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Henderson Smaller Companies is targeting Brexit-proof companies

Neil Hermon explains to Kate Beioley why his portfolio is like an expensive beer and what mistakes he made after the Brexit vote
October 6, 2016

Henderson Smaller Companies Investment Trust (HSL) took a beating following the vote for Brexit and its manager Neil Hermon has regrets over the holdings he sold. But Mr Hermon says he has found the UK stocks that will deliver regardless of the outcome of the UK's decision to leave the European Union, and that they are worth paying for.

662.5p

Henderson Smaller Companies has been a stellar performer over the long term: over 10 years it has returned 203.9 per cent compared with 81.4 per cent for its benchmark, Numis Smaller Companies ex investment companies (ICs) Index. But after the referendum on 23 June 10 per cent was shaved off its share price in a week - double what its benchmark lost during that time. And over the year to date the trust is down 3 per cent while its benchmark is up 8 per cent.

Mr Hermon admits he "didn't expect the result and the portfolio was not positioned for [a vote for] Brexit". Before the vote, the trust had gearing (debt) of 9 per cent, which Mr Hermon immediately reduced to 5 per cent to protect against losses.

"We probably should have left the gearing where it was, but 24 June was a traumatic day," he says.

He also regrets selling stocks such as airline concession company SSP (SSPG), which rallied strongly in the aftermath.

Indriatti van Hien, deputy manager of Henderson Smaller Companies, says: "IAG (IAG) issued a profit warning on the day of the referendum and we felt that [SSP] was a richly valued stock that we'd already made a lot of money from."

And Mr Hermon adds: "We were not only worried about the impact of Brexit. There was a lot of terrorism going on too in France and Belgium, and we felt that might affect airlines. But that hasn't come to pass, and SSP is a good business and its management team is exceptional. It is up 10 per cent since the sale so that's not disastrous, but with hindsight we shouldn't have sold it."

The trust also halved its position in Howden Joinery (HWDN). "We were concerned about consumer confidence after [the vote for] Brexit but it's held up well," explains Mr Hermon. "Our selldown wasn't as well-timed as we would have liked it to have been."

Good sell decisions include estate agent LSL Property Services (LSL). Its share price, at £2.13, remains some way below its £3 pre-Brexit vote level.

Mr Hermon has added to Jupiter Fund Management (JUP) and Brewin Dolphin (BRW) on weakness, which have both rallied by more than 20 per cent since he bought them. He has also added to several housebuilders, including Crest Nicholson (CRST) and Bellway (BWY), following falls of around 40 per cent in share prices.

Despite its name, Henderson Smaller Companies is heavily weighted towards mid-cap stocks. "We find better-quality businesses among mid-caps than small-caps because the relative earnings growth of the former has been superior to small-caps over the past 15 years," says Mr Hermon.

But he has also been adding to Aim stocks as FTSE Small Cap shares have shrunk from about 7 per cent to just 1 per cent of the FTSE All-Share over recent years.

Aim stock holdings include Accesso Technology (ACSO), an online ticketing platform that also owns the intellectual property for Q-bot, a ride reservation system used by theme parks. Smaller attractions are able to use Accesso's technology in order to sell tickets online and the company recently signed a three-year contract with theme park operator Merlin Entertainments (MERL), which Ms Van Hien says justifies the hefty valuation of the stock.

"When we bought the stock it was trading on a price multiple of 18 times 2018 earnings," she says. "We were happy to look that far out because of the Merlin contract."

However, Accesso Technology is looking fairly expensive today. "At the moment, the valuation is close to 32 times earnings and we certainly wouldn't buy any more, but the valuation can be justified," she explains.

Other costly examples include NMC Health (NMC), a healthcare operator in the United Arab Emirates (UAE) and the trust's largest holding. "At 20 times 2017 PE it's not cheap," says Mr Hermon. "But it's a growth business driven by good economic fundamentals in the areas it operates in and there is an underprovision of healthcare by the UAE government."

The company has also been expanding by acquiring new hospitals and demonstrated astronomical growth in recent years: its share price is up 63.9 per cent over just one year alone, and over five years has soared from £2 per share to over £12.

Mr Hermon says the portfolio is, to borrow from Stella Artois' branding, "reassuringly expensive" due to its focus on long-term growth. "We do have a more expensive portfolio (than the market) but it has grown a lot faster and the premium you pay is more than justified for that superior growth," he says.

In 2015 the trust's portfolio earnings grew by 14 per cent against an earnings decline of 8 per cent for its benchmark and 15 per cent for the FTSE All-Share. Between the start of this year and August Henderson Smaller Companies' earnings increased 12 per cent against a 2 per cent increase for its benchmark.

Mr Hermon says it is too early to tell what the impact of Brexit will be so is focusing on companies that sell overseas, and should remain competitive due to niche positions and high barriers to entry. He says exporters such as Victrex (VCT) will continue to do well. "For the time being lower sterling is acting as an effective shock absorber, but we can't know exactly what will happen," he says.

The trust's allocation to stocks whose end market is the UK has reduced from 52 per cent to 48 per cent.

Henderson Smaller Companies' discount to net asset value (NAV) of more than 13 per cent remains wider than its 12-month average of around 12 per cent, which Mr Hermon says "has been frustrating for us". The trust will consider buying back shares if the discount level becomes "out of kilter with our peer group".

But he adds: "The best way of reducing a long-term discount is by performing strongly."

 

HENDERSON SMALLER COMPANIES INVESTMENT TRUST (HSL)
Price:662.5pGearing:5%
AIC sector: UK Smaller CompaniesNAV:758.35p
Fund type:Investment trust Discount to NAV:13.5%
Market cap:£490.05mOngoing charge:0.44%
No of holdings:108Yield:2.30%
Set-up date:16 December 1887More details:henderson.com/ukpi/fund/170/the-henderson-smaller-companies-investment-trust-plc
Manager start date:1/11/02

Source: Morningstar, as at 3.10.16

 

Top 10 holdings %
NMC Health 3.2
Bellway3.2
e2v technologies2.9
Melrose 2.0
Paragon Group of Companies2.0
Playtech 1.9
Intermediate Capital1.9
WS Atkins1.9
Renishaw 1.9
Victrex1.9

Source: Henderson, as at 31 August 2016

 

Sector breakdown%
Industrials 36.1
Financials16.6
Consumer services14.5
Technology9.5
Healthcare8.7
Consumer goods6.5
Basic materials 4.4
Oil and gas 2.8
Telecomms0.8

 

Performance (% cumulative share price return)

1m3m6m1yr3yr5yr10yr
Henderson Henderson Smaller Companies Investment Trust5.619.013.06.539.5186.7206.4
Sector : IT UK Smaller Companies 4.014.811.79.833.9117.3158.9
Index : Numis Smaller Companies Ex Investment Companies 0.611.17.87.725.4109.1136.5

Source: FE Analytics, as at 4.10.16