Private Investor’s Diary: Two new high-quality bargain stocks

A semblance of calm returned to markets after the anxiety caused by the sudden demise of Silicon Valley Bank (SVB) in March. Equity market volatility dropped despite concerns about the potential impact of SVB’s demise on other regional banks. First Republic was the main casualty of depositors withdrawing their cash; eventually JPMorgan came to the rescue. US March inflation numbers were encouraging, as were April’s, released earlier this month. The Federal Reserve will want to see more conclusive evidence that the underlying numbers are moving in the right direction, but the 0.25 per cent rate hike at its May meeting may be the last. The US 10-Year Treasury ended the month unchanged at 3.5 per cent, suggesting the market believes we are close to the end of this period of interest rate increases.

In the UK, inflation dropped to 10.1 per cent in March. It was another disappointing number, coming in above expectations. Inflation for the year to April is guaranteed to record a significant fall due to the base effect of the jump in energy prices a year ago. We will see what happens this week. The Bank of England (BoE) once again increased interest rates earlier this month. The BoE is concerned about core inflation and the impact of rising wages. BoE chief economist Hugh Pill said: “We are all going to have to accept we are going to be worse off.”

I’m not expecting readers to get out their violins, but I saw this first-hand. I receive a monthly final-salary pension. The annual amount went up in April by 5.0 per cent. The letter notifying me of the increase said that over the year to 31 December 2022, inflation had increased by 10.5 per cent, but under the scheme’s rules, my annual pension increased by inflation up to a maximum of 5.0 per cent. A shortfall of 5.3 per cent in one year is manageable, but one wouldn’t want too many of those at what is hopefully early in a long and fulfilling retirement. Inflation is insidious. Luckily, I’m not wholly dependent on that pension. However, I will need to do my best to ensure my self-invested personal pension (Sipp), individual savings account (Isa), and other investments beat inflation over time.

On the corporate front, first-quarter earnings in the US were generally better than anticipated. In the UK, the main story was the increase in corporate activity. Private equity and trade buyers see value in the UK and are taking advantage. There were bids for FTSE 250 members Dechra Pharmaceuticals (DPH) and Network International (NETW). Medica Group (MGP) and Numis (NUM) were the latest to succumb to offers. The FTSE All-Share was up 3.4 per cent, faring better than other major markets. The Nikkei 225 gained 2.9 per cent, the CAC 2.3 per cent and the Dax 1.9 per cent. The S&P 500 was up 1.5 per cent, and the Nasdaq was flat, but due to robust performance by its largest stocks, it is up 17 per cent this year. Meta Platforms (US:META) has doubled, Tesla (US:TSLA) is up 33.3 per cent, and Apple (US:AAPL) is up 31 per cent – I didn’t see that coming.

Despite spiking up on Opec+ production cuts in early April, the oil price was flat over the month. Brent crude ended April at $79.86 (£64.18) per barrel, down 25 per cent on a year ago. Sterling was strong, gaining 2.0 per cent against the US and at 1.25, stood at its highest since June last year. After the sharp move up in March and early April, gold was flat over the month. 

Portfolio performance

I’m still struggling to make headway. The JIC Portfolio was down 0.3 per cent in April, which means that year-to-date it is down 6.1 per cent. The FTSE All-Share is up 6.5 per cent. Since its inception in January 2012, the JIC Portfolio has gained 303.9 per cent, equivalent to an annualised growth of 13.1 per cent. By contrast, the FTSE All-Share (Total Return) Index achieved a 125.2 per cent increase, with an annualised gain of 7.4 per cent. Over one year, the JIC Portfolio is down 7.3 per cent versus 6.0 per cent for the index, and over five years it is up 54.8 per cent versus 24.1 per cent.

The JIC Funds Portfolio is doing better. It was up 1.3 per cent, leaving it up 1.8 per cent this year. Over the respective periods, the FTSE All-World (GBP, TR.) Index was down 0.1 per cent and 4.2 per cent. Since this portfolio’s inception in June 2020, it is up 30.4 per cent versus 30.1 per cent for the All-World.

Of my 22 positions in the JIC portfolio, 11 were up and 11 down in April, hence my flat return. The best was Polar Capital Holdings (POLR), up 8.1 per cent, and the worst was IG Index (IGG), down 12.3 per cent. Polar Capital’s assets under management on 31 March were encouraging, with a decent increase in assets under management during the first quarter and a slowdown in net withdrawals. I acquired Polar Capital last July as I liked the company’s valuation, and I was confident that it would maintain the dividend at 46p during this market downturn. It kept the interim at 14p. We will have to wait until results for the year ended 31 March on 26 June, but given today’s improved AUM numbers, I remain confident that a final payment of 32p, making 46p for the year, will be paid. That gives a yield of 9.4 per cent. Other notable gainers were Renew Holdings (RNWH), 7.5 per cent, and Serica Energy (SQZ), 7.3 per cent. A steady trading update helped renew in early April. Interim results are due on 16 May. Serica Energy responded to results for the year ending 31 December 2022 and announced a final dividend of 14p. That alone yields 6.0 per cent – it goes ex on 29 June. In addition, Serica published a material uplift in its reserves.

IG Design (IGR) updates on its year ending 31 March. The positives were a more robust margin recovery than expected, improved cash flow and lower debt. Perhaps the share price had got ahead of itself after a strong run, but the market reacted poorly to the news that the full-year results would see it writing down the value of certain UK businesses. While emphasising that the recovery was on track, management was also cautious about the outlook for the consumer. The write-down of the UK business has no impact on the business’s cash flow, and the profit recovery is evident. Current forecasts suggest the shares are valued at 21 times the year we have just entered, ending March 2024, but that drops to 7.0 times March 2025. I am sticking with it and was pleased to see that having initially dropped 26 per cent to 133p on the morning of the results, it recovered to end the month at 172p.  

Harbour Energy (HRB) was down 9.9 per cent, but nearly 4.0 per cent of that was down to it going ex-dividend at 9.66p on 13 April. CentralNic (CNIC) was down 8.4 per cent. A first-quarter trading update showing growth had slowed down from the heady heights of last year did not help. Gulf Keystone (GKP) was down 6.9 per cent. The delay and little news on the resumption of oil exports from the Kurdistan autonomous area of Iraq weighed on the share price. Management also cast doubt on the payment of the dividend due in July. If oil does not start to flow again, it will need to conserve cash.

The JIC Funds Portfolio

The standout performer was recent addition Polar Capital Healthcare Trust (PCGH), which was up 5.0 per cent. Most of the other positions were in positive territory, with the L&G Gold Miners ETF (AUCO) up another 3.6 per cent. Fundsmith (GB00B41YBW71) gained 3.3 per cent to 646p and is only 5.2 per cent off its all-time high of 680p in December 2021. Well done, Terry. BH Macro (BHMG) and VT Argonaut Absolute Return Fund (GB00BN722925) were flat, while BlackRock World Mining (BRWM) and Blackrock Energy & Resources (BERI) were off a couple of per cent.

New activity

I added two new positions to the JIC Portfolio in April. The first was Brooks Macdonald (BRK), on 17 April at 1,791p. The valuation compared with the market and its peers did not reflect its growth prospects. The market valued it at less than 10.0 times free cash flow, 12.4 times earnings forecasts for the year ending June 2023 and carried a dividend yield of 4.2 per cent. Net cash of £37.6mn on 31 December was also a positive. It passed my screen of free cash flow growth higher than 5.0 per cent compound over five years, valued at less than 10.0 times enterprise value to free cash flow, has net cash on the balance sheet and is seeing earnings upgrades. The final piece of the jigsaw was that its latest update on 13 April showed an improvement in its funds under management after a period when it struggled compared with its peers. Net inflows were up 2.3 per cent during the quarter, the best since 2018. I rate it medium risk/high reward, pointing to a target weight of 5.0 per cent. Unfortunately, due to a lack of cash, I’m only at 2.2 per cent, so something will have to give elsewhere for me to add to the position.

The other new position is Howden Joinery (HWDN), added on 26 April at 667p. A high-quality company with good growth prospects is valued most attractively. By high quality, I mean it generates a high return on capital and equity, has high operating margins and generates plenty of cash. So much cash that it can reinvest in the business (where it creates high returns) while leaving money for buybacks and dividends. Growth comes from opening further depots in the UK and international expansion. In the UK, it sees a capacity for 1,000 depots, up from its current 808. It is expanding in the Republic of Ireland and France, with enormous potential. It’s a quality growth stock available at deep value. In the past, Howden has commanded a multiple of earnings of more than 20.0 times but is currently valued at 13.9 in 2023, forecast to fall to 12.8 in 2024. In February, it announced a £50mn share buyback, and although not its busiest time of the year, the update on 27 April covering the first 16 weeks of 2023 was encouraging. I rate Howden Joinery medium risk/high reward with a 5.0 per cent target. I had to scramble to find the cash to get to 2.5 per cent.

I reduced Niox (NIOX) to my target weight of 2.5 per cent on the 26th at 45.25p. It has performed well this year, up some 30 per cent. I stand by my central investment thesis behind my position in Niox, but on balance Howden may be a better medium to long-term investment. I semi-grasped the nettle with Gulf Keystone. I admitted that I had made an error when rating it medium risk. Whatever the strength of the balance sheet and cash flow, its reliance on its contract with the Kurdistan Regional Government makes it high risk. High risk/high reward points to a 2.5 per cent target weight, which I duly moved to on 26 April at 150.0p.

There was one other trade on 3 April to help pay for my purchase of Brooks Macdonald. I reduced Sylvania Platinum (SLP) to my target weight of 5 per cent. Performance over the past few years led to the position growing to 6.7 per cent. Given the weakness in the rhodium price, it made sense to lock in some profits. My risk/reward assessment points rightly or wrongly to a 5 per cent position. 

There were no trades in the Funds’ Portfolio.

Other news

Glencore (GLEN) launched a bid for Canadian miner Teck Resources (US:TECK). It hopes to combine the two operations and spin off the coal assets into a separate entity. It would become the world's third-largest copper miner. So far, the Canadian company under the control of the Keevil family have been reluctant to talk. That Teck pulled its plan to demerge its coal assets suggests that it may be forced to the negotiating table. This story has further to run. As a Glencore shareholder, it would be great news if it combined with Teck at the right price. If Glencore fails to bag its prey, I can console myself with a nearly 8 per cent dividend yield. It went ex a 17.6p dividend (3.8 per cent) this week.

Kistos (KIST) acquired Norwegian oil & gas company Mime Petroleum. It’s taken time for chief executive Andrew Austin to nail his next deal, but the Energy Profits Levy meant that investment in the UK North Sea was no longer an option. Austin sees Mime as a platform for growth on the Norwegian Continental Shelf.

Sylvania Platinum published results for its third quarter ending 31 March. After robust production, it increased its guidance for the year ending 30 June. Weaker platinum group metal prices hit turnover, but such is the strength of cash flow that cash on the balance sheet still increased to $144m. Next Energy Solar Fund (NESF) said it was looking to divest around 25 per cent of its solar generating capacity. It hopes this will demonstrate the value of its assets. It intends to use the proceeds to pay down debt, fund further growth, pay dividends and buy back shares if the discount to NAV widens too much. It looks like a sensible plan. Earlier this month it said it planned to increase the dividend by 11 per cent in 2024. 8.35p (paid in four quarterly instalments of 2.0875p) gives a dividend yield of 8.1 per cent.

Dividend income

Last year, dividend income in the JIC Portfolio totalled £31,104. So far this year, £9,929 has been received, and a total of £18,083 has been declared (excluding Gulf Keystone’s July dividend). I expect dividend income for the entire year to exceed last year’s. That will mean that over the 12 years of the JIC Portfolio, the total dividends received of £163,000 will exceed the starting capital of £151,000. More detail at www.jicuk.com.

Outlook

Last month I concluded, “I continue to be fully invested with an emphasis on value”. A slight modification this month. I remain fully invested but with an emphasis on ‘valuation’. The bear market in mid and smaller companies has led to a compression in valuations. The range between the highest and lowest-valued companies has narrowed. One can pick up high-quality companies such as Howden Joinery or Brooks Macdonald at the most attractive ratings. Private equity managers and trade buyers are not ignoring that feature. Unless UK investors start valuing UK companies at less of a discount to overseas markets, the number of takeovers will proliferate. I think we are at the start of a takeover boom leading to many of the UK’s finest companies no longer being publicly listed. That would be sad.