Liontrust UK Smaller Companies Fund

April 2018 review

The Liontrust UK Smaller Companies Fund returned 3.1%* in April, compared with the 7.0% return from the FTSE Small Cap (excluding investment trusts) Index. 

Equities rebounded strongly on an easing of the trade war worries which had stifled markets in March. Although China revealed some (fairly tentative) retaliatory tariffs of its own early in the month, April saw an acceptance that the confrontational rhetoric may well give way to a more pragmatic solution. From a geopolitical standpoint Donald Trump’s Twitter attack on Russia – for supporting a Syrian regime accused of using chemical weapons – would in normal circumstances be expected to spark some signs of risk-averse behaviour, or demand for ‘safe haven’ assets. However, April also brought us the spectacle of Kim Jong-Un becoming the first North Korean leader to set foot in South Korea for over 60 years, alleviating one of the largest geopolitical risks of recent months. 

A number of portfolio holdings experienced share price moves which were news driven, encompassing financial results, trading updates, acquisitions and fund-raisings. 

Sumo Group (+28.8%) provides a range of services to the video game industry. It was added to the Fund in December of last year during its initial public offering (IPO). Shares in the company rallied strongly on the release of its first set of final results as a listed company. The rise was catalysed by outlook comments referring to a strong start to 2018, leaving it on course to be slightly ahead of consensus market expectations for the full year. Due to its change of ownership structure in late 2017 – moving from private equity to public ownership – and the associated reduction in debt and financing costs, the audited results are not an accurate guide to the balance sheet and profit & loss picture we might expect to see in 2018. The accounting impact of such a change in ownership/financing structure is one of the many investment considerations when deciding whether to participate in an IPO. On an underlying, adjusted basis, Sumo Group’s revenues rose 40% year-on-year to £28.6m while adjusted PBT increased by a similar rate to £7.5m.

In its outlook comments Sumo Group took a bullish tone on the growth of the market for videogame development services, noting that global videogaming is already estimated to be worth over US$113bn and forecast to grow at an average annual rate of 8% through to 2021. Sector peer Keywords Studios (+21.9%) would almost certainly echo these sentiments. The company is enjoying rapid growth, fuelled by acquisitions, as it looks to consolidate what it considers to be a highly fragmented market. Final results released in April showed a 57% increase in revenue to €151.4m, which was primarily driven by the inclusion of 11 businesses it purchased. Stripping the acquisition effect out, revenue rose 15% on a like-for-like basis. Within the statement, the company referred to a healthy acquisition pipeline, so more deals can be expected.  In fact, on the same day as the results release, Keywords Studios announced details of two further bolt-ons: Cord Worldwide and Laced Music Limited. The two businesses are being bought from Cutting Edge Group for a consideration of £4.5m.

Unfortunately, results from Proactis Holdings (-44.1%) were less well received. In six months to 31 January 2018, revenues more than doubled to £26.4m and adjusted EBITDA (earnings before interest, tax, depreciation and amortisation) rose 180%. The sales increase was almost entirely the effect of acquisitions; underlying revenue growth was 3%. Proactis commented that up-selling and cross-selling between existing customers and acquired businesses had been positive. However, it stated that revenues had not increased as it would hope due to the loss of some customers and the restrictive effect of sterling on sales into the US. The company commented that it does not expect further customer losses this year, and has a strong order book of £47.8m, with annualised contracted revenue to £45.5m. Nevertheless, the shares were de-rated on the news of customer departures. 

In more positive news, Clipper Logistics (+23.6%) announced a contract with PrettyLittleThing.com, part of boohoo.com, to provide logistics services from a new site in Sheffield. Although no financial details were revealed by Clipper, the share price reaction reflects its description as “one of the Company's most significant contract wins”. Clipper also updated on trading, stating that the year to 30 April 2018 had been in line with its expectations for revenues and earnings. 

Learning Technologies Group (+18.2%) announced the reverse acquisition of PeopleFluent, a provider of cloud-based recruitment and HR solutions, for a cash consideration of £107m. The deal is expected to more than double Learning Technologies Group’s (LTG) revenues to around £135m and boosts its presence in the US. Over 85% of PeopleFluent’s sales are recurring in nature compared with 39% for LTG, lifting the combined entity’s average to around 68% - just shy of the level at which we would consider it to represent an intangible asset with Economic Advantage characteristics. LTG expects to integrate the two businesses within 100 days, and states that it should be “immediately and significantly earnings enhancing”. Investors concurred with LTG’s upbeat appraisal of the deal, pushing the shares 18% higher over the month to finish at 104p. This strong gain was registered despite the acquisition being financed by a share placing to raise £85m at 98p.

Aside from Proactis, Animalcare (-27.9%) was one of the portfolio’s largest detractors. A trading update warned that 2018 earnings will be below market expectations due to “a changing sales mix and competitive pressures” squeezing gross margins. Investors paid little heed to management’s indication that synergies and cross-selling from recent acquisitions should boost profit margins from 2019 onwards. Shares in the company peaked in March 2017 but have drifted since the £134m reverse takeover of Belgian Animal Pharmaceutical business Ecuphar last summer. 

RWS Holdings (-17.0%) also experienced share price weakness, the result of a half-year trading update which commented on the impact of currency trends and the initial performance of Moravia, a business acquired in late 2017. RWS warned that dollar weakness against the pound, if maintained, would lead full year profits to fall short of consensus. RWS’s recent acquisitions in the US – LUZ, CTi and Moravia – have extended its operations beyond patent translation and into specialised IP support to sectors such as technology and pharmaceuticals. While this move has sound strategic logic, the Moravia purchase has experienced some teething problems in the form of lower-than-expected activity from certain clients. 

However, RWS commented that Moravia’s pipeline of new opportunities is strong, while integration of the business has identified more cost synergies than had been anticipated. We view this setback as a short-term hiccup and have taken the opportunity to buy into share price weakness. The effect of currency trends on profitability is very much a case of “swings and roundabouts” and has no impact on the Economic Advantage attractions which we have identified in RWS. 

The position in Idox was closed during April, the conclusion of a sale process which was initiated after management’s share ownership fell below 3%, the threshold level we require of smaller companies in the Fund. 

Omega Diagnostics was also removed following a mid-month trading update which included a downgrade and strategic review by new CEO Colin King. Despite possessing intellectual property, and recent positive news on its CD4 test for HIV, the company has struggled to make progress in recent years as the theoretical Economic Advantage it possesses has failed to turn into meaningful financial returns. In addition, due to the lack of growth, the position had become de-minimis in overall fund terms. 

The Fund bought Hilton Food Group, a business specialising in processing and packing food for supermarkets, with Economic Advantage credentials in the form of a strong distribution network. The main driver for Hilton’s business is that there is an increasing focus on the quality and integrity of the supply chain for retailers, particularly in the wake of several recent scandals where the provenance of fresh food has been called into question (such as the ‘horsemeat’ outcry of 2013). The company positions itself as a ‘trusted supplier’ to its customers, working together with them and constantly innovating to achieve better outcomes. It is testament to the calibre of these relationships that Hilton’s typical contract with a new customer is around 10 years in length. The company already has a strong market position in packing of meat products, but added capability in fish produce with the acquisition of Seachill last year.

Positive contributors included: 
Sumo Group (+28.8%), Clipper Logistics (+23.6%), Keywords Studios (+21.9%), Learning Technologies Group (+18.2%) and Tracsis (+16.8%).

Negative contributors included: 
Proactis Holdings (-44.1%), Animalcare (-27.9%), RWS Holdings (-17.0%), Curtis Banks (-7.6%) and Gateley Holdings (-5.7%).

Discrete years' performance* (%), to previous quarter-end:

 

Mar-18

Mar-17

Mar-16

Mar-15

Mar-14

Liontrust UK Smaller Companies I Inc

17.1

26.3

18.1

-3.0

34.6

FTSE Small Cap ex ITs

2.2

19.7

5.9

1.2

32.3

IA UK Smaller Companies

14.9

18.7

8.2

-2.1

29.7

Quartile

2

1

1

3

2


*Source: Financial Express, as at 30.04.2018, total return (net of fees and income reinvested), bid-to-bid, institutional class.
 
For a comprehensive list of common financial words and terms, see our glossary here.



Key Risks

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. The issue of units/shares in Liontrust Funds may be subject to an initial charge, which will have an impact on the realisable value of the investment, particularly in the short term. Investments should always be considered as long term.

The portfolio is primarily invested in smaller companies and companies traded on the Alternative Investment Market. These stocks may be less liquid and the price swings greater than those in, for example, larger companies.

Disclaimer

This content should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Examples of stocks are provided for general information only to demonstrate our investment philosophy.  It contains information and analysis that is believed to be accurate at the time of publication, but is subject to change without notice. Whilst care has been taken in compiling the content of this document, no representation or warranty, express or implied, is made by Liontrust as to its accuracy or completeness, including for external sources (which may have been used) which have not been verified. It should not be copied, faxed, reproduced, divulged or distributed, in whole or in part, without the express written consent of Liontrust. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.

Thursday, May 17, 2018, 5:01 PM