Equity markets were thoroughly shaken earlier this year with the ‘great rotation’. Stocks which had outperformed in the preceding year or so tended to fall in value. Stocks which had underperformed tended to rise in value.
In our view, the rotation was largely unrelated to any change in fundamental data or expectations but was in essence a momentum issue. Our response was therefore predominantly to focus on our current positions, though this cost some short-term performance. We have felt for some time that present conditions favour careful stock-picking rather than broad themes and we continue to maintain a relatively neutral stance in respect of domestic and overseas earnings.
Within this, there is an emphasis favouring growth, balanced between ‘structural growth’ and economic sensitivity. Looking through the portfolio in detail, we can expect aggregate earnings growth around 11 per cent for this year and 18 per cent next year. This compares with a contraction of 3 per cent for the FTSE 250 for this year and growth of 11—12 per cent in 2015. The price-earnings ratio on the fund is a little higher than for the index, at 15.5x compared with 14.5x, but we feel the premium is justified given the superior growth prospects.
The portfolio is now down to just over 50 stocks, and we expect to sell off 2—3 more in coming weeks. Some 20 per cent of the fund is currently off-benchmark, mainly companies we like and which have done well for us and which have moved into the FTSE100. One result is that the ‘active exposure’ of the fund is now much greater.
Some examples of stocks we currently favour –
The company describes itself as the ‘food travel experts’. It runs concessions in airports and rail terminals, including outlets under such brands as M&S and Burger King. Kate Swann has lately stepped in as Chief Executive, bringing with her the wealth of experience gained in her successful turnaround of WH Smith, a brand with similar dynamics to SSP. The focus on travel terminals gives SSP establishments a greater degree of price elasticity than their peers in more generic locations.
SSP currently has profit-margins (EBITDA) of around 8.4 per cent, compared with over 10 per cent prior to 2008. If Kate Swann can impose cost-efficiency, and we believe she can, passenger-traffic growth and price inflation could combine to bring profit-growth to 20 per cent a year.
I make no apology for continuing to refer to Ashtead as an example the kind of stock we like. We first bought it on 9 April 2009 and between then and the end of August it returned 1968 per cent. It is a company that had the right strategy for its time and market. It recognised the US construction industry would increasingly adopt the UK model of plant hire and its management team aggressively pursued the opportunity to accelerate its growth at a time when deep recession increased demand for just such a capital-conserving approach. Now that the US economy is growing, companies have learnt the lesson of minimising capital investment, turning Ashtead from a company that prospered in recession to a company that is prospering from expansion. The stock is now 5 per cent of the portfolio and our only regret is that we didn’t buy more.
The merger of these two great brands creates a powerhouse of a retail distribution channel for electronic goods. We have liked both firms for some time now and, to borrow a phrase, we like them ‘better together’. The mobile operators are increasingly dependent on direct distribution and they are consolidating third-party retailers. In our view, Dixons/Carphone Warehouse will be a survivor, with the opportunity to benefit from the greater concentration.
Richard Watts is manager of the Old Mutual UK Midcap Equity fund