Q4 Portfolio Review


With 2014 coming to a close, it's time to look back at how the site portfolio performed in Q4 2014 and to put the performance into perspective against the wider market. The Q4 portfolio activity was largely minimal as a result of several factors including volatility within the UK stock markets, and the closure of numerous positions early in October. The FTSE 100 significantly underperformed its US counterpart, actually ending the year down by almost 3% partly as a result of extreme weakness in both the mining and energy constituents as a result of price collapses in various commodities. AIM was also dragged lower by nearly 18% for similar reasons, plus significant price drops in previously highly valued companies such as ASOS, Monitise and Quindell. Perhaps a better indicator of overall UK market performance is the FTSE 250, which ended the year up 0.9%.

Rating Changes

There have been a total of eleven rating changes during the period, nine of which closed out profitably, two that did not.

The changes in October were largely movements of stocks out of the portfolio as a result of a technically significant pullback in the UK indices, especially since the FTSE 100 had again failed to surpass the 7000 level.

The portfolio sales of Manx Financial Group, Panmure Gordon and Driver Group were directly as a result of market weakness and were consequently precautionary moves.

In fact, although these three are now lower than the portfolio sale price, the latter two have continued to perform well operationally, with stockbroker Panmure Gordon involved (on various scales) with over £350m IPO, fundraising and advisory work during the final quarter of the year. That leaves the company in a sound position to report strong results in 2015 and likely re-commence a dividend, barring a sharp market decline. On that basis and with the market cap roughly equivalent to Tangible Assets - Total Liabilities the company remains firmly on the site's watchlist. There has also been an interesting stake acquisition recently, and this appears to have helped clear the previous stock overhang. Therefore, although a circa 12% loss was taken on Panmure Gordon the shares appears strikingly undervalued. The caveat is that stockbrokers are incredibly reliant on wider market conditions to drive advisory and other work (much of which is related to IPOs and fundraisings).

Similarly, Driver Group has dropped to 90.50p at present as a result of market weakness and investors selling on recent results. Despite those factors, Driver unveiled 8.6p in EPS for 2014 and the acquisition of Initiate Consulting on a seemingly attractive multiple. Having also formed a Joint Venture in the Middle East earlier in December, and winning a £7.8m contract in Oman in November, Driver appears increasingly well placed to drive earnings forward in 2015 and 2016, even though over 1.5 million shares were issued as a result of options exercises. Driver is trading on FY15 prospective earnings of around 10 and likely between 8 and 9 for FY16.

I noted the following in the Q3 Portfolio Review. "With market conditions likely to remain volatile, and commodity prices a key consideration for several portfolio stocks, I re-iterate the need to remain flexible with portfolio positions and I will not hesitate to close out positions if weakness looks likely, or to simply lock-in gains."

That is exactly how Q4 has played out positions in all the portfolio's oil stocks - Fastnet Oil & Gas, Petroneft Resources, Trinity E&P - being exited early in the quarter. That process included taking a considerable loss on Trinity, but reflected my increasingly bearish expectations for the oil price once $100/barrel had been broken for Brent Crude. Indeed, the last of the three exits was Trinity when the brent crude price was circa $87/barrel. Those bearish expectations have played out with brent now trading around a third lower than the $87 level. Unfortunately, as a result of the oil price weakness I consider most of the sector to be unattractive and it makes sense to wait for signs of a more serious price recovery before looking at companies with a production reliance on oil.

What the movements out of the oil positions (when I did) does show is the inherent benefit that private investors have over institutions; private investors benefit from trade agility where it's far easier to exit positions given the relatively small trade sizes. Consequently, it makes complete sense in such situations to exit positions early if a fundamental shift has occurred as if the shift has longevity, then the presence of institutions can end up as a lead weight on the share price as they slowly unwind their position. That is something that has occurred with Trinity E&P.

Spectra Systems was also moved to No Rating following an unsuccessful banknote trial with Banco de Mexico; this was not the main catalyst for the move, and the company has since updated positively on its Aeris patent. The main catalyst was the slippage in the Aeris commercialisation timescale without clear reasoning, and this could suggest further refinement of the technology is required first. Nonetheless, a gain of over 30% was locked in.

The portfolio stake in Regenersis was also cut back for a circa 13% gain following erratic price movements triggering a trailing stop loss. That said, the technical outlook appears bullish, and financial forecasts remain attractive; the single obstacle towards re-opening a position is the existence of a new 0.7% short position by GSA Capital Partners.

On the topic of short positions, the site position in Concha was closed out during the period as a result of continued volatility and uncertain technical movements. The valuation remains ludicrous but supported by external buyers or stock likely known by Chris Akers. In the long-term the share price will probably be considerably lower unless the eventual deal is phenomenal, which remains unlikely.

OptiBiotix Health was one of the more appreciable success stories for the quarter with a gain of 76% locked in after just over 6 weeks, or over 12.5% per week. The re-rating was largely the result of revised investor expectations of the newly formed company and as a result of the speculative investor purchases outlined at the initial review.

The final portfolio change for the period was of Bushveld Minerals, which continues to transition itself towards a vanadium focus in light of the iron ore price decline to circa $70/tonne, which undoubtedly has severely set back the iron ore project, and the overall distaste for mining projects means the project finance remains difficult. The pricing assumptions contained within the vanadium scoping study do mean the IRR and NPV at current prices are a great deal lower than the headline figures, but there should be room for improvement given a subsequent triple digit resource increase and several optimisation possibilities. Alongside that, Lemur Resources has launched a share buyback, the Darwin facility has been closed, and a vanadium Pre-Feasibility Study (PFS) has been launched. Cash remains the crucial issue for Bushveld, but from a medium-term perspective a sustained rise in the share price above 3p could signal a change in fortunes.

Portfolio Companies

The portfolio remains well diversified - albeit slimmed down with just 8 slots filled - with companies operating in the following sectors:
Fixed Line Telecommunications [ADT]
- Forestry & Paper [AEG]
- General Retailers [AO (S x2)]
- Home Construction & Household Goods [TW]
- Leisure Goods [CCT]
- Travel & Leisure [FLYB, PEL]

Notably, the 8 portfolio positions are now largely focused on companies with intrinsic value propositions, and that is reflective of the current market uncertainty. The result of this portfolio structure is that it has allowed for outperformance of the market indices, yet each holding remains within the portfolio for sound reasons and unlike in the previous quarter, these companies should be capable of performing well even if there is a further downward drift over the first half of 2015.

I'll start with online white goods retailer AO World, where the site portfolio has a 2x short position hence taking up the full allocation available for a company. This is the sole company of the eight that is in the red. I initially covered the company at approximately 205p where I concluded the valuation was extremely generous, but that it would make sense to keep a stop loss around the 230p level. That would have been a prudent move to make, but I made a common mistake to ignore the technicals and persevere with the short on the basis that the fundamentals are highly unattractive in my view. Naturally, the technical outlook has firmed up and the share price has advanced to circa 280p at present.

Having opened a second position during the course of the month, the average portfolio price has risen to around 252p meaning that there is a loss of 11% outstanding. The price rise appears to have materialised on the back of both periodic institutional buying (below the disclosure levels), traders buying the recovery, a short squeeze taking place and private investors accumulating shares. However, with institutional short positions being increased again and EPS forecasts from Shore Capital and Canaccord Genuity appearing lofty, I have no hesitation in keeping this position open. The assumptions used in Numis Securities' FY2016 earnings forecasts appear most sensible and point towards a 2016 PE ratio of 118, which is in bubble territory.

Taylor Wimpey remains the largest capitalised stock in the portfolio with it recently entering the FTSE 100, which is testament to the excellent share price performance. The share price is towards its multi-year highs and with housebuilders typically enjoying a strong Q1 I have increased my target price to 150p as a reflection of the market accepting higher valuation multiples across the sector. Interest rates remain at the record 0.5% low and are likely to remain so through the most part of 2015; if they rise, the rise is likely to be small and gradual, which is supportive for demand for housing. On an individual level, Taylor Wimpey boasts a strong free cash flow yield and remains attractively valued compared to peers; at 137.8p it trades on a 2015 PER of 9.6 and should return over 6% in dividends in financial year 2015. Excluding dividends, the portfolio holding is up 22.3% since October, which demonstrates the potential for attractive gains with large-caps.

The move to initiate a Buy tag on The Character Group paid dividends with the release of excellent FY2014 results and international growth proving an engine for further upside, as outlined in the initial review. As a result of the excellent results and outlook, the technical situation has also played out as anticipated, with the pivotal ~215p - 220p band conclusively broken through. The valuation still looks attractive too, with expectations for 2015 substantially upgraded after a robust start to pre-Christmas trading. Broker Charles Stanley certainly took note that their forecasts were particularly cautious and upgraded 2015 EPS forecasts to 36.84p, suggesting a forward PE of just 7.3. A continued uptrend looks likely to add to the 31% gain already recorded.

AdEPT Telecom was a recent addition to the portfolio with the reasoning for the addition covered over two articles. What I would stress is that investors need to be more aware of the free cash flow generation of companies they are invested in. For income-producing stocks, free cash flow is ultimately what matters; it's a proxy for the ability of a company to pay dividends or embark upon share buybacks should they so wish. There are numerous companies on AIM who supposedly report excellent profits, but don't actually generate cash; InternetQ, Globo and K3 Business Technologies are just three technology companies trading on extremely high multiples of free cash flow. AdEPT is the complete opposite and is a cash generating machine. The share price has advanced 11.7% from the portfolio open price and the free cash flow generation has enabled the company to start a share buyback up to a maximum ~3.3m shares. This should assist in driving a re-rating and ensure the EPS continues higher.

There has been a profit warning for one portfolio company, and that was for Active Energy Group. The reason for the warning was not fully company related; rather it was linked to port activity in Ukraine being prioritised for the import of coal for the Winter period. Despite that, AEG reported its first operating profit, and the focus should remain on Canada, which is the flagship asset now and boasts over 34.8 million cubic metres in the first land package for sale. Marketing for the first package of ~108,000 hectares (that are deemed most attractive) has started and there should be progress over the course of Q1. The relative insignificance of the Ukrainian asset is shown by the share price ending flat on the previous quarter. The position is up 86%.

The final two companies to look at operate within the Travel & Leisure sector. Flybe was a new addition to the portfolio during the period, and although half-year results fell shy of expectations, the long-term investment case is intact and built against a highly credible management team. After taking advantage of the dip on results, the portfolio average stands at 102.9p, and the position is in mid single digit profit. The sharp drop in oil prices should enable Flybe to hedge at much lower costs into the future and the recent announcements of reducing/scrapping Air Passenger Duty should enable incremental profit improvements. The outstanding issue still is the grounded planes and associated cash burn, but a resolution on that front could drive a sharp re-rating upwards and unlock long-term prospectivity. Several partnerships were formed during the period, which all add to the investment case, and this is likely to be a scenario where taking a patient approach and backing the management team could generate attractive returns. In the interim, it is wise to keep a mental stop loss just below 105p support as the technical position is not particularly bullish.

I end with the enigma that is Paragon Entertainment, a nano-cap company by any measure. I did suggest that I may have re-looked at Paragon after the Q3 portfolio review, but after consideration it made sense to await company news to mark a change in sentiment. After all, the company unveiled two profit warnings since the original review. The share price is currently 2.25p, capitalising Paragon at £4.22m. Towards the end of Q4 the share price was languishing at a lowly 1.5p, and after a further drop, I doubled the position at 1.4p (as per the real-time tweet) prior to a swift recovery to the current level.

However, that profit is immaterial relative to the initial review price, and there are further reasons to be highly optimistic of a successful 2014. Although in the Design & Build segment the company are often bound by confidentiality, the AGM presentation viewable here points towards several positive indications for the months ahead. Notably, the company is broadening its partnership with Greek listed LAMDA Development and is working with Hamleys to develop its Hamleys World offering. Further guidance from the company is required to confirm the exact scale of these opportunities, although they could and should eclipse the market capitalisation.

The site portfolio has performed well again during Q4 despite tricky market conditions and a continued weak performance in relevant market indices. With the site watchlist growing to well over 25 companies, there are attractive opportunities re-opening in the market, and alongside the bullish performance and outlook for the companies currently in the portfolio, Q1 appears as though it has every chance of being another positive quarter. 2014 has been a highly successful year for the site portfolio against an unfavourable backdrop. Happy New Year and I wish you a successful 2015.

4 comments:

  1. Thanks for all your ideas and excellent picks in 2014 el1te :0). Long may it continue.
    HNY to you

    ReplyDelete
  2. Merry 2015 and keep up the fab work!

    ReplyDelete
  3. Happy new year El1te. I look forward to another year of incisive and thorough analysis.

    ReplyDelete
  4. Thanks for all your effort and stuff from 2014. Let us hope the markets are kinder in 2015 so that it is easier to make money!

    And hopefully the Toon can recover from the brink of disaster :(

    CraigJ

    ReplyDelete