Tips of the Year Review 2017

Last year’s torrid tip performance came off the back of a disappointing outing in 2016, which was the first time in five years our Tips of the Year had underperformed the market. Unfortunately it got a lot worse in 2017 (see table). Still, on a total return basis over three years our Tips of the Year show outperformance against the FTSE All-Share’s total return (35.4 per cent versus 33.2 per cent) and the same is true over five years (81.2 per cent versus 59.0 per cent). That said, these figures are based on the cumulative performance of the Tips of the Year, which would involve switching from one portfolio of stock ideas to the next each year. That kind of stock turnover does not come for free in the real world. If an annual charge of 1 per cent is factored in, three-year performance falls below that of the index to 31.3 per cent, although the five-year performance remains some way ahead at 72.3 per cent.

A ghastly 2017

Maybe the best place to start with a painful review of these tips is with the recommendation that went most awry – satellite company Inmarsat (ISAT), which was our Contrarian Tip of the Year. As 2017 got under way, the tip certainly had the 'yuck' factor one would associate with a contrarian pick. Unfortunately it got yuckier as the year progressed. When we made the recommendation, the cyclical characteristics of the highly capital-intensive satellite industry were a key factor preying on investors’ minds, along with the potential that technological innovations could put established players on the back foot. Against this we felt a recent refinancing by Inmarsat, its strong aviation business and the possibility of a pick-up in marine orders put the company in a good position to outperform. However, the year began with rumours swirling that the company’s top brass was prepping City players for a profit warning.

As these concerns calmed and the company continued to report strong performance from its aviation division, the shares briefly bounced back. Speculation about the need for industry consolidation also helped sentiment as Inmarsat looks the right size for a larger company hoping to scale up. However, the shares turned south once more in the second half. Arguably, a key fundamental mistake we made in backing Inmarsat was that we did so before the industry had started to see a significant withdrawal of capacity through corporate failures and the like.

Our second-worst performer of 2017 was drugs company Merck (US:MRK), our International Tip of The Year. The problems it ran into were both caused by risks we’d foreseen playing out worse than expected, as well as problems surfacing that were much harder to predict. In the harder-to-predict camp was a cyber attack on the group, which led to sales falling shy of targets during the year. An issue that was highlighted when we presented the tips at the start of 2017, and which did come to bear during the year, was the potential for the dollar to fall from its lofty valuation. While this was a negative factor affecting many of the internationally-focused businesses we tipped, the impact was clearest to see on Merck's dollar denominated shares. Indeed, measured in dollar terms the negative total return from Merck was 3.5 per cent, compared with the sterling-adjusted negative 11.4 per cent, as shown in the accompanying table. One problem Merck faced at the start of 2017 that we hope would alleviate over the 12 months was the implied threat from President Trump’s mooted healthcare reforms. While legislation on healthcare failed to gain traction, sentiment towards big drugs companies has not rebounded in a marked way, especially compared with other parts of the US healthcare sector. Furthermore, while we have been impressed by the progress made by Merck with its hugely exciting cancer immunotherapy drug, Keytruda, there have been other disappointments from its drug pipeline. Overall, though, despite the hiccups in 2017 and the clear risk that the dollar will continue to weaken, we remain keen on Merck's shares.

Another tip that ran into problems that were hard to predict was Imperial Brands (IMB), our Takeover Tip of the Year. True, regulation is always an issue for any investment in a company that produces highly addictive products that can lead to premature death. However, as 2017 got under way the regulatory outlook for once seemed benign (maybe, though, that should have served as a warning). What’s more, the combination of Imperial’s attractive income characteristics and the potential for a takeover got the shares off to a strong start. The curve ball came when news broke halfway through the year that the US Food and Drugs Administration had unveiled a multi-year roadmap for the tobacco industry that included plans to cut the amount of nicotine in cigarettes to non-addictive levels.

What’s more, the takeover case for Imperial lost its lure during the 12 months as investors saw rising impediments to a bid from Japan Tobacco, often slated as a likely acquirer. The company, however, has announced £300m of investment in the coming year into next-generation products, such as a potential heated-tobacco product launch. While this will have an impact on profits, it should improve Imperial’s ability to navigate industry. Furthermore, for income seekers the near-6 per cent yield offered by the shares is continuing to rise at the target rate of 10 per cent a year.

Our Growth Tip of the Year, food-to-go company Greencore (GNC), encountered problems associated with a far more easily foreseeable risk than the regulatory issues faced by Imperial. Indeed, the risk in question was tied in with the potential rewards we saw from investing in the shares. We had recommended Greencore encouraged by what we saw as considerable potential in a transformational US acquisition. What’s more, prospects were supported by the fact that the food-to-go market is one of the fastest growing areas in food distribution.

Unfortunately, with any acquisition there is integration risk. Several signs emerged during the 12 months that suggested things may not be progressing entirely smoothly for Greencore with its US deal. Negative events during 2017 also increased the market’s nervousness about the risks associated with the company’s reliance on a few very large customers. Indeed, despite the fact most big customers are tied in with long-term contracts and close working relationships, it was the purchase of a competitor by Tyson Foods – Greencore’s largest stateside client – that saw sentiment towards the shares really begin to darken. As small bits of bad news continued to surface during the year, we moved our recommendation on Greencore to a hold. We think the business still has a lot of potential, but a negative trickle of news and a number of earnings forecast downgrades by analysts have certainly tempered our enthusiasm.

Value Tip of the Year Cairn Energy (CNE) also had a tough time in 2017. The share price swelled as our Tips of the Year issue went to press based on optimism about the oil price. However, sentiment fell away quickly as the year progressed and the oil price faltered. That said, the mood has improved towards both the oil price and Cairn over the past few months of the year. From a company perspective, Cairn has made solid progress with its assets and cash flow is expected to improve markedly as a number of key fields move into production. Meanwhile, the resolution to a major tax dispute with Indian authorities has been pushed back further. While it looks to us that there is little in Cairn’s share price to suggest the market expects a successful outcome from this long-running squabble, the lengthening time horizon on a settlement is likely to have weighed on the shares during 2017, too. We remain Cairn fans, though, and think much has been done over the past 12 months to boost the potential returns shareholders could enjoy in the years to come. On that basis, at the end of the year we decided to reiterate our buy advice on the shares in the magazine’s weekly tip section. We think the potential we saw for the stock in 2017 has been delayed but not diminished.

Three of the tips delivered pretty much as expected during 2017, although in share price terms the rewards varied. Our Old Reliable Tip of the Year, Ted Baker (TED), has continued to trade well and push into new international markets. However, the brand seems to have found itself just on the wrong side of the luxury/high-street fashion divide for investors’ tastes. While shares in sub-sector rivals such as Burberry and Jimmy Choo (bid for during the year) had a storming run during the 12 months as investors went crazy for luxury goods companies, Ted was left on the shelf. We continue to like the shares. Income Tip of the Year Aviva (AV.) has continued to successfully follow a strategy of pushing further in to asset management and essentially has been playing catch-up with peers that have already undertaken similar strategic shifts. Late last year the group upped its EPS growth, cash remittance and dividend payout targets and the valuation of the shares continues to look attractive. Finally, our best performing Tip of the Year, consultancy group RPS (RPS), has benefited from restructuring in 2016 and improved end-market conditions that encouraged us to make it our Recovery Tip of the Year. The company has benefited from a number of earnings forecast upgrades which have helped the shares re-rate.

With our 2017 Tips of the Year we kiss several frogs that croaked; we hope we’ve learned a few lessons and that 2018 will bring a few more princes.