Smithson powers on – 2019 was a great year for Smithson Investment Trust and its results, which cover the period from the launch of the trust in October 2018 to the end of December 2019, show the trust generating an NAV return of 25.5% and a share price return of 29.8% against an 11.8% return for the trust’s benchmark. There is no dividend – one was not anticipated as the investment approach does not favour high yielding shares.
The trust’s IPO, which raised £822.5m, broke records for the largest new issue. remarkably, the trust has been able to issue an additional £426.5m worth of shares since.
Extract from the manager’s report
“In July 2019 we initiated a position in Fevertree Drinks plc, a producer of premium carbonated mixers including tonics, gingers and cola, which it sells predominantly in the UK, Europe and the US. This is a company we have admired for some time. In the UK, which still accounts for over 50% of the business, it dominates the premium tonic market with 90% market share, despite many ‘copy-cat’ products having been launched. Or put another way, it is almost ten times the size of all its UK competitors put together. In the US they have a fledgling business which is growing rapidly, at around 30% a year, and they have recently signed a domestic bottling contract and national distribution agreements to galvanise the position. As in the UK, they appear to have already stolen a march on other competitors in the market, and we believe the US is an opportunity which could be several times the size of the UK market. On top of this, it also has an established business in Europe (Spain is one of the largest consumers of gin in the world) and a growing presence in Australia and Canada which could also become meaningful to the group.
What attracted us to the company was its strong market positions, current and potential growth rates and impressive history of profitability and returns on capital. However, at the time of the Company’s IPO we felt that the valuation was not attractive enough for inclusion in the portfolio.
We continued to watch the company closely and in the subsequent months from September 2018 until acquiring our first shares in July 2019, the share price declined by 47%. At the same time, the free cash flow generated by the company was more than double what it had been a year earlier and progress in its international businesses had been excellent.
The most likely reason for this significant share price decline was slowing growth in the UK market. It seems reasonable to us that the UK should now be considered a mature market for premium mixers and that this slower growth (likely around 3%) should be expected to continue. After the year end, the shares took another leg down in January 2020 when the company announced that further sales weakness was expected in the UK market until mid-2020 and that it would have to reduce prices in the US as they had reached inappropriate levels. After we conducted further investigation, both of these issues appeared to be of a short-term nature to us, and we used the price decline as an opportunity to buy more shares. Only time will tell if this assumption is correct.
In September 2019 we decided to sell one of our holdings, namely CDK Global. This is a US company that produces software to help car dealers run their business, and one which we have written about in previous reports. The decision to sell was due to two reasons. First, the change of CEO in November 2018 had subsequently led to a material change in strategy, with management selling the prior designated ‘growth’ business of digital advertising, to focus on the lower growth core software business. This gave us some concern over future capital allocation given the large capacity for cash deployment from the balance sheet, coupled with a new CEO who has a history of making expensive acquisitions. Second, the remaining business wasn’t quite as good as we had previously thought it was. We believed initially that the core business would continue to grow with the launch of a new dealer management software, called DriveFlex. What we learned from the new management team, was that this product still lacked the required investment, and as such wouldn’t be ready for full commercial launch for another two years (after significant further development cost). The combination of these issues, the full extent of which we learned with the last reported results in August and by speaking directly to the management at that time, gave us the realisation that we were more confident in the long-term outlook of the other 29 companies in the portfolio than in CDK Global. We therefore made the decision to sell the company and deploy the proceeds into other existing positions.
To discuss some of the events which have affected the portfolio since launch, we have set out the top five contributors and top five detractors to NAV performance below.
Top 5 Contributors Security Country Contribution%
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ANSYS United States 2.4
Halma United Kingdom 2.2
Rightmove United Kingdom 2.1
Paycom United States 1.8
Masimo United States 1.8
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ANSYS, the US simulation software company, was the top contributor to performance, rising 80% over the period after announcing several major business wins, which served to demonstrate the increasing use of simulation software in product design and development.
Halma is a UK conglomerate of companies which manufacture safety equipment and environmental sensors, which we value for its ability to continually invest incremental capital at very attractive rates of return by adding more small companies to its group each year. This makes it a very rare breed in the corporate world – a good acquirer. 2019 provided more progress, demonstrated by the excellent results released in both June and November, driving further gains in the share price.
The strong performance of Rightmove, the UK online property advertising company, may come as a surprise to many of you, if the regular conversations we have had with our shareholders are anything to go by. This company is very often a talking point, because many are worried that it has been one of our largest holdings during a period of considerable uncertainty in the UK political environment and housing market. We believe such concerns come from a degree of misunderstanding about the Rightmove business model. Rightmove charges UK estate agents a fixed monthly subscription fee irrespective of the number or value of the houses advertised. This, of course, means that no matter how many houses are being advertised or sold, and no matter what is happening to UK house prices, Rightmove still receives the same monthly fee. In fact, this fee actually tends to go up over time, as Rightmove is able to sell additional digital ‘products’ to estate agents, such as buyer mapping and lead generation software. Ultimately what this means, is that Rightmove’s earnings are not as exposed to the vagaries of the UK housing market as most believe. This provided us with an interesting opportunity in early 2019, as the original Brexit deadline approached, and passed, and the valuation of Rightmove became subsequently depressed amid general UK economic concerns. We added meaningfully to our holding during this time, making it the largest position in the portfolio, in our belief that even if the UK housing market took a turn for the worse, Rightmove’s revenue model, and dominance of its market niche, would remain resilient. In the end, this resilience was not tested under a hard Brexit scenario, and Rightmove’s valuation has subsequently recovered toward more reasonable levels for what remains an excellent company.
You may note from the above that often the opportunity to buy very good businesses at cheap valuations arises when there is a “glitch” in the company’s normal operations or environment. Providing we are convinced that it is only a glitch, and not an existential threat, we will seize these opportunities as we did in the case of Rightmove. It illustrates how good investments can result from not focusing on the immediate situation and by ignoring popular mis-conceptions and anecdotal evidence.
Paycom is a US provider of human resources (HR) software which allows employees to perform many HR processes themselves by interacting with the software, rather than with a human HR manager. The company is seeing exceptional growth due to the cost savings and HR productivity that its clients achieve after adopting the software. The reason the company is not at the top of the above list, which it might well have been given its performance, is that at the time of launch, the shares were trading at a valuation which we thought was approaching the upper end of what we were comfortable paying. It was therefore initiated as a smaller position in the portfolio, with the hope that we would get a chance to make the position larger at a later point. However, from the end of 2018 up to the point of writing, the shares have almost tripled in price. Having only a small initial position was therefore a mistake on our part and serves as another reminder why our investment process has ‘don’t overpay’ as the second tenet after ‘buy good companies’.
Masimo, a US medical device company, again had a strong performance in the first half of the year after very positive results were published during the period. Improving relations between the US and Mexico further helped sentiment, as Masimo manufactures many of its products in Mexico.
Top 5 Detractors Security Country Contribution%
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CDK Global United States -0.9
Chr. Hansen Holding Denmark -0.4
Sabre United States -0.4
Fevertree Drinks United Kingdom -0.3
Check Point United States -0.1
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CDK Global, discussed above, was unfortunately a significant detractor to performance prior to it being sold.
Chr. Hansen shares reacted very negatively after the company pre-announced disappointing results, indicating that growth rates for 2019 would be lower than we previously expected. Further disappointment came in October when it announced annual results which showed a sharp slowing of revenue growth in the fourth quarter, which the management attributed to difficult sales in emerging markets. The guidance for 2020 was not particularly rosy either, with further low growth expected. However, the company has several potential growth opportunities from new product areas and partnerships which have yet to come to fruition. As there is still some uncertainty regarding this future growth, the company remains the smallest position in the portfolio while we monitor its progress.
Sabre, the provider of booking software to the travel industry, suffered during the year as Lion Air and Ethiopian Airlines, operators of the 737 MAX aircraft which suffered devastating crashes, and Jet Airways, the now bankrupt Indian airline, were all major customers and will represent a significant loss of business as fewer passengers from those airlines are booked through its systems. It was interesting to note a more positive earnings release from the company in October which highlighted, after a few quarters of declining operating margins, that they appear to have increased in the third quarter of 2019. Whether this is the end of the recent negative trend for margins, we don’t yet know. However, it was well received by the market, and helped Sabre shares to post a positive return during 2019, although combined with weakness at the end of 2018, the return was negative for the period since launch.
Fevertree Drinks was purchased during a period in which its share price was declining, and which continued after our acquisition – further proof in our view that market timing is very difficult – and so detracted from overall performance.
Finally, Check Point, a US security software company, posted disappointing revenue growth numbers during 2019 as competitors appeared to be taking some of its market share. The company claims that this is an issue with its sales force, rather than its products, which it is now in the process of addressing. We will continue to monitor the company closely to determine if these changes are having the desired effect, although it may take some months for this to become apparent.”