May 2020 portfolio update

The COVID-19 saga moves onto the next chapter. Some welcome moves towards normality with businesses gradually opening. Lock-down fatigue certainly seems to be setting in at Chez Sleepy, I can't see everyone accepting a similar level of restriction if we get further waves of infections.

In other news it's nice to see The Donald getting back to normal and stoking the China trade war embers once again. I expect this will be a central plank (and useful diversion tactic) of the orange buffoon's re-election strategy, so more volatility awaits.

A couple of reassuring updates were announced from companies in the portfolio this month, giving me comfort that whilst we're not out of the corona woods, the businesses in which I'm invested seem to be managing their way through the mess that lock-down has created. The most impacted of my core holdings is Compass, the global catering firm, who have been taking the appropriate steps to shore up the business and this month issued shares to raise funds to avoid taking on more debt. I was tempted, as the offer was open to retail investors, and at a fair discount but ultimately I think it could take them a while to recover the business back to previous levels so decided to pass. We are yet to see what impact the virus has on the daily operations of businesses, including Compass, what has been on display so far is the aftershock of an economy being put into hibernation. All will become clear over the coming weeks and months, particularly in the next round of corporate reporting.

I'm continuing my cautious approach of waiting for business updates to get some understanding of the state of their operations and finances before any investments. Historical data has to be taken with a decent amount of salt at the moment. A positive set of preliminary results from defence firm Qinetiq saw it jump from the watchlist to the portfolio this month.

Portfolio performance
The portfolio was up 3.8% in May, slightly behind my chosen benchmark the Vanguard FTSE All Share Accumulation which was up 3.9% over the same period.

Best performers this month:
Saga +28%

Abcam +16%
Tritax Big Box +15%

Worst performers this month:
Compass -11%
AB Dynamics -6%
PZ Cussons -6%

May share purchase: QQ.
Defence firm Qiniteq was added to the portfolio in May. They were spun out of a UK Government defence research agency in 2001, and listed on the stock exchange in 2006. There are a supplier of defence services including various technologies, R&D, testing and assurance capabilities, mainly to the UK Govt where they have a long term arrangement with the Ministry of Defence. 

Their other main customers include the US and Australian Governments (the "home countries"), which along with the UK provide their main sources of revenues. Increasing exposure to other international clients and diversifying their customer base is part of the current strategy and appears to be bearing fruit. But this is at the expense of taking on shorter term deliverables, which provides less visibility over earnings than the longer term contracts with the "home countries".

Qinetiq have a sticky customer base, the sensitive nature of the products and services being transacted coupled with the amount of red tape to become a trusted supplier offers a moat of sorts. A recent update indicated that COVID-19 had not disrupted the company unduly. Revenues and profits were up, and the order backlog is growing nicely.

Revenues have been picking up in recent years following a change in strategy a few years ago. Return on capital and net margins have both been in double digits since 2015, and the balance sheet is healthy with a nice net cash position. Dividends are on hold at present whilst COVID-19 is doing the rounds, but there is a progressive policy and it has been covered by free cash flow.

With the above sticky customer base comes a risk of course - with a small number of customers providing revenues, should any of these decide to move to an alternative supplier it could be painful for Qinetiq. Another risk is that should we enter a horrible recession that leads to government defence budgets being reduced, it's likely Qinetiq will also feel the squeeze.