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Aurora publishes first annual report since new manager

Aurora Investment Trust has published its first annual report since the management of the company was passed to Phoenix Asset Management. The report covers the year ended 29 February 2016 – Phoenix took up the reins on 28 January 2016 so most of the performance of the fund over this period is attributable to the old manager / investment approach. The performance for the year to end February 2016 was – 4.71%, outperforming the benchmark FTSE All-Share Index -10.64% by 5.93% and mostly reflecting the historic Mars’ investment strategy.

A new Investment Management agreement with Phoenix was entered into on 28 January 2016.  Its key features are no management fees and an annual performance only fee, equal to one-third of NAV per share total returns in excess of the FTSE All-Share return.  This fee is subject to claw back and a high water mark and is capped at 4% of NAV, p.a., in the case of an absolute increase in NAV per share; and 2% in the case of a decrease.

Liberum was appointed Broker to Aurora on 25 January 2016 since when, as of 2 June 2016 a total of 3,492,104 shares have been sold out of the Treasury in addition 4,858,750 new shares were admitted under the placing programme on 29 March, 2016.

The Board proposes a dividend of 1p per share, meeting the HMRC minimum distribution regulations. As advised at the 11 December 2015 General Meeting of Shareholders, future Dividend Policy will be to distribute substantially all of the net revenue, which is likely to vary from year to year.

The managers talk through a number of their holdings in the statement:

Bellway and Barratt Developments, our two house-building investments, are currently experiencing very favourable trading conditions. Consumer sentiment is robust, interest rates are incredibly low and there is a housing shortage in the UK. If that’s the kindling for the fire, the Government is wafting the flames with a number of favourable policies and initiatives including: the Help to Buy Scheme (whereby the Government subsidises the buyer’s deposit, giving them access to more favourable mortgage terms), simplification of the planning system and the sale of land owned by the Government to house-builders. The consequence of all this is that house-builders are currently making hay; sales and profits are growing, returns on capital are at record levels and both Barratt & Bellway are buying land today on very favourable terms, which is important for future profitability.  We have recently asked ourselves more than once, is this too good to be true? In answering that question, we can’t help but observe that for all the tailwinds and good news, both stocks are already cheap. It would be concerning to us if the valuations reflected the current wonderful trading conditions or the attractive long term growth prospects that they both face. And yet these great, well managed businesses trade on less than 10 times earnings, with practically no debt. 

We sometimes get asked how Lloyds meets our investment criteria. Generally, banking isn’t for us. We have considered and rejected other businesses because they have investment banking operations we don’t understand or overseas divisions exposed to unknown risks. Lloyds does not have either of these issues and its appeal to us today can be attributed to a few fairly simple observations. Firstly, it is a bank focused on UK domestic business: current accounts, mortgage lending and loans, i.e. nothing racy. Secondly, (as the competition commission discovered when they investigated the banking sector) Lloyds customers (and in fact UK banking customers in general) are very loyal and don’t change their banking provider very often. This means that Lloyds has been able to maintain persistently high market share despite not being the cheapest provider of almost any service and product it provides. Thirdly, the hideous banking crisis of 2007/8 and its aftermath means that Lloyds is operating cautiously and under far more scrutiny than at any time in recent memory. Over the last couple of years the strong underlying profitability of the business has become apparent and the current valuation appears to be very low. 

Another question that crops up quite frequently at the moment is: “have you found any investment opportunities in commodities businesses?” the implication being that distressed sectors often yield rich pickings for value investors. The short answer is no. The slightly longer answer is that Gary has been looking quite excitedly at opportunities in the oil, gas and mining sector for the last 18 months. However, our view is that there is potentially a lot more pain to come and that watchful waiting is the appropriate course of action at the moment. Having said that, in Vesuvius we do have some existing exposure to the steel production industry. (They sell products and services to foundries) Phoenix’s MD, Charlotte Maby, is the analyst responsible for this stock and, after her most recent visit to the annual industry conference in the Black Forest, (where she was one of if not the only financial analyst in attendance) she assured us that this excellent, 100 year old business was in good shape, and demonstrating resilience and pricing power in what are difficult markets. 

Mystery shopping and gathering “scuttlebutt” keeps us in-touch with what’s happening at the coalface of a business and is a very important aspect of our approach. Last year, we (meaning a very busy James Wilson and a number of bemused interns) visited approximately 200 food retail locations, dividing that effort primarily between Tesco and Morrisons. Both are making some progress towards being rehabilitated after several years of underperformance. Generally speaking, the evidence from our store visits validates the “back to basics” strategies that have been announced by both management teams.   For example, some of Morrisons problems came about when, attempting to attract wealthier southern customers with flash store fittings and slick advertising, they lost the hearts and minds of their core “value” market. Now under new management and without compromising the freshness and quality for which they are renowned, Morrisons stores have a clear appeal to the value oriented shopper. Under CEO Dave Lewis, Tesco is asking its customers what they want and then making the necessary improvements to deliver things like: better service, simpler ranges and consistently low pricing. But it’s not all good news for Tesco and Morrisons and the recovery stories have a long way to go. The future of online grocery shopping is an unknown quantity and a risk to be watched. But that last point is important: we have the ability to watch the risk unfold (and relatively slowly; shopping habits are persistent) and respond accordingly if we need to. We also see a lot of hand wringing about the threat from the German discount supermarkets, Aldi & Lidl. Our view is that they are very formidable competitors who have been given more freedom to compete in the UK than should have been the case; both Tesco and Morrisons have had to do some fire-fighting to respond to the threat. We think that the important point is this: there are parts of the UK where the German discounters have been trading for well over 20 years (Bristol for example) and yet their market share in these areas is bounded by the willingness of the local population to do some or all of their shopping in a discounter. Even in these areas where the Germans have been established a long time, Tesco and Morrisons (and Asda and Sainsbury) have strong market positions. We think this can be extrapolated nationally and leads us to conclude that the end is not nigh for Tesco and Morrisons. The share prices of both stocks are low; we think the long term prospects for both businesses are excellent.

Some of our peers smirk when they hear we are invested in Sports Direct.  We can’t be sure why although our best guess is that it is intended as a knowing gesture, an acknowledgement between investors that we are taking a bit of a punt on a beaten-up company with a slightly swashbuckling reputation. How strange! We are invested because it is one of the best run businesses we have ever come across. We have owned the shares a long time, (in the offshore fund we have been running since 1998) originally buying shortly after the (not very well managed) floatation. At that time (2007/8) the City narrative was something along the lines of “the stores are jumble sales and the management team are incompetent”. Mike Ashley and his excellent management team then spent several years proving the City wrong, out-foxed several of their competitors and until last year the business was feted as an exemplar of retailing excellence.  One or two PR snafus followed by a profit warning in January has halved the share price from 8 pounds to 4. We visit around 60 sports retail locations in the UK and Europe each year and don’t see  any evidence to suggest that the valuation today should be half of what is was last year. 

Diageo, Unilever and Glaxo are in quite different businesses (the former sometimes making you sick, the latter making you better) and yet the investments have some similarities. Firstly, steady, long-term global population expansion and GDP growth provides a helpful tailwind and means that both businesses have more potential customers this year than last. Furthermore, as the world becomes richer, consumer demand for their products increases.  Secondly, each derives a strong competitive advantage from their industrial capability. Vast distribution networks, sophisticated marketing divisions and, (especially relevant in Glaxo’s case), world class research and development, are all widening the moat and helping to protect market share. Each year there will be ebbs and flows for all three businesses; notable failures and successes with particular products or in certain markets.  But we expect the trends mentioned above will deliver a favourable result to us as long term shareholders.

Staying on the subject of alcohol, JD Wetherspoon is a good example of how a great business can prosper in the face of headwinds. The number of pubs in the UK is in steady decline and yet they open new ones every year. Wetherspoon’s margins have fallen because of price pressure and wage cost increases and yet return on capital (a much more important metric for us) has remained stable. Why? Because the business is run in a rational way by people who have a relentless focus on making the pubs as good as they can be. Chairman Tim Martin was recently speaking to one of his kitchen staff about serving traditional Sunday lunches (presumably a sacrosanct meal for many pub businesses). The employee told him that roasting potatoes and joints of meat was interfering with the breakfast service. On further analysis it turned out that there was more money to be made from getting breakfast right than serving “Sunday lunch”. So they stopped serving “Sunday lunch“.

ARR : Aurora publishes first annual report since new manager

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