Focusing on the longer term

The US 10 Year Treasury yield exceeded 3.0 per cent for the first time since January 2014. At that time, growth was sluggish and the main fear was deflation. The atmosphere is different now, with resurgent inflation the main concern. The market is forecasting further US interest rate increases. The worry is that this will put the brakes on economic growth and in the worst case tip the US into recession. After sustained dollar weakness since Trump’s election there was some respite, with the dollar gaining around 2.0 per cent versus the euro and sterling.

Much to the frustration of goldbugs, gold failed to break though $1,370 an ounce (oz), which has proved a ceiling for nearly two years; it finished the month down 1.0 per cent at $1,316 an oz. Bitcoin, however, had a good month, gaining 36 per cent to $9,392. While up 508 per cent over the past year, it’s still down 38 per cent this year and 50 per cent from December’s peak.

Performance

An improved performance from the JIC Portfolio, but up by 5.5 per cent it still lagged the FTSE All-Share (Total Return) a little. There is some catching up to do in 2018, with it 5.6 per cent behind the index since 1 January. 

The best performing holding was Faroe Petroleum (FPM), up 24.8 per cent. The North Sea exploration and production company was already gaining ground when the sale of Delek’s 15.3 per cent stake to Norwegian oil company DNO really got it’s shares moving. DNO immediately added to its stake through a reverse book build and market purchases, taking its position to 28.7 per cent. It says it has no intention of bidding for the company, which ties its hands for six months. Faroe responded by announcing some good news, including better-than-expected initial production from the Tambar field in the North Sea, in which it has a 45 per cent interest. I suspect there will be plenty of news from the company as it attempts to keep the share price as high as possible. Following the Tambar update, I am hopeful that one such piece of positive news will be an upgrade to its 2018 production guidance from the current 12,000-15,000 barrels of oil equivalent per day. Two of my other oil stocks benefited from the strong oil price; Serica Energy (SQZ), up 17.2 per cent from my purchase price in early April, and Royal Dutch Shell (RDSB) up 14.3 per cent.

It was pleasing to see a decent bounce from XLMedia (XLM), up 13.8 per cent, and Taptica (TAP), up 10.6 per cent. Last month I said I was sticking with them, feeling that the market was overreacting to concerns that the Facebook scandal would hit their business. I noted that both companies had net cash on their balance sheets and decent cash flow. So far so good!

U&I Group (UAI), the urban regeneration property company, responded well to good results, gaining 12.1 per cent, while India Capital Growth Fund (IGC), up 15.6 per cent, benefited from strength in the Indian market. After some of the first quarter’s disasters, it was pleasing to see none of my holdings fell more than 10.0 per cent.

Statpro Revolution’s attribution analysis, which considers holding size as well as stock price performance, shows that XLMedia had the biggest positive impact, adding 0.9 per cent to overall performance. Faroe Petroleum added 0.8 per cent, Royal Dutch Shell 0.8 per cent, India Capital Growth 0.6 per cent, and Bioventix (BVXP) +0.4 per cent. The worst detractor was Central Asia Metals (CAML), which cost just 0.3 per cent; it did, however, go ex-dividend losing 10.0p or around 3.3 per cent of the share price. 

Activity

I cleaned out a few more of the underperforming smaller positions in the portfolio. I had originally bought them to add some excitement, and as they did not meet my normal criteria were small positions. Best to stick to one’s knitting. The two stocks to go were Satellite Solutions Worldwide (SAT) (sold on 17 April at 8.7p) for a loss of just £81, and 7Digital (7DIG) (17 April at 4.0p) for a slightly bigger loss of £626, or 0.157 per cent of the portfolio. In Satellite’s case, I felt that the valuation was taking too much on trust regarding its growth prospects and risks. With 7Digital, I was more concerned about its ability to deliver sustainable profitable growth in an ever-changing industry for streaming music.

I have replaced those holdings with companies I think have more attractive prospects and valuations. On 17 April I bought Miton Group (MGR) at 44.7p. Miton is an investment management company with a growing stable of funds including multi-asset, equity growth, equity income and investment trusts. As far as ticking boxes is concerned, its valuation was attractive on 11.7 times December 2018 forecasts of 17.3 per cent earnings growth and a prospective dividend yield of 3.8 per cent, the balance sheet is strong, with net cash of £19.9m at 31 December 2017, and it generates lots of cash. 2017 earnings per share of 3.24p converted into operating cash flow of 3.88p, and with capital expenditure of only 0.021p, left free cash flow per share of 3.86p. Margins are improving as growth in assets under management fuel faster growth in income than costs. Last year’s margins of 22.3 per cent have some way to go to reach those of larger competitors such as Jupiter – with margins at 40 per cent – and Polar Capital’s 27 per cent. Management and staff have significant stakes in the business, with Gervais Williams at 8.2 per cent, Martin Turner 4.8 per cent and the Miton Group Employee Benefit Trust 11.6 per cent. Finally, there looks to be decent momentum in the business, with net inflows of £190m in January and February, and chief executive David Baron commented in March, “2018 has commenced strongly. We have seen positive net flows with [assets under management] passing £4bn”. Of course, operational gearing can work both ways. The main risk is probably a sustained bear market, which would most likely hit income and profits.

Prior to that, I added Alpha FX Group (AFX) on 10 April at 500p. Alpha FX describes itself as “a corporate foreign exchange specialist working internationally for businesses and institutions impacted by currency volatility”. It says that it has “been able to take the currency management practices employed by some of the world’s largest businesses and make them accessible to all companies affected by currency volatility”.

Put simply, it provides advice and currency hedging strategies to corporates to help them plan and manage their exposure. It focuses on small to medium-sized companies and has an impressive client list: Asos, Holland & Barrett, Abercrombie & Kent, Hornby, Magimix and Faroe Petroleum, to name a few. 

Again, it ticks the boxes: It achieves operating margins in the high 40s and a return on capital of around 30 per cent. At 31 December, it had cash on the balance sheet of £13.0m. Management are big shareholders in the business, with founder and chief executive Martin Tilbrook owning 29.8 per cent. Other significant shareholders include co-founder and commercial director Jonathan Currie with 9.7 per cent, James Stuart, head of portfolio management, 5.0 per cent, and Henry Lisney, chief operating officer, 3.4 per cent. Like Miton, there is strong momentum in the business, with 2018 expectations being upgraded following recent results. Liberum increased its earnings forecast for 2018 from 17.5p to 20.9p. At 23.3 times forecast earnings and a prospective yield of 1.3 per cent, it is a little more highly valued than I typically like. But given its growth prospects – it only has an estimated 1.0 per cent of the market – and the momentum in the business, I think the valuation is justified. Hopefully current forecasts will prove conservative. 

I bought Serica Energy following the publication of 2017’s results, (11 April at 71.4p). Following its purchase of North Sea assets from BP, announced last November and expected to complete in the third quarter, the shares look materially undervalued to me. On last November’s announcement, the shares shot up from 28p to 93p, but I guess in the absence of news and with some profit-taking drifted back this year. At 71p, stripping out cash on the balance sheet leaves a market value of around £160m. Earnings per share are forecast to be 2.6p in 2018, rising to 17.8p next year and 23.0p in 2020. That’s just 3.5 times 2020 earnings at the current price of 81p. I funded the purchase by reducing Central Asia Metals to 5.0 per cent, realising a nice profit (11 April at 321p). I made my monthly purchase of Scottish Mortgage Investment Trust (SMT) (6 April at 433p) and following U&I’s results I increased the position to 4.0 per cent (27 April at 214p). Including a special dividend of 12.0p, total dividends for the year ended February 2018 were up 106 per cent on the prior year. The final dividend of 3.5p and special of 12.0p gave a yield of 7.2 per cent at 214p. Management was confident about its ability to realise further value from its property portfolio. I added in expectation that the 30 per cent share price discount to NAV of 303p would close during the remainder of 2018.

Outlook

Much of the first quarter’s correction in equity markets has been recovered, but there is still a sense of unease. Markets remain nervous about how the highly valued US equity market will react to further interest rate rises. Any serious pullback would inevitably hit other equity markets such as the UK. I continue to resist the temptation to increase cash, preferring to focus on stock selection and the longer term. As fellow columnist John Baron often says, “time in the market, not timing the market” is the best way to build wealth over the long term.

The US 10 Year Treasury yield exceeded 3.0 per cent for the first time since January 2014. At that time, growth was sluggish and the main fear was deflation. The atmosphere is different now, with resurgent inflation the main concern. The market is forecasting further US interest rate increases. The worry is that this will put the brakes on economic growth and in the worst case tip the US into recession. After sustained dollar weakness since Trump’s election there was some respite, with the dollar gaining around 2.0 per cent versus the euro and sterling.

Much to the frustration of goldbugs, gold failed to break though $1,370 an ounce (oz), which has proved a ceiling for nearly two years; it finished the month down 1.0 per cent at $1,316 an oz. Bitcoin, however, had a good month, gaining 36 per cent to $9,392. While up 508 per cent over the past year, it’s still down 38 per cent this year and 50 per cent from December’s peak.