One in one out as UK markets recover

Oil was strong, with Brent crude finishing the month up 4.0 per cent at $77.64 per barrel. It briefly touched $80 following President Trump’s decision to withdraw the US from the Iran nuclear agreement and impose sanctions on Iran and those doing business with it. In industrial metals, nickel was particularly strong, gaining 11.2 per cent. At its highest price in three years the trend looks strong. Its use in electric vehicle batteries is likely to drive demand for some time.

Gold does not seem to be responding to heightened geopolitical tension as might be expected and remains firmly stuck in the middle of its trading range. It was down 1.0 per cent on the month to $1,303 an oz. I have dabbled with gold in the past, but struggle to get too enthused about it. For a start, it doesn’t pay a dividend. True believers like it as a ‘store of value’ that will maintain its price in an equity bear market or during a period of higher inflation. In 2008, during the height of the financial crisis, it fell 30 per cent between March and November. Admittedly, this was not as bad as equity markets, but cash would have proved a better option. Regular readers will know that I can live with short-term volatility, preferring to focus on the longer term – and, more importantly, the dividend-paying potential of the portfolio. I know I’ll continue to struggle with gold, but for now I am happy with no direct exposure.  

Performance

Another up month for the portfolio, but alas still slightly behind the FTSE All-Share (Total Return) index. The portfolio’s return of +1.8 per cent leaves it down 4.7 per cent since 1 January. Over the respective time periods the All-Share returned +2.8% and +1.9%. Over the longer term, since inception in January 2012, the portfolio is up 166.1 per cent (+16.5 per cent annualised), versus a gain of 86.5 per cent (+10.2 per cent annualised) for the index.

For the second month running, Faroe Petroleum (FPM) was one of the best performing stocks, gaining 14.2 per cent. The oil price was obviously beneficial, but a flow of good news helped, including the completion of the sale of part of its interest in the North Sea Fenja field.

The really pleasing move was from Bloomsbury (BMY), up 32.2 per cent following excellent results. The highlight for me was very strong cash conversion, leading to year-end net cash of £24.5m, up from £15.4m in the prior year. This allowed the dividend to be increased by 12 per cent (compared with forecasts of 5.0 per cent). Harry Potter is the gift that keeps on giving, with sales up 31 per cent as the illustrated edition of Harry Potter and the Prisoner of Azkaban proved highly popular. It is not all about Harry Potter, though; Tom Kerridge's Lose Weight for Good was also a top seller. Non-consumer revenues grew by 4.0 per cent and digital revenues were up 20 per cent to £4.7m. The company says that it is on track to deliver digital sales of £15m, with profits of £5m in 2021-22. 

The outlook statement was very positive: “The board expects our performance for 2019-20 onwards [to be] well ahead of our previous expectations.” On upgraded forecasts, the shares at 240p, are valued at 16.7 times February 2018 earnings, for 18.9 per cent growth and a prospective dividend yield of 3.3 per cent. More importantly, to me at least, it is valued at only 11.4 times free cash flow. None of this should have been a surprise to the market given its bullish year-end trading update in March. Over the years, I have detected that often share prices do not respond as enthusiastically to 'ahead of expectations' trading updates as perhaps they should. It’s almost as though the market does not believe it and wants to see more evidence first.

U&I Group (UAI), another strong performer from April, continued to perform well, up 10.3 per cent, despite going ex-dividend at 12.0p a share. Medica Group (MGP), a new holding, was up 26 per cent, but only 11.0 per cent from when I purchased it mid-month.

Now to the negatives. Serica Energy (SQZ) was hit by President Trump’s Iran decision. Unfortunately, the 50 per cent of the Rhum Field it is not acquiring from BP in the recently announced 'BKR' transaction, is owned by the Iranian Oil Company (UK) Limited. Serica issued a statement saying that it and BP were committed to completing the deal in the third quarter and “identifying measures acceptable to the US authorities to protect safe and efficient Rhum operations”. Having been nicely up on my April purchase, I am now 10 per cent down. While not confident enough to add to my position, I am happy to hold my current 1.3 per cent on the basis that I believe there is material upside if this problem is resolved.

XLMedia (XLM) and Taptica (TAP) continue their rollercoaster ride, down 10.5 per cent and 13.0 per cent respectively. In XLMedia’s case, it looks like the market, as is so often the case, got it right. On Monday, it issued a trading update saying that expected revenues and operating profits would be around 10.0 per cent lower than previous expectations.

Activity

One in and one out. I bought a new position in Medica Group (market capitalisation £163m) on 14 May at 133p. It is an independent provider of radiology reporting services, employing radiologists who examine the x-rays, CT scans and MRI scans performed in NHS and private hospitals. Through its NightHawk, Routine and Specialist services it delivers more than 1.5m reports a year. Like my purchase of Miton Group (MGR) in April this seems to tick the right boxes. Growth is strong, with revenue and earnings growth of 18 per cent and 41.6 per cent respectively last year, and 17 per cent and 39 per cent forecast for the current year ending December 2018. It has a lot going for it qualitatively, with return on capital and operating margins in the high teens and year-end net debt of just £5m.

Cash generation is strong, with 5.53p of earnings in 2017 converting into 5.0p of cash flow. Capital expenditure of 1.3p left free cash flow of 3.7p. The valuation looks attractive on 19 times 2018 forecast earnings for 39 per cent growth, falling to 16.7 times in 2019 and according to ShareScope just 14.3 times in 2020. Management has a decent shareholding, with chief executive John Graham holding 3.3 per cent, medical director Dr Stephen Davies holding 1.4 per cent and chief financial officer Tony Lee holding 0.47 per cent. Timing: Medica floated on the main market in March last year and got off to a great start. The share price peaked in June at 240p, but clearly the valuation got ahead of itself. When it announced that 2017 growth would come in at 18 per cent against market expectations of 22.0 per cent, the price got caned. It more than halved to 117p in April. I think the current valuation reflects more realistic expectations. The share price has started to recover, helped by the company’s recent assertion that 2018 had got off to a good start and that recruitment of radiologists has continued to be strong.

The one complete sale was the disposal of one of my largest positions, TR European Growth Trust (TRG). I sold on 29 and 30 May at 1,057p and 1,039p, realising a 38 per cent profit, including dividends, over the near-two years I held it. There were two drivers of the decision: first I’m not sure I need to have direct exposure to continental Europe while there is scope for the current political situation in Italy to throw a spanner in the works of the euro. Second, there is a growing consensus that the UK market looks cheap, not just relative to other markets but in absolute terms. While it can be intellectually satisfying to have a non-consensual view, I think in this case the consensus view feels correct. I am not struggling to find UK stocks that look attractive.

Other trades included my monthly addition to Scottish Mortgage Investment Trust (SMT) (8 May at 499p), and a reduction in XLMedia to 4.5 per cent of the portfolio to pay for the purchase of Medica. I sold at 178p on 14 May, realising a nice profit into the bargain. With US technology stocks doing well, my purchase of Scottish Mortgage is looking good so far, with it up 12 per cent on my average purchase price. 

Outlook

Equity markets have staged a decent recovery after the first-quarter correction and hopefully there is more to come over the remainder of the year. Last month I finished with “time in the market, not timing the market” is the way to build wealth in the long term. Readers of my website will know that I have put much of the May month-end cash balance of 7.2 per cent back to work. As well as my monthly purchase of Scottish Mortgage Trust, I have added two new positions, one investment trust that invests in UK smaller companies and the other, a stock on a 4.7 per cent prospective yield and valued at 10 times free cash flow – but more on that next month.

John Rosier's portfolio (at 11 June 2018)