Trading Updates 11/07/2019
Trading Update - July 2019
Changes to the UK Equity Portfolio
Whilst it is highly likely that policy makers will respond over the Summer to slowing growth and support asset prices, numerous economically sensitive companies have reported relatively disappointing trading performances year to date and are relying on a strong second half to deliver results in line with previous management guidance. This will be difficult to achieve (although the dialling down of the trade war tensions and policy maker support are helpful in this regard). Despite the cuts to earnings forecasts that analysts have made to date, forecast earnings growth for 2020 over 2019 continues to look over ambitious and this may become a material issue towards the end of 2019. As a result, we’ve started to take advantage of high asset prices to reduce the economic and market sensitivity of the UK equity portfolio, having participated in the strong equity market returns during the first half of the year:
PURCHASED: Smith & Nephew
Smith & Nephew are an advanced medical technology group that support healthcare professionals in more than 100 countries. They operate in the $400bn global medical devices market operating across three broad franchises; Orthopaedics, Sports Medicine & ENT and Advanced Wound Management. They sell into end markets with an attractive underlying growth rate of around 4% per annum, however, in recent years Smith & Nephew have been unable to achieve market rates of growth. They appointed a new CEO in May 2018, Namal Nawana, who has instigated significant change and improvement in the business. Around two thirds of the leadership team has been replaced or removed, operationally the business has been restructured from a regional to a franchise model improving focus, and the expanded business development team has begun making strategic bolt-on acquisitions. There is reason to believe that these changes will result in growth rates at or above the 4% market rate which should result in a re-rating of the stock. Long-term the group’s activities are supported by the ageing demographic trends in the developed world and the increasing healthcare penetration in the emerging world. The business is defensive, cash generative and attractively valued.
INCREASED: Auto Trader
Auto Trader is the dominant UK online auto sales platform, benefitting from ‘network effects’. Its customers – used car sales forecourts – pay Auto Trader to be able to advertise their cars on its website. It is more than four times larger than its nearest competitor and has unrivalled brand awareness amongst consumers. In addition to being able to implement price increases and upsell its customers on to higher level packages with more sophisticated tools, they also have ambitions to grow their business in new car sales and expand their B2B offering. The valuation is attractive at current levels and the business should be resilient going forward in this environment, and so we have increased our allocation to a full weight in the portfolios
SOLD: Direct Line
We have sold our holding in UK insurer Direct Line, over concern that the current weak pricing environment and elevated claims inflation will result in a more difficult trading environment going forward. The stock has rallied over the last several weeks due to relatively benign weather conditions in the first half of the year, we used this opportunity to sell into strength, investing the proceeds into higher conviction stock ideas.
REDUCED: Weir Group
We have reduced our position in Weir Group, the engineering equipment supplier that has operations across two divisions; Minerals and Oil & Gas. The Minerals division accounts for approximately 85% of the groups profits and is a high quality, high returns business, with a robust outlook due to most of what they sell being spare parts and maintenance in the ‘aftermarket’. However, some of the group’s activities are economically sensitive, hence, at this time we felt it prudent to reduce the size of the position.
Whilst we continue to believe, that from a medium to long-term perspective, Melrose will create substantial value from the turnaround of the acquired GKN assets, the industrial end markets that their businesses sell into are economically sensitive and therefore, at this time, we felt it prudent to reduce the size of the position.
Cornelian Investment Team