Henderson Smaller Companies suffers in growth selloff

Henderson Smaller Companies has published results for the 12 month period ending 31 May 2022. The trust underperformed its benchmark over the year, delivering an NAV total return of -17.8% against -9.5% for the Numis Smaller Companies Index (ex Investment Companies). A widening of the discount left shareholders with a return of -27.0%.

On the plus side, improved revenue generation allowed the fund to declare dividends totalling 24p (up from 23.75p), covered by earnings of 24.57p. The return to a fully covered dividend reflects the improvement in dividends post COVID. This marks the 19th consecutive year of dividend increases, putting the trust on track to be declared an AIC dividend hero next year.

The chair’s statement says “Smaller companies have materially underperformed larger companies during the year as investors favoured the defensive and liquid characteristics of larger stocks. The company’s underperformance in the past year is largely due to the de-rating of growth companies with the characteristics of the underlying portfolio remaining strong.”

The widening of the discount to 14.6% at the year end was not met with share buy backs. The chair’s statement says that the board do not currently believe that share buy-backs represent the most effective way of generating long-term shareholder value. Last night the discount was about 13.5%.

Extracts from the manager’s report

The underperformance came from a combination of negative contribution from stock selection, gearing and expenses. Negative contribution from stock selection was principally a function of the significant underperformance of growth companies as they de-rated in valuation terms due to rising interest rates and higher bond yields. In the vast majority of cases, this was independent of the operational and financial performance of these businesses, which remained strong.

Serica Energy is a North Sea oil and gas producer. After significant acquisitions in 2017 the company accounts for around 5% of total UK gas production. The company has benefited from the significant rise in gas prices in the last year. Even though the company will be subject to the new windfall tax on North Sea operators it is generating significant cashflow and has a very strong balance sheet. This will allow Serica the opportunity to make further value-enhancing acquisitions.

Petropavlosk is a Russian gold explorer and producer. The Ukrainian conflict severely constrained the company’s ability to trade and finance its borrowings. The Company did not own a position in this stock.

Trustpilot provides a digital platform for consumer insights and reviews. The shares have declined as the market has rotated away from growth companies in addition to the company guiding to increased investment and a consequent delay in reaching profitability. The Company did not own a position in this stock.

Cineworld is an international cinema operator. The company has significant financial liabilities and, with cinema box office receipts still well below pre-pandemic levels, the business is failing to generate any free cashflow. Its financial position appears very tenuous. The Company did not own a position in this stock.

Ultra Electronics is a supplier of electronic equipment and systems which are primarily used for defence and security applications globally. The company has a unique set of products with high levels of intellectual property in the marine, aerospace and communications sectors. During the year, the company received a bid approach from Cobham Limited,  which is ultimately controlled by Advent International, a private equity vehicle. The deal is currently going through a review by the UK Government and conclusion of the transaction is expected in 2022.

1 Not owned by the Company

Energean is an oil and gas producer and developer with particular focus in the Mediterranean. The company benefited from a rise in the gas price and continued progress in its large offshore Israeli development. The Company did not own a position in this stock.

Future is a tech-enabled global platform for specialised media which targets 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 is focused on purchasing new brands and titles to leverage its scalable technology and drive digital growth using its revenue optimisation model. The shares have fallen in the last year, even though management has upgraded their earnings expectations on a number of occasions, as growth companies have de-rated and the market has become bearish on the outlook for digital advertising and e-commerce spend.

Team17 is a developer and publisher of video games for PCs, consoles and mobile devices. The company focuses on the independent games market and selectively works with developers and third parties to launch new content on multiple platforms. The business listed in 2018 and has had a strong record of growth driven by well-received new releases, the monetisation of new content and improved profitability as the portfolio expands. With a balance sheet in a net cash position, the company has made a number of acquisitions of complementary assets. The decline in the share price in the last year was mostly due to the de-rating of growth companies and some small pressure on profitability from wage inflation.

Bellway is a national UK housebuilder. The housing market has remained very robust in the last year and demand for new houses is strong. House price inflation has offset materials and labour cost increases and margins have improved. The company has an excellent long-term track record of controlled expansion whilst maintaining a strong balance sheet. Although the company has delivered strong operational and financial performance, the share price has fallen due to the requirement for Bellway to take a large provision to cover the cost of remediating all fire safety deficiencies on buildings it has constructed over 11 metres high in the last 30 years. Additionally, the housebuilding sector has seen reduced investor confidence due to rising interest rates and potential economic slowdown.

Gamma Communications provides voice, data, mobile and internet-based telecoms to small and medium-sized enterprises in the UK and Europe. The company is focused on selling cloud-based telephony solutions, a market which is rapidly growing as users switch to more flexible services. The company has been highly successful with this approach in the UK and has recently expanded through acquisitions in Germany, Netherlands and Spain to replicate this strategy. We expect this positive growth to continue both organically and through further acquisitions in Europe. The share price decline in the year under review is due to the wider market de-rating of growth companies.

HSL : Henderson Smaller Companies suffers in growth selloff