portfolio review ahead of the dawn of 2017. As I wrote about previously, as well picking out individual contrarian stocks I also like to focus on Macro themes and getting exposure to these through ETFs and quality Investment Trusts. I find this strategy allows me to make money by getting it right at a Macro level even if I make a few mistakes at a Micro level. Today’s focus is on UK listed Smaller companies, it’s an area I love and where I place most of own money when it comes to individual stocks. But after a bull run is this area still hot for growth and what is the best way to get exposure?

The Macro Picture for UK Smaller Companies

Ultimately a small company is tomorrow’s big company, so no matter what is going on in the broader macro environment there is always lots of potential in this area. The small company definition is fairly broad though and for investment trusts the selection criteria for companies to place their capital can be a market capitalisation of anything between £50m and £3bn.

As I discussed in my post last week on Vietnam opportunities, there are certain sectors that are for stock pickers rather than ETFs, which tend to track indexes. Smaller companies is another sector where active management is essential in my opinion. Smaller companies are inherently more risky, they tend to have more limited access to resources, this is financial capital but also human capital, i.e. experienced people. Smaller companies may also be earlier in the development cycle or more likely to be pursuing growth, which again makes them inherently more risky than their larger cap brethren.  All this means failure rates are higher and consequently you need to be able to accept volatility in this sector.

The sector though is also full of promise for those with the eye. Overall the sector is relatively poorly researched too, in fact many smaller companies have no independent research published on them at all, so for a skilled asset manager there are massive opportunities for returns. Given the risks it is essential though to throughly research stocks and if possible look the management in the whites of the eyes.

What are the potential HeadWinds and Tailwinds for 2017 for the small company sector?

Always a tough assessment. Economic contraction is a risk to all stocks, but given the general restriction in capital that smaller companies have the risk is magnified in this sector. Bank’s lending books really dry up during times of toil. No surprise then that in the last major economic crisis of 2008, the smaller stocks were consequently hammered. The FTSE All share overall shed 45% value from peak to trough, the AIM All share 65% – see Figure 1.

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Figure 1 – Performance of AIM All Share vs. FSTE All Share in 2008 crash. Source: Google Finance.

So are we due another shock? I personally don’t like to plan for potential black swan events, it has been 8 years since the last financial crisis so I admit perhaps we are due one. However, equities over the long term deliver 7% a year, so by parking money in cash since 2008 waiting for the next black swan you would be giving up 72% of gains over the same 8 year period. My preferred strategy is therefore to keep 10%-30% of my portfolio in cash to buy into dips and leverage up when I see extreme buying opportunities. Given where we are in the cycle I am holding the upper end of the above range in cash and I’m certainly not thinking about leverage.

I’m not going to go into a full analysis of all the macro risks, but a flavour of what the ‘known unknowns’ are, just for fun. You need to look to the US, Russia, Europe and China in general, these are the only players that can really trigger an economic crisis. If any of these sneeze Britain will catch the cold. The biggest risks I see are slowing Chinese growth and the consequent credit bubble bursting, Donald Trump (catch all), Putin aggression and further pressure on the European project. As for the ‘unknown unknowns’, aliens landing in piccadilly circus…

What about Brexit?

This homegrown risk is a more tangible risk, but only just. Smaller companies tend to be more domestic led, therefore theoretically less vulnerable to the FX risks and new complexities of overseas trading that Brexit may bring. However, clearly the domestic economy is linked to the broader economy, it would be naive to suggest otherwise. On the flipside, a Brexit could also make doing business in the UK easier given the reduction in EU regulations to contend with.

I think at this stage though there are far too many variables to consider to ‘call’ this whole sector on the brexit factor. It will though for sure affect some companies more than others, exporters may be quids in but importers may struggle, this goes back to the importance of choosing a solid asset manager who can pick the right stocks…

So how can I get exposure to the UK Small Cap Scene? 

There are 100s of funds, trusts and ETFs covering the sector. It is essential that you do your own research to find the right fund for your circumstances. My favourite though in the sector is Standard Life UK Smaller Companies Trust (SLS). This trust has performed exceptionally well over the last 10 years (Figure 2), an investment in December 2006 would have returned you 200%, against 10% decline for the AIM100 and relatively flat performances for the Numis SmallCo Index and the FTSE100.

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Figure 2 – 10 year SLS performance vs. benchmark. Source – Interactive Data

Performance has been weaker this year (Figure 3) though, down 12% against the AIM100 benchmark. One of the drivers for the weak performance is the same reason for its outperformance over a longer horizon, the lack of exposure to resources sector. As a result the share price discount to the Net Assets has slipped to 7%, above the longer term discount of 5%. I have a lot of belief in the asset manager Harry Nimmo though and his long term track record is very good. I expect he may look to add in the resources sector as we enter 2017.

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Figure 3 – 2016 SLS performance vs Benchmark. Source – Interactive Data

Another key factor for me is the size of the fund, £288m as at 23rd December. This makes it reasonably sized and thus able to operate relatively nimbly in the small cap area. As a result the trust is able to focus on a relatively small number of holdings, around 60. The trust also concentrates 56% of it’s NAV in it’s top 20 (figure 4). This means the asset manager Harry Nimmo can understand the companies inside out. The risk of funds getting too large is they end up having to take lots of positions, the Black Rock Small Cap Trust is a good example, it is double the size at £0.5bn and has 160 holdings. How can the asset manager keep track of this many holdings? Trusts can be often be victim of their own success, but as a shareholder I want the success to be returned to me via special dividends rather than through new investments in this sector. This keeps the trust nimble and hopefully performing well.

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Figure 4 – Top 20 SLS Investments. Source: Standard Life

Final comment, the trust has exposure to AIM micro caps all the way to FTSE250 (Figure 5). This is a sensible weighting given the potential uncertain times we are entering.

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Figure 5 – Composition of SLS. Source: Standard Life


Summary

Author Opinion – Positive on Sector / Positive on SLS Trust

Over the long term I expect the UK small company sector to continue to flourish, for as long as we have a government that is pro business. The SLS trust is an excellent way to get exposure, whilst 2015 has been a disappointing year I have confidence in the long term track record of Harry Nimmo.

Disclaimer – I have no positions in this stock. ShareInvestors.co.uk requires me not to deal in this stock in the next two trading days from the date of the post being published.

This post is purely my opinion and should not be taken as financial advice. I welcome any alternative comments and will consider adjusting posts based on information made available to me.

San Leon – Share Price Fails to Respond to Indicative Bid

Disclaimer: Shareinvestors is not authorised by the Financial Conduct Authority to give investment advice. Terms such as ‘Buy’, ‘Sell’ and ‘Hold’ are not recommendations to buy, sell or hold securities, these statements and other statements made by the author have the meaning only to express the author’s personal views on the quality of a security. Independent financial advice from an authorised investment professional should always be sought before making investments. CAPITAL AT RISK. Full Disclaimer here.


I previously wrote about San Leon (SLE) here and at that time in September my opinion was this was a BUY, with a preliminary target of 65p. At the start of this week things got interesting, a number of rumours were published by ‘reputable’ news sources and subsequently confirmed by San Leon. Why then have the shares failed to respond anywhere close to the price?

What’s was the background?

On Sunday, the Irish paper the business post published the following rumour which suggested San Leon were in discussions with an unnamed Chinese bidder to acquire the entire share capital, but no price was mentioned. San Leon very vaguely confirmed the rumour before market on Monday here, but stating as is normal in a bid situation that ‘there can be no certainty that an offer will be made or as to the terms on which any offer might be made’. The shares opened up 23% higher, but quickly ran out of steam shedding 10% from the highs of 53p, back down to 49p.

The share price had another boost on Wednesday lunchtime when Sky News suggested a price of £485m has been tabled and suggesting the counterparty to be Geron Energy. The article also stated this equated to an indicative offer of 80p. San Leon after hours on the same day confirmed this here, confirming the details of the deal but caveating that ‘Talks are at a preliminary stage and there are significant uncertainties as to whether or not the matter will proceed further. A formal offer would only be made following due diligence’.

The share price currently though sits at a 37.5% discount at 50p to the tabled indicative offer of 80p.

So what’s going on? Why has the share price failed to react?

The market does not believe this offer will materialise and hence is heavily risking the likelihood. The first issue is the bidder, Geron Energy Investment. Anyone heard of them? There is not much of a record of them on the internet, the only presence I could find is at www.geron-invest.com, but I’m not convinced this is the party named. So no real clarity and given the recent case where Fitbit was subject to a fake bid from an unknown Chinese investment company I can understand the market being cautious.

The press articles also look heavily like they have been placed by an insider. Unsurprisingly Sky News does not put much work into investigative journalism around a unpopular small cap oil companies. My bet would be therefore that someone has fed Sky the story ‘word for word’. I think the market is questioning, who and why?

San Leon also has a long history of failing to deliver and letting down shareholders. Whilst it did appear to get a good deal in Nigeria and the fundamentals look solid we still have not yet had a substantial trading update on the asset despite the deal completing at the end of September. There is a deep mistrust of the management and good news just fails to stick at San Leon.

Is there room for optimism though? Should the share price be higher?

ToscaFund, the majority shareholder at 55.12% released this statement today, which has some interesting wording:

Toscafund has requested that the board of San Leon Energy respects and engages in discussions with the potential Offeror to assess its approach.

Toscafund notes that the only two comprehensive external research notes covering San Leon Energy were issued in September 2016 by Whitman Howard and SP Angel and set a target share price of 130p and 100p, respectively

Tosca is requesting the ‘board respects and engages in discussions with the potential offeror’. It also points to two notes from the house brokers which have targets significantly above the indicative offer price.

I’m not accusing Tosca of leaking this information, it could have come from a number of sources but I certainly don’t think they would have been upset to see this information in the public realm. The bid rumours forced the board to announce the potential deal, which they may have been sitting on for a while. It wouldn’t surprise me to learn that Tosca are putting serious pressure on the board to get a return on investment as the shares meanwhile languish again below the most recent placing price, at 44p. Let’s not also forget that Tosca has been a longer term holder in San Leon and has previously placed money in at 80p and higher. I believe Tosca are also suggesting by pointing to the broker notes that the minimum they are likely to accept is 100p+. Tosca to me is therefore sending a clear signal of a beauty parade to be had. Their share is potentially for sale and these are the terms.

But ToscaFund has majority control, so why don’t the offeror deal directly with Tosca? Irish Law makes hostile takeovers very challenging due to the requirement of the buyer to gain greater than 90% of shareholder support for takeover. Scheme of Arrangements can reduce this requirement, but this requires the blessing of the board. So it’s best bet for now is to appeal to the board to facilitate offers.

Final comment to my opening concern, San Leon did also ‘confirm that Geron Energy Investment is a party to the Offeror’. This to me suggest Geron are an agent to an ultimate buyer, this may explain why no one has the foggiest about who Geron are. Who therefore is the real interested party?

What’s my view?

Author’s View – Maintain BUY, Target 65p Minimum

As mentioned in my earlier piece, I like this company a lot on fundamentals, I won’t try and repeat my earlier article here, but assuming performance of the asset is currently as expected San Leon is expected to be on 19% dividend yield in the near future. The company is not distressed so I feel fairly comfortable holding the shares even with no bid situation. I appreciate the past but I feel there is a heavy discount already priced in here for the history. The OPEC deal can’t have done any damage to the business case since my last blog either.

There is now also the potential added upside of the major shareholder being open to a potential sale. The major shareholder is also a shrewd bugger, a $4bn hedge fund is not necessarily a bad fellow investor to coexisit with on the share register in this context.

If the bid comes to nothing though I would expect the shares to slump back in the near term. The failure to meet guidance may also hammer the share price given the continued lack of delivery. I am very much looking forward to the next trading update and for now I’ll try and ignore the speculation.

Disclaimer – I have long positions in this stock equal to 2% of my NAV

This post is purely my opinion and should not be taken as financial advice. I welcome any alternative comments and will consider adjusting posts based on information made available to me.

When will the corporate bond bull market burst?

Disclaimer: Shareinvestors is not authorised by the Financial Conduct Authority to give investment advice. Terms such as ‘Buy’, ‘Sell’ and ‘Hold’ are not recommendations to buy, sell or hold securities, these statements and other statements made by the author have the meaning only to express the author’s personal views on the quality of a security. Independent financial advice from an authorised investment professional should always be sought before making investments. CAPITAL AT RISK. Full Disclaimer here.


 

I have a three different investing strategies, all with fundamentals at that their core. One of my investing strategies focuses on macro trends, i.e. looking at what I believe to be under valued asset classes, sectors and currencies on fundamentals. I then pick appropriate ETFs and Investment trusts to get exposure to these areas.

In today’s post I look at the sterling corporate bond asset class and specifically at the iShares Core Sterling Corporate Bond fund (SLXX). Corporate bonds have been on a bull run since 2009, well actually you might argue the run has been in play since 1980. My favourite in the Sterling Corporate Bond sector, iShares Core £ Corp Bond (SLXX) had seen 45% capital gain alone from mid-2009 to the most recent peak in the market at August 2016. When you add distributions over the same period you can add a further 30% on top. This is a whopping 85% return in 7 years, these are equity like returns.

Firstly, how can I gain exposure to Sterling Corporate Bond?

As above my favourite in the sector is SLXX, the fund is an Exchange Traded Fund (ETF) which tracks the Markit iBoxx GBP Liquid Corporates Large Cap Index. This is an index of large cap, liquid, investment grade bond issues. At 8,000 issues it is also very well diversified. It is therefore a great way of getting exposure the to corporate bond asset class at large. It is also worth mentioning that with an average maturity of 14 years it gives a longer dated exposure to bonds, this becomes relevant later.

As mentioned above the fund has done very well and performed well ahead of the sector and a similar mutual fund offering from BlackRock (see figure 1). The total expense ratio (TER) is 0.2%, higher than BlackRock corporate bond tracker which Hargreaves Lansdown can offer at 0.12% TER. However many fund brokers such as HL also include a management fee on mutual funds, for HL this is 0.45%, so the true cost of this could be upto 0.57%. This of course depends on your circumstances and also bear in mind dealing fees with ETF. I’ll do a separate piece at some point discussing the pros and cons of different ‘wrappers’ for your investment.

bond-chart
Figure 1 – SLXX vs Sector and Peer. Source – Financial Express

Anyway, not much more to say on SLXX, it’s an ETF. You can access this asset class in many ways, the important factor is the macro picture though…

So can the corporate bond bull market continue?

Let’s start with the basics. There is a an inverse relationship between Corporate bond prices and the yield. The demand and hence the price of corporate bonds are solely a function of risk (represented by yield), and this can be subdivided into two factors:

  1. Interest Rate Risk – Relative yield of corporate bonds versus other asset classes, most notably cash.
  2. Credit Risk – Real or perceived Counterparty risk .

Is the yield on corporate debt now too low? Are we consequently due a fall in bond prices?

The yields on sterling corporate debt hit a record low earlier this year. A major factor behind this is the ongoing quantitative easing, where the central bank buys investment grade corporate bonds, among other assets. The logic here is that by buying bonds this increases the price, reduces the yield and hence the cost of corporate borrowing. This should theoretically stimulate the economy. Some argue though this action from the central bank distorts the yield and doesn’t fairly represent the risk of holding corporate bonds. Taking our fund from above, the current average Yield to Maturity (YTM) of SLXX is 2.77%, this compares to an Weighted average coupon (WAC) rate of 5.09%. This means the average bond in the SLXX fund is yielding around 1.4% less than the underlying coupon rate of the bond. This means the bonds held by SLXX are trading at a premium to issue price, a 26% premium to be precise, as at 16th December 2016.

This premium sounds extreme but a yield of 2.77%, despite being well below the coupon on the bonds is still significantly more than you can hope to achieve by parking your money in cash. But what about a Sub Investment Grade Emerging Market Bond Fund? The iShares WING fund has a current YTN here of 4.86%. But this sounds high a risk fund right, but a yield of less than 5%? Would you lend your money at this rate? Do you feel more comfortable with 7.5%, or perhaps even 10%? A yield requirement of 7.5% or 10% would represents a 16% or 29% underlying decrease to the price of the bonds. I am very concerned about counterparty risk on ‘high’ yield corporate bonds, default rates of 5-6% would not be uncommon in any economic downturn, this would start to seriously affect the returns of bond investors and could trigger a flight to safety. Investment grade bonds are unlikely to have the same counterparty risks but may be dragged down in association.

Now let’s look at the second risk, interest rate risk. A major factor causing people to turn off from investment grade bonds is potential yield from elsewhere such as increasing interest rates on cash…

Are UK interest rates likely to rise?

As mentioned above the price of bonds are very sensitive to interest rate increases. A hypothetical scenario but if the interest rate for cash increased to 3% then given SLXX and similar bond funds only offer a YTM of 2.7% then a rational investor would sell SLXX as cash is zero risk and has more liquidity than bonds.

We are a long way from 3% base rate though granted. We are in an era of ultra low interest rates, it’s been that way since the 2008 financial crisis and the general trend has been down since the late 70s (see figure 2). Whilst 3% base rate is unrealistic in the near term the current interest rate is 0.25%, so there is also very little potential for further decreases and therefore upside to bond prices from this factor.

uk-base-rates-79-11
Figure 2

What is the likely trajectory for base rates from here?

Interest rates are a monetary policy tool to control an overheating economy, one where inflation is running high. The collapse in Sterling post Brexit is starting to impact inflation given we import a lot of raw materials and a lot of the food we eat.  Could this force the MPC to increase rates? The risk is currently considered low, current predictions are that interest rates won’t make it to 0.5% until 2021. But since when did the experts get it right?

If interest rates do rise then longer dated bonds are likely to be much more sensitive, this is for the simple reason of longer exposure to the narrower spread between base and current yield. A shorted dated ETF such as iShares £ Corp Bond 0-5yr UCITS ETF (IS15) may be safer, but for obvious reasons the current yield is much lower.

SUMMARY

Sell

I am not saying the next bubble to burst will be corporate bonds, I just see very little upside from here and on balance more potential downside so this comes down to risk/reward ratio for me. Interest rates increases are unlikely in the near term, but then so was BREXIT and Trump for president.

Disclaimer – I have no positions in any of the stocks mentioned. To my knowledge no close family, friends nor associates have any further position. 

This post is purely my opinion and should not be taken as financial advice. I welcome any alternative comments and will consider adjusting posts based on information made available to me.

IG Group – Battered by the FCA, is the share price fall overdone or more pain to come?

Disclaimer: Shareinvestors is not authorised by the Financial Conduct Authority to give investment advice. Terms such as ‘Buy’, ‘Sell’ and ‘Hold’ are not recommendations to buy, sell or hold securities, these statements and other statements made by the author have the meaning only to express the author’s personal views on the quality of a security. Independent financial advice from an authorised investment professional should always be sought before making investments. CAPITAL AT RISK. Full Disclaimer here.


IG Group (IGG) had delivered 600% growth for those shareholders who got in at the IPO in 2005, this compared to 40% for the FTSE100 over the same period. Disaster struck though earlier this month with the shares down almost 45% to 441p in the month of December so far, this being some way off their record high of 967p, set earlier this year. In this article I consider whether the the sell off is overdone or whether investors should start to think about catching a falling knife?

What Prompted the Major Fall in the share price?

The FCA published a note on 6th December 2016 proposing stricter rules on leveraged CFD and Spread betting products. The headline statement is below and the full document for the anoraks is here.

FCA has concerns that more retail customers are opening and trading CFD products that they do not adequately understand. The FCA’s analysis of a representative sample of client accounts for CFD firms found that 82% of clients lost money on these products…

It is fairly shocking at first that almost 84% of punters lose money, but once you reflect further consider whether this is any different than a casino or a bookies? No, in fact the win ratio is slightly better for punters at the likes of IG than the rest of the gambling industry, in fact data compiled by the WSJ suggests that 90% of non financial gamblers lose over a 2 year period. The real beef the FCA has is around the marketing of the spead betters products, is it really clear to people they are gambling as opposed to investing? The other beef is the leveraged nature of the products, which is another difference versus the average bookie, they don’t lend you money to bet and there would be massive public outcry if they did! The measures proposed as follows by the FCA therefore seem to be in the public interest:

  • Introducing standardised risk warnings and mandatory disclosure of profit-loss ratios on client accounts by all providers to better illustrate the risks and historical performance of these products.
  • Setting lower leverage limits for inexperienced retail clients who do not have 12 months or more experience of active trading in CFDs, with a maximum of 25:1.
  • Capping leverage at a maximum level of 50:1 for all retail clients and introducing lower leverage caps across different assets according to their risks. Some levels of leverage currently offered to retail customers exceed 200:1.
  • Preventing providers from using any form of trading or account opening bonuses or benefits to promote CFD products.

How do CFD/Spread Betting companies make their money?

The clue is in the name. The principle revenue stream for companies such as IG is the spread between the buy(long) and sell(short), this is effectively the profit margin on a trade for companies such as IG. Bear in mind lots of punters will be betting in varying directions at different prices. The net exposure therefore may be neutral and the companies will often buy shares in the market to hedge the total net position where not. Offering leverage magnifies these gains because margin calls are required if the price moves against you, miss these calls and the position can be closed resulting in a potential new trade and consequently margin for IG. Leverage of course also allows for the total position to be larger than otherwise, which means more profit from the spread. On top of the margin from the spread, companies like IG also charge interest on the leverage as punters are effectively borrowing money, for IG this is 2.5% + Interbank rate.

So how will these measures affect IG?

The FCA states:

We expect that these measures will reduce the overall number of clients, the total volume and value of trades and total firm revenues. These measures could consequently affect the profitability of firms across the sector…

The FCA believes the total saving for consumers, consequently losses for the industry will be around £150m to £295m (see figure 3). Pretty big figures but when you consider 45% was wiped from IG Group’s valuation, i.e more than £1bn does the sell off begin to look extreme then? Maybe, let’s look into the exposure further:

ben-consumer-fca
Fig 3 – Total benefits to CFD investors of regulatory change. Source: FCA

Per Figure 1 below almost all of IG Groups revenue comes from the products that are under the spotlight:

igg-2016-revenue-split
Fig 1 – Revenue by Product. Source – IG Group Annual Report 2016

The FCA though only has jurisdiction over the products sold to UK customers. Figure 2 indicates this makes up around 50% of the total group revenue.

igg-2016-revenue-split-geo
Fig 2 – Revenue split by Country. Source – IG Group Annual Report 2016


It is pretty clear from the above that a question mark has been placed over a large chunk of IG’s business, but the extent of the sell off is due to uncertainty discount factor. There is a need to estimate how the regulation will really flow to the bottom line.

So what is the likely effect on earnings and dividends?

IG Group has not yet revised market guidance to take account of the new regulations, the above measures are currently under consultation, a process which is not expected to conclude until summer 2017 and realistically become law before 2018. The current share price gives a Price/Earnings ratio of 10 for 2017 and 2018 based on prior guidance, but let’s look at how we might expect the P/E ratio of future years to be if the regulations are implemented.

The FCA further states in its paper:

We calculate investor benefits on the expectation that investor losses will be between 20% and 40% lower after introducing leverage limits.

Taking the mid point 30% here and multiplying it by the 50% revenue from UK  customers gives an expected reduction of revenue by 15% for 2018, which is the first full financial year likely to be affected by the new regulations. Current guidance for revenue in 2018 is £510m, so this would fall to £434m. Applying the operating margin of 42% earnings would fall £32m to £150m, or £117m using an effective tax rate of 25%. This gives a P/E of 17, pricey. However IG has stacks of cash so perhaps better to look at EV/E given the circumstances, this gives little over 12 against a current enterprise value of £1.43bn. This starts to look like a potential value stock.

On the dividend yield front, this is currently 6.95% and with a cash pile of £329m, zero debt and a dividend cover of 1.4x (before revised guidance), this distrubution looks more than sustainable in the near term to me.

Is there a risk to other geographic markets IG operate in?

Potentially and if so we could expect further mark downs on earnings. It would not be surprising that regulators in other countries follow the lead of the FCA. Germany earlier in December introduced measures ‘propos[ing] that the marketing, distribution and sale of CFDs to retail clients in Germany can only be undertaken if the client is not at risk of losing more than the value of their account.’ This is a lighter touch than the FCA and IG have recently created limited risk accounts, i.e. where the maximum punters can lose is the value of their account. Ultimately the regulatory risk remains but I see this as a mid term threat, given how slow regulators are to act.

What else has IG Group got in its locker?

IG group recently launched ISA and Share dealing accounts. I think management probably knew leveraged CFDs were on borrowed time so they made this decision to broaden their offerings last year, it pleases me that they have vision here. I admit these products currently are a tiny proportion of revenue but I see a lot of potential. The leader in this area is Hargreaves Lansdown and I think to compete with HL is obviously a huge ask. However I believe IG can focus on a different segment entirely, they are offering share trading with Direct Market Access and Level 2 prices. This enables their customers to place orders directly at the market, so being a ‘price setter’ rather than a ‘price taker’. Level 2 prices also give visibility over the order book to better time position taking. The requirements for these services are just a trading balance of £1,000 and a small fee of £10 for the LSE, refundable if 1 trade a month is placed. This service attracts serious private traders and some smaller institutions, a completely different sector to HL, whom are more focused on the moderate/limited knowledge investors with a particular focus on Open Ended Fund markets.

It is not inconceivable either that that IG Group could move into this lucrative fund area too. One big advantage IG has is it’s focus on technology. This can lower the costs of trading/holding and carve some market share. Hargreaves Lansdown based on it’s 2016 results I calculated earns on average profit £300 a person on it’s popular ISA Vantage platform and has 0.86m accounts. The operating margin is 67% too, this suggests to me a market ripe for further competition.

stockbroking-ig
Fig 3 – IG Stockbroking progress – Source: IG Investor Presentation

IG has a long way to go granted, counting just 3,000 active clients to May 2016 but has grown this product by 600% on an annualised basis. The company is also rolling out this stock broking service to Australia. To temper the excitement there may well be an uptick in costs in the near term to market and manage this new sector, so some short term transitional pain is likely.

IG also continues to move into new markets for it’s leveraged products including Dubai and Singapore, potentially in doing so diversifying some of its exposure further from the more regulated European markets.

The final positive for IG is the ‘only the strongest survive’ mantra. IG has a solid balance sheet, it could be that these regulations put some of the weaker competition out of business, so could IG pick up more customers from this in the mid term, which could smooth or even offset the negative earning impact?

Summary

BUY – Target 600P. 

Based on the current business model a PE ratio of 17 makes the IG valuation fairly full but when you include the cash position the EV/Earnings ratio is just 12 after adjusting for likely impact of the new regulations. Given the new areas of growth for IG and the potential picking at the carcass of any troubled competition I think the sell off is well over done. On top of this the current dividend yield is around 7% and well covered. I would therefore be fairly comfortable with the EV/E sitting around 15, a 25% uplift giving a target of 600p. Do monitor carefully the regulatory enivroment in all the key markets IG operate in, also the fate of competitors and perhaps most critcally pay close attention to IG’s stock broking take up. Good luck punters!

Disclaimer – I have a long positions in this stock equal to 2% of my NAV bought at 465p. To my knowledge no close family, friends nor associates have any further position. 

This post is purely my opinion and should not be taken as financial advice. I welcome any alternative comments and will consider adjusting posts based on information made available to me.

A Vietnamese Opportunity Beckons

Disclaimer: Shareinvestors is not authorised by the Financial Conduct Authority to give investment advice. Terms such as ‘Buy’, ‘Sell’ and ‘Hold’ are not recommendations to buy, sell or hold securities, these statements and other statements made by the author have the meaning only to express the author’s personal views on the quality of a security. Independent financial advice from an authorised investment professional should always be sought before making investments. CAPITAL AT RISK. Full Disclaimer here.


Today I make another departure from my usual small cap territory and take a look at another investment trust. The Vietnam Opportunity Fund (VOF) is a London listed Investment Trust focusing on Vietnam. The trust is currently valued at £530m with shares changing hands at 256p. As with all investment trusts you need to get comfortable with both the macro and the micro though.

The Macro – Does Vietnam promise returns?

Vietnam has been growing fairly consistently between 5% and 6% each year in the last decade with the most recent data suggesting a growth rate of 5.93% to the 9 months ending September 2016. This places Vietnam as the fastest growing economy in the world after India for 2016. As Latin America and other Asian economies slow Vietnam is the standout emerging market opportunity in my view.

A big catalyst for this growth is the steady liberalisation which has resulted in the country opening up to Foreign Direct Investment. Samsung is a recent beneficiary, recently setting up manufacturing plants focusing on various electronic goods.

 

vietnam-2
Fig 1 – GDP Growth Source: World Bank

The recent softening on foreign ownership rules allow foreign companies to take bigger stakes in local companies too, also encouraging is the fact that ‘Vietnam is also keen to make its stock market more attractive by winning an upgrade from “frontier” to “emerging” market status in the influential MSCI index. While Vietnam’s population is a third bigger than that of neighboring Thailand, the Ho Chi Minh City bourse is less than an eighth of the size of its counterpart in Bangkok.’ This could also make Vietnam stocks more attractive to overseas investors and provide necessary capital for the economy to grow further.

There is still plenty of potential growth to come too if the capital does arrive. If you compare Vietnam to other countries in the region (fig 2) despite all of the progress so far Vietnam still has one of the lowest GDP per Capitas in the region.

gdp-ppp
Fig 2 – GDP Per Capita – Source: ShareInvestors

 

What about the macro risks?

Vietnam has been politically stable in recent years. There is an ongoing geopolitical concern around territorial claims in the South China Sea. This has been brewing for a while but no major escalations have occurred of late. There are also economic risks to consider, the government has a relatively high debt and foreign currency reserves covering just 2-3 months of imports. As with overseas assets there is always a currency exposure to contemplate, the VND has been steadily strengthening against sterling since 2014, posting 15% gains to date. Any strength in sterling would reverse this trend and impact future gains, but overall I would expect the potential gains from the underlying assets/environment to be capable of delivering well in excess of this.

What about the fund – is this the right vehicle to get exposure to Vietnam?

The fund invests in a broad range of sectors focusing on domestic growth opportunities. Roughly 50% of the portfolio are in listed stocks with the remainder in a variety of assets.

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Fig 3 – VOF Portfolio – Source: VOF October 2016 Report

 

Performance on the portfolio has been excellent in recent years. When it comes to ‘frontier’ markets this trust is a good example of where it can pay to choose an active manager as opposed to an Index tracker such as an ETF. The Vietnam Opportunity Fund manager VinaCapital has done very well against the the benchmark beating the MSCI Vietnam Index by 131% over the past 5 years. Despite this performance the trust still trades to a huge 22% discount to NAV. This can be partly explained by holding 50% of the portfolio in less liquid assets where there is not always an active market to get an up to date valuation.

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Fig 4 – VOF Fund 5 year performance to Oct 2016 – Source: VOF

 

The fund does though plans to tackle the large discount through a share buy back programme, it has also Sold it’s real estate holding in the Sofitel Hotel. This was at sizeable premium to NAV and was quasi related transaction to ‘to a newly-formed hospitality joint venture between it and US private equity firm Warburg Pincus’. This is inline with the funds strategy to exit real estate investments and focus on equities.

Summary

BUY

The manager has a solid track record in this fund and the Vietnamese economy has a promising outlook. Vietnam has all the signs of being the next big thing and this trust is an excellent way of getting exposure.

Disclaimer – I have no positions in this stock and to my knowledge nor do any close family, friends nor associates. I do plan to open a long position in the near future equal to around 2% of my net assets.

This post is purely my opinion and should not be taken as financial advice. I welcome any alternative comments and will consider adjusting posts based on information made available to me.

Genel slumps further – it’s a sell from me

Disclaimer: Shareinvestors is not authorised by the Financial Conduct Authority to give investment advice. Terms such as ‘Buy’, ‘Sell’ and ‘Hold’ are not recommendations to buy, sell or hold securities, these statements and other statements made by the author have the meaning only to express the author’s personal views on the quality of a security. Independent financial advice from an authorised investment professional should always be sought before making investments. CAPITAL AT RISK. Full Disclaimer here.


Back in September I wrote a piece on Genel Energy (GENL) here, at the time I issued a Hold recommendation with the price at 90p. Since then the shares have slumped further with traders now swapping these shares at just 71p. At the time of my original article I advised potential investors to consider buying around 80p ceteris paribus, I thought it was worth revisiting Genel given we are now significantly below that level.

What has happened since?

The oil price has risen thanks to OPEC’s deal to cut production. You can see though from figure 1 below that the Genel share price has failed to track oil by a margin of 40%! So what else has gone on?

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Figure 1 – Genel Share Price vs. Brent Crude

The sharp decline in Genel’s share price was on the back of the most recent trading update in October 2016, i.e. for the 9 months to September 2016. It revealed that production from crown jewel Taq Taq is declining rapidly. In Figure 2 below I have tried to piece together all of the available information to get a view of production and after adjusting for pipeline downtime. The results are not good, Taq Taq has declined from approximately 80,000 Boe gross per day at the start of the year to 50,000 boe in October. If you follow the trend line this would be below 40,000 Boe a day , i.e a 50% yearly decline by the time Genel close the books in 2016. This is an increasingly worrying trend and even attempts at slowing the decline don’t seem to be assisting a great deal. Genel have drilled two side‐track wells, TT‐27x and TT‐07z in 2016 with the company admitting that these have only succeeded in ‘partially offsetting the decline from existing wells’. This is pretty disastrous for Genel given that Taq Taq contributes around 70% of the groups revenue.

genel-prod-normalised
Figure 2 – Genel Production adjusted for Pipeline Downtime

 

Is there anything that can be done to improve productivity at Taq Taq?

As at year end and based on the last Competent Persons Report (CPR) I estimate around 120 million barrels gross left at Taq Taq, but based on the decline rates one does start questioning whether this is very optimistic indeed. As a result Genel are currently working on a revised Field Development Plan and CPR which should identify how to maximise production from Taq Taq. Maximising production doesn’t come without a price tag though, this will almost certainly require a significant CAPEX investment.

What valuation can we place on Taq Taq in light of the declining production?

Taq Taq had an NPV of $406m as at Dec 2015 based on the Taq Taq CPR (see page 29). Let’s start by revisiting the key inputs in Fig 3 below:

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Fig 3 – CPR 2P Case – Assumptions

The oil price assumptions look pretty robust, the 2016 average rate is current $42.5 vs $42.28 above. We may see average oil price reach around $46 in 2016 and perhaps $55 in 2017 so perhaps some upside in the valuation here. The production figures are way down though on expectations, 80,000 boe per day was assumed in the CPR for 2016 whereas Genel now expects 60-65k Boe, a production decline which was not expected until 2018 in the CPR. Given the vast amounts of uncertainty over the revised CPR and FDP I’ve decided to revert to the 1P NPV valution of $152m, adjusted for $70m of NPV relating to 2016 production. This gives a valuation of $82m for 1P. Given the large uncertainty over the 2P reserves I have now risked this by 70% in the valuation below, Fig 4. This could be excessively bearish and of course the ‘Risk’ factor is heavily subjective here.

What about the arrears? Is Genel any closer to setling the debt with the KRG?

Another depression on the share price is the continued payment irregularity and the continued lack of real progress made on recovering arrears from the KRG. From the start of this year a repayment mechanism commenced whereby an amount equal to 5% of the oil sales each month would be paid to reduce prior arrears. Based on $210 net revenue expected for 2016 this is only around $10m though. Genel are owed a total of $812m from the KRG of which $412m is on the balance sheet, so at this rate 40 years to repay or 80 years if you include the already impaired receivable!

To make matters worse there doesn’t seem to be much in the way of hope for repayment in the near term, the KRG oil minister was recently quoted as saying “stop complaining… or take your money elsewhere. You get paid 60 days late… so do our peshmerga.”

With no real progress on the horizon I’m now risking the $412m payable by 50% in my valuation in Fig 4, it will be interesting to see if the auditors force Genel to take a similar write down in the 2016 annual accounts.

Is there anything else to be concerned about?

Genel has net debt at present of around $240m and total debt of $640m. This is unsecured debt repayable in May 2019. Not an immediate concern here and there should be no issues with servicing this debt in the near term. There could be a longer term issue though of getting this refinanced, certainly at the same rate. The bonds are currently trading at 80$ vs a par of $100.

The final risk is any strengthening of sterling vs the dollar, being relevant as Genel’s shares are quoted in sterling. We are at 20 year lows GBP:USD and  an improvement in the outlook for GBP is possible which will reduce the valuation further in Fig 4.

Is there anything for the bulls?

My fundamental concern here remains the same as earlier in the year, the financing of Kurdish exploration/appraisal and Gas assets which is where the future value is. Genel does not have the balance sheet to execute these projects and resolve the issues at Taq Taq. The big issue with the gas and exploration projects is though they require tons of up front CAPEX, the gas projects require $2.5bn alone. This would require a combination of equity, debt and JV partner entry to get this financing away. In a situation where the KRG are not paying Genel I can’t see this being possible nor worth proceeding with in this uncertain environment. I have been generous and assigned various risked valuations to the ‘sundry assets’ in figure 4 below, but there is a chance that they could sit on the shelf for a long time. That said it is the season of miracles, if the KRG do settle the arrears then all of a sudden it’s game on.

I may also be overly pessimistic on the Taq Taq issues above and consequently my risking on the reserves. The field is in steep decline but with an appropriate field development plan it could be that 2P reserves are still in play and the 3P and contingent resources are also given a future. Genel do have a cash pile of $400m and this would go a long way to developing it’s share of Taq Taq. A coherent FDP and CAPEX plan may together with regular payments from the KRG may also trigger a major re-rate.

Final obvious point, price of oil increasing would also help and improve valuations. However, there are far better/safer plays on oil price that this stock in my opinion.

Latest Valuation

My valuation is 68p which in my view means the shares are trading around the right level . However, most of the valuation relates to risked assets, stripping these out gives a valuation for the ‘core business’ closer to 20p, so a lot of value is still placed on future hope despite the heavy riskings already used.

I also believe sentiment will come into play here, the Taq Taq CPR is almost certainly likely to see a downgrade in reserves and consequently we could see further impairment on Taq Taq in the 2016 reports. This combines with the already confirmed impairment of $100m+ on Chia Surkh which Genel stated in October would be written down to nominal value. This lot is going to be hard to stomach and I expect significant selling pressure which will take us towards 60p or lower if all of my above assumptions are correct.

genel-val
Fig 4 – ShareInvestors Valuation

SUMMARY

SELL – Target 60p

There are bags of potential in this stock and Genel have lots of promising assets to develop. The major catalyst here is for the KRG to create an environment suitable for investment, settling the areas of IOCs in full. This would trigger a major re-rate. In the near term though I see significant selling pressure, particularly if Taq Taq takes another reserve downgrade. It is advisable to keep this company on your watchlist and be prepared to BUY once certainty over Taq Taq improves and certainly if payment issues with KRG are resolved.

Disclaimer – I have a LONG position in this stock equal to 2% of my net assets at time of publish but plan to exit this position. This post is purely my opinion and should not be taken as financial advice. I welcome any alternative comments and will consider adjusting posts based on information made available to me.

CloudTag – Why delaying the L1 conversion RNS could be a major issue

Disclaimer: Shareinvestors is not authorised by the Financial Conduct Authority to give investment advice. Terms such as ‘Buy’, ‘Sell’ and ‘Hold’ are not recommendations to buy, sell or hold securities, these statements and other statements made by the author have the meaning only to express the author’s personal views on the quality of a security. Independent financial advice from an authorised investment professional should always be sought before making investments. CAPITAL AT RISK. Full Disclaimer here.


Yesterday I wrote here about the suspension of Cloudtag shares and commented on what I considered to be breach of Cloudtag through delaying the release of the Conversion Notice from L1 by 48 hours. There has been subsequent debate on social media whether Cloudtag is in breach or not.

In my view there is a clear moral breach, but let’s look into the regulations which cover CloudTag. The first question is whether the RNS was inside information, i.e. information which is price sensitive to the trading of CloudTag securities. The issue of 19m new shares represents around 5% of the current shares in issue so this is clearly material and price sensitive. There are also 19m warrants issued, these are currently in the money and represent a further 5% of the share capital. Let’s just follow this through to the end though for complete avoidance of doubt. Only information which is price sensitive should be RNSed and the company goes a step further in the RNS (as is required by law) to put the issue of ‘inside information’ beyond avoidance of doubt:

This announcement contains inside information for the purposes of Article 7 of EU Regulation 596/2014.

What is article 7 then? This relates to the Market Abuse Regulation (MAR) relating to EU regulated markets. As Cloudtag has shares traded on AIM it must comply with these rules. The MAR sits on top of the FCA DTR rules and the FCA handbook has been amended to include these rules. Let’s start with the golden rule on inside information as follows:

[There should be] prompt and fair disclosure of relevant information to the market [DTR 2.1.3]

There are though valid reasons when inside information can be delayed, the FCA handbook refers us back to EU regulation , which states:

[there are] cases where immediate disclosure of the inside information is likely to prejudice the issuers’ legitimate interests [Article 17(4) of MAR]

The ‘issuer’ in this context is Cloudtag and ‘legitimate interest’ is taken to mean something that is commercially sensitive or requires regulatory approval. There is no commercially sensitivity here as far as I am concerned, the conversion is based on an agreed contact which is in the public realm. The EU (useful for something then) have made a list of examples. I won’t copy them all down here but you can read them yourself, I can’t see how Cloudtag can meet any of them and thus has no excuse for delaying this RNS. Indeed is this why the shares were suspended by AIM?

Examples of when the FCA may require the suspension of trading of a financial instrument include:

  1. if an issuer fails to make an announcement as required by the Market Abuse Regulation within the applicable time-limits which the FCA considers could affect the interests of investors or affect the smooth operation of the market [DTR 1.4]

I also note an interesting article on ShareProphets which questions whether Cloudtag actually has authority before the EGM on Monday to issue the full 19m shares. This could be the reason for the delay, i.e. trying to sort out the mess. However, a holding statement should have been put out immediately after hours on 7th December or at 7am on 8th December with perhaps suspending the shares until the situation was clarified. I’ll get to my summary soon but just to kill a red herring which is doing the round on social media:

Red Herring

A lot of people have quoted DTR 5.8.3 on social media to claim that Cloudtag has acted appropriately.

The notification to the issuer shall be effected as soon as possible, but not later than four trading days in the case of a non-UKissuer and two trading days in all other cases, after the date on which the relevant person:

  1. learns of the acquisition or disposal or of the possibility of exercising voting rights, or on which, having regard to the circumstances, should have learned of it, regardless of the date on which the acquisition, disposal or possibility of exercising voting rights takes effect; or
  2. is informed about the event mentioned in DTR 5.1.2 R (2).

I am fairly sure this is a red herring and governs the ‘person’, i.e. L1 Global Fund in this case notifying ‘issuer’ of securities CloudTag. Once this notification was made to CloudTag it became inside information, which should have been released without delay in accordance with the above rules.

What about AIM rules? How do they interact with MAR/FCA DTR?

Cloudtag is listed on AIM and thus must also comply with these rules. Compliance with MAR does not mean that an AIM company will have satisfied its obligations under the AIM Rules, just as compliance with the AIM Rules does not mean that an AIM company will have satisfied its obligations under MAR. However, AIM is pretty clear though:

An AIM company must issue notification without delay of any new developments which are not public knowledge which, if made public, would be likely to lead to a significant movement in the price of its AIM securities [AIM rule 11]

Summary

Cloudtag allowed its securities  to open on December 8th at 15.25p, 2.5x greater than the L1 exercise price. Shareholders were unaware at this point that dilution by upto 10% was already in motion. This is a false market and potential evidence for market abuse. In my reading of the MAR and AIM rules I can see limited grounds for delaying the Conversion RNS. The market should have been notified and if Cloudtag were not in a position to do so the shares should have been suspended pending clarification on December 8th 7am.

I believe it could well be that the NOMAD is spending the weekend with Cloudtag getting to the bottom of this. I hope all works out for those locked in, even if my assessment is wrong those invested should ask themselves whether they are comfortable with the way this RNS has been dealt with?

Disclaimer – I have no positions in this stock and to my knowledge nor do any close family, friends nor associates. This post is purely my opinion and should not be taken as financial advice. I welcome any alternative comments and will consider adjusting posts based on information made available to me.