Neil Hermon’s Henderson Smaller Companies mildly underperforms

Henderson Smaller Companies (HSL), managed by Neil Hermon (pictured) has announced its annual results, for the year ended 31 May 2019, during which it mildly underperformed its benchmark. The chairman, Jame Cayzer-Colvin, highlights that this is just the second year of underperformance in the 16 years that Neil Herman as managed its portfolio. Specifically, HSL’s net assets fell by 6.4%, underperforming its benchmark by 0.3% on a total return basis, while its share price fell by 9.0%. The statement says that the underperformance came from a negative contribution from gearing and expenses, which was partially offset by a positive contribution through underlying positive portfolio performance.

Neil Herman and Henderson Smaller Companies Long-term record intact

The trust’s long-term record of outperformance remains intact. For example, the statement also reports that, during the five years to 31 May 2019, HSL provided NAV and share price total returns of 67.2% and 76.1%, both ahead of its benchmark’s total return of 33.1%. HSL is proposing a 9.5% increase in the proposed total dividend for the year, which makes it the trust’s16th consecutive year of dividend growth.

Attribution analysis

The manager’s comments on attribution analysis are provided below.

The tables below show the top five contributors to, and the top five detractors from, the Company’s relative performance.

RWS Holdings is a translation services business with particular strengths in intellectual property, life sciences and technology. The company has demonstrated long-term sustainable growth through a combination of organic and acquisitive expansion which has generated substantial shareholder return over the long term. Over the last year the much-improved trading performance of the recent acquisition, Moravia, has accelerated earnings growth and led to significant share price performance.

Aveva is an international provider of software and services to the engineering industry, particularly the oil and gas, mining, marine and power industries. It merged with Schneider Electric’s industrial software business in 2018, significantly expanding the global reach of its digital transformation solutions. In this process Schneider took a controlling 60% stake in the business. The markets that Aveva is supplying are seeing robust expansion and the digitalisation of industrial markets is providing a further fillip to growth. The merger with Schneider is also providing cost saving synergies which is boosting profitability.

Intermediate Capital is an alternative finance provider and asset manager. It is a leading provider of mezzanine finance to LBO markets. It also owns a highly successful mezzanine, property lending and credit fund management operation. Its portfolio of investments is performing well but the primary growth engine of the business is the fund management operation. This division is having real success in asset gathering due to the strength of its performance track record, the quality of the team and underlying demand for its product in an income-hungry world. The management have also boosted the company’s return on equity by returning substantial surplus capital.

Gamma Communications is a UK-based telecoms operator offering voice, data, mobile and internet based products to small and medium sized enterprises. The company has performed strongly over the last few years as it has utilised the channel network in order to gain market share. Gamma has an exciting product set that provides customers with flexibility and scalability in an environment where products are moving to internet based services. 2018 was a strong year for the group as Gamma expanded overseas into the Netherlands and launched new products with extra functionality.

John Laing is an international originator, active investor and manager of infrastructure projects. Its business is focused on major transport, social and environmental infrastructure projects awarded under governmental public-private partnership (“PPP”) programmes and renewable energy projects. It does this across a range of international markets including the UK, Europe, Asia Pacific and North America. Our investment in the company provides us with exposure to growing infrastructural expenditure globally. The company has a large and growing pipeline of opportunities and raised further equity in 2018 to capitalise on these opportunities. The company is delivering healthy NAV growth, driven by new projects, the discount rate unwind and an ability to improve project returns throughout their life.

Greggs is a UK based convenience retailer of bakery products. The Company had no holding in Greggs. The bakery company has performed strongly, aided by the appeal of its value-for-money offering and the publicity around its launch of vegan sausage rolls. Strong profit growth has combined with a substantial valuation re-rating leaving Greggs on expensive earnings multiples.

Victoria is a pan-European floor coverings manufacturer. The company has bought, rationalised and integrated a number of UK carpet manufacturers. It has more recently expanded into the ceramic market in Europe through acquisitions in Italy and Spain. This expansion combined with a slowdown in trading saw debt expand to uncomfortable levels and combined with negative commentary from short sellers meant the shares underperformed. Recognising these concerns we sold our position in Victoria.

Dunelm is a UK retailer of homewares products. The Company had no holding in Dunelm. After a number of years of poor operational delivery and subdued earnings growth, Dunelm has seen an improvement in its performance, led by a new management team. This has led to a substantial valuation re-rating.

Just Group is a provider of enhanced annuities. The company has been impacted by its regulator, the PRA, deciding that the company needs to hold more capital against its portfolio of lifetime mortgages. To satisfy this capital requirement Just Group issued fresh debt and equity to restore its solvency position to more acceptable levels. The shares now trade at a substantial discount to both its tangible book value and embedded value and we believe they are very vulnerable to predatory interest.

Renishaw designs, develops and manufactures high technology precision measuring and calibration equipment. The business is a global leader in its field with strong patent protection. The company invests heavily in research and development to maintain its market leading technological position. Over the medium term the organic growth delivered has been one of the strongest in the capital goods sector. It has expanded its operations by diversifying into healthcare and additive manufacturing markets, both of which offer long-term attractive growth. In the short term the company is suffering from weakness in Asian demand and, given short visibility and high operational gearing, profitability is under pressure. That said, Renishaw, with a very strong balance sheet and a well-invested production base, is superbly positioned for the long term.

Portfolio activity

The manager’s comments on portfolio activity are provided below.

Trading activity in the portfolio was consistent with an average holding period of five years. Our approach is to consider our investments as long term in nature and to avoid unnecessary turnover. The focus has been on adding stocks to the portfolio that have good growth prospects, sound financial characteristics and strong management, at a valuation level that does not reflect these strengths. Likewise we have been employing strong sell disciplines to cut out stocks that fail to meet these criteria.

During the year we have added a number of new positions to our portfolio. These include:

Alliance Pharma acquires, markets and sells pharmaceutical and consumer healthcare products. The company has over 90 brands which are predominantly sold in the UK, US, China, France and Ireland. Alliance Pharma is an acquisition-driven business: the company buys niche products from major pharmaceuticals companies and looks to improve sales through focused marketing and expansion into new geographies. The company has solid underlying growth with strong cash generation and there remains a number of opportunities for the business to deploy capital to expand into new products.

Future is a tech-enabled global platform for specialised media which targets both consumers and business-to-business (“B2B”) brands across Europe, America and Asia Pacific. The company creates specialised content to attract and grow high value audiences. These audiences are then monetised through memberships and subscriptions, print and digital advertising, e-commerce sales and events. Future has both an organic and inorganic growth strategy. Management are focused on purchasing new brands and titles to leverage their scalable technology and drive digital growth using its revenue optimisation model.

Savills is a real estate services company offering retail and corporate sales, valuation, fund management, property facilities and consulting for a broad range of clients across Europe, America, Asia and Australia. It is a business that has significantly diversified over the years, reducing its exposure to transactional services towards more predictable revenue streams. Our investment in Savills provides us with a quality, diversified real estate business with a strong management team and opportunities for expansion through tactical acquisitions.

Serica Energy is a North Sea focused oil and gas exploration and production company. The company expanded significantly through the acquisition of the Bruce, Rhum and Keith fields from BP, Total, BHP and Marubeni. This deal, which solved ownership issues of the vendors, was achieved at a fantastic price for Serica and transformed it into one of the major independent oil and gas producers in the North Sea. The company will generate substantial free cash flow in the coming years leaving it well placed to do further value-enhancing deals.

Vitec is a leading manufacturer and supplier of specialist camera/video accessories, lighting and sound equipment. The company has a high market share in each of its product categories and continues to outperform its peers through new product innovation. Whilst the consumer camera market has shifted to the use of mobile phones, there still remains an active professional and amateur photographer market that buys high quality equipment. Our investment in Vitec provides exposure to a company with an improving demand cycle, increasing margins through efficient manufacturing and the potential for small acquisitions of other niche brands.

In addition to the companies mentioned above, we invested in a number of initial public offerings (“IPOs”) in the year. These included AJ Bell, an investment platform business, Codemasters, a software games developer and publisher, Tekmar, a provider of subsea protection systems and engineering services and Watches of Switzerland, a retailer of luxury branded watches.

To balance the additions to our portfolio, we have disposed of positions in companies which we felt were set for poor price performance. We sold our holding in Elementis, a speciality chemicals group, where the company made a poorly judged and expensive acquisition of Mondo Chemicals, an industrial talc company. This boosted leverage to levels we were uncomfortable with. We also disposed of our holding in NCC, a cybersecurity consultancy and escrow services business, as the company warned that recruitment and retention of employees was proving difficult. In addition the software escrow business is seeing structural decline as software moves to the cloud. Other companies we sold due to a belief that they were structurally challenged or suffering from poor operational performance included: Playtech, a software and services provider to the gaming industry; Ricardo, a consultant serving the automotive, rail and environmental markets; XPS Pensions, a pensions consultant; Accesso, a queueing and ticketing software business; and Ted Baker, a clothing brand and retailer. We also sold our positions, in line with our stated policy, in GVC, a gaming company and Melrose, a diversified industrial group, as both were elevated to the FTSE 100.

We benefited from a level of takeover activity in the year, albeit at reduced levels compared to previous years. Three portfolio companies received agreed bids. Within our portfolio, takeover bids were received for: Faroe Petroleum, an oil and gas exploration and production company, from DNO; Tarsus, an international exhibitions company, from Charterhouse Private Equity; and WYG, an engineering consultancy, from Tetra Tech.

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