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Mining underweight sees Standard Life UK Smaller Companies modestly underperform

Standard Life UK Smaller Companies has announced its interim results for the half year ended 31 December 2016. During the period, the company provided an NAV total return of 16.7% and a share price total return of 17.7%, these both modestly underperformed the company’s ‘reference index’, the Numis Smaller Companies Index (excluding Investment Companies) Index, which returned 17.7%.

The manager, Harry Nimmo (pictured) says that performance during the period was driven by macro events rather than underlying trading and prospects of individual companies, which he says has been unhelpful for the trust’s relative performance. Specifically, he says that the rally in Mining stocks and heavy UK exposure as having a negative impact. He says that mining stocks recovered dramatically during 2016 and have been given a late year boost by Trump’s victory and pronouncements on infrastructure spend. UK orientated businesses, particularly real estate and financials also generally performed poorly. The Trust was light in both these sectors. In Harry’s view, the more overseas exposure, the better the performance of the share was the rule, with exporters doing best. The oil & gas sector recovered strongly following OPEC agreeing on reducing production, particularly after Russia agreed to add to the cuts.

Looking at individual stocks, the highest contributors were Fevertree Drinks, Accesso Technologies, CVS Group, JD Sports Fashion and Sanne Group. Fevertree Drinks gained 58%. Harry describes Fevertree as a phenomenal success story that has managed to beat expectations again and again as it revolutionise the mixer drink market as the premium category expands. Accesso Technologies gained 31%). Harry says that the company is the world leader in “queuing technologies”( through smart phones for visitor attractions) and continued to roll out with key customer Merlin. CVS Group gained 42%. CVS is a chain of vets that is consolidating the UK market and is expanding into the Netherlands. Its recent trading statement was strong. JD Sports Fashion gained 38% is continuin with its international expansion plans. Harry says that Ath-leisure clothing continues to gain momentum across markets and that there is also evidence that its foray into outdoor-wear may be starting to pay off. Sanne Group gained 49%. Harry describes this as an ambitious specialist fund administration company. Harry says that Sanne Group acquired a significant funds administration business based in Mauritius in an earnings enhancing deal. In addition, avoiding the poor performers and those companies issuing profit warnings, such as Laird, Mediclinic, NCC and Mitie, proved helpful in the period.

Looking at the detractors from performance, not owning four Mining stocks, Vedanta, Kaz Minerals, Evraz and Ferrexpro cost the Trust 2.2% of relative performance. Not owning the strongly performing Electrocomponents was also negative. There were three smaller holdings that issued profit warnings in the period. Harry says that Novae Group, was hit by underwriting losses, Motorpoint, misjudged the impact of Brexit, and Eckoh, saw its joint venture with West Corp start more slowly than previously anticipated.

In terms of portfolio activity, the five largest additions to the existing portfolio were Hilton Food Group, Ricardo, James Fisher, Diploma and Novae.

Hilton Food Group (1.7% weighting) is a meatpacking business which operates on an “open book” basis with supermarkets around the world from the UK to Australia. It is a founder-run business. Harry says that they recently announced business wins in Portugal. Ricardo (1.6%) is an auto engineering consultancy that has been around for one hundred years. It specialises in emissions and fuel efficiency and has exposure to the new areas of autonomous vehicles. Harry says that the business is well diversified by client, geography and segment. James Fisher (1.4%) is a transport and resources orientated engineering group. Harry says that it is in decent growth markets, that have visibility, and its bolt-on acquisition strategy is sound and earnings enhancing. Diploma (1.2%) is a specialist distributor of seals, laboratory and telecoms equipment. It operates internationally and, historically, has made earnings enhancing “bolt on” acquisitions most years while operating in a growth niche market where there is less competition. Novae (1.1%) is a Lloyds underwriter with some interesting specialist niches such as cybercrime, that is on a low rating. Harry says that shortly after investing in the company, it announced what they considered to be very poor loan-loss numbers, such that they reviewed their investment thesis and the holding has been sold since the period end.

One wholly new holding was added to the portfolio. ECO Animal Health owns an antibiotic (Aivlosin) mainly for pigs and poultry for multiple indications. Harry says that a particularly positive attribute is the short duration of Aivlosin, meaning it breaks down quickly in the body.  Growth and international expansion is rapid, particularly in the USA and China.

Hary says that, following the Brexit vot, their stock selection matrix has been steering the new purchases towards businesses with significant overseas exposure. Larger follow-on purchases include Hill & Smith in infrastructure construction safety equipment with substantial US exposure, Midwich the distributor of visual display units and 4imprint in US orientated sales promotion materials. UK exposed Workspace (work centres) and Domino’s Pizza UK & Ireland were also bought.

Seven holdings were sold in their entirety. Four were in companies at the larger end of the spectrum which had been in the portfolio for many years and Harry says that these had mostly made outstanding returns for the Trust. These were Shaftesbury in retail London property, Computacenter, Victrex (high performance polymers) and Halma (safety electronics). Three smaller holdings with poor matrix scores were also sold.  They were Solid State and Sprue Aegis in electricals and Lookers, the car dealer. Other significant sales included Rightmove, Moneysupermarket and Dunelm, these three also being large long-term profitable transactions.

In terms of outlook, Harry says that it looks as though the UK economy has confounded the pessimists who expected an immediate decline in business confidence in the wake of the UK’s Referendum decision last year and that it feels as though a significant proportion of the public, in particular, are relaxed about the prospects of even a hard Brexit outcome.He also notes that there have been no wholesale reductions in corporate earnings forecasts with a rough balance of upgrades and downgrades. The end of March should signify the firing of the starting gun for the exit negotiations to begin as Theresa May and her Government trigger Article 50 of the Lisbon Treaty. Harry says that it is only then that any real shape to the outcome starts to develop and he believes that the negotiations will take all of the two years permitted, which takes us into 2019. It is only some time after the implementation of the withdrawal treaty that the full impact can be properly assessed. The manager’s prognosis is that oil remain in a trading range of $30 to $60 for a number of years. A similar pattern may become apparent in industrial minerals although gold may firm up in this rather uncertain period.

Mining underweight sees Standard Life UK Smaller Companies modestly underperform : SLS

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