Portfolio COVID-19 update

Given the destruction wreaked upon the markets of late, it seemed like a reasonable time to reflect on the status of my investments.

My goals are pretty simple and can be distilled into 2 key points:

• Don’t lose money
• Build a portfolio of dividend paying investments

There is more finesse to these goals detailed here but it boils down to these two things. Since I’m looking to these investments to supplement my pension in a few years, I’m principally looking for income over capital growth.

Many businesses are experiencing disruption to both supply and demand, hardly a recipe for fat cashflows and pristine balance sheets. I’ve been through each of the investments that make up the core of my portfolio and the updates provided by each company over recent weeks, and tried to guess what the likely short-term and long-term impacts are likely to be.

Company	Business activity	COVID-19 update	Likely short-term impact	Likely long-term impact
Abcam	Provider of biological ingredients, kits and information to life sciences	9th March Chinese impact to operations quantified. Further impact outside of China unknown.	Reduced turnover and potential supply chain disruption. Possible increase in demand for products if relevant for COVID-19 research.	Little impact. Potential for increased funding for life sciences as a reaction to global pandemic which might benefit Abcam.
AG Barr	Soft drinks	23rd March Delayed annual results. Contained update on COVID-19.	Not material so far. No immediate interruption to production, hit to demand, balance sheet ok.	Little impact.
Compass	Contract catering	17th March Severe impact from March onwards.	Severe impact. Possible breach of debt covenants if impact continues.	Assuming customers remain trading, long-term impact should be positive. Compass should have scale to take market share from smaller businesses or to acquire these at lower prices.
Computacenter	Tech services	12th March	Increased demand for remote working. Potential for decreased technology infrastructure.	Likely to see increased spending in ecommerce and ensuring resilient remote working.
Foresight Solar	Solar energy provider	9th March FSFL Statement: No impact	Minimal impact.	Minimal impact.
Glaxosmithkline	Pharmaceuticals and consumer health products	5th February GSK Statement: Impact unknown	Reduced turnover and potential supply chain disruption. Potential increase in demand for any respiratory medicines.	Potential for increased funding for research and respiratory medicines.
National Grid	Energy infrastructure	None	Minimal impact.	Minimal impact.
Nextenergy Solar	Solar energy provider	20th March No significant impact. Cancellation of scrip dividend.	Minimal impact.	Minimal impact.
Nichols	Soft drinks	None	Reduced turnover and potential supply chain disruption	Little impact.
Reckitt Benckiser	Consumer goods	27th February Some disruption to Chinese supply chain	RB’s portfolio contains a number of household cleaning products which should benefit. Potential supply chain disruption.	Little impact.
Telecom Plus	Utilities and telecoms reseller	None	Little impact.	Little impact.
Tritax Big Box	Distribution centre property REIT	17th March Vague risk around global recession.	BBOX customers include retailers that could become distressed, e.g. M&S. These could look for rent reviews, or even potentially fail.	Potential for increased demand for online sales during COVID-19 outbreak. If ecommerce gets even more ingrained into consumer habits it could benefit BBOX.
Unilever	Consumer goods	30th January Statement: impact unknown	Little impact.	Little impact.

The true extent of the disruption is unknown, and fortunately for most of my investments is it unlikely to be crippling. The one exception is Compass. Compass is a catering company, providing catering services to business, governments, events, and have the market essentially split with Sodexho.

By my calculations if the current levels of disruption continue for too long, they may breach their debt covenants. Exactly what this means is unclear, if the loan defines covenant breaches as ‘potential’ or ‘actual’ events of default. The lenders may either have the right to demand immediate loan repayment – which with a cashflow crunch may not be ideal. Watch this space (from behind the sofa)

Compass update and back of the envelope calculations below:

"Compass' organic revenue growth for the five months ending 29 February 2020 was 6% as measures to contain the virus in our Asia Pacific region did not materially impact our business. Our operating margin during that five month period increased by around 10bps with the benefits from the restructuring programme in Europe coming through strongly. 

However, the acceleration of containment measures adopted by governments and clients in Continental Europe and North America have affected our expectations for the Half Year. The vast majority of our Sports & Leisure and Education business in these regions has been closed, and our Business & Industry volumes are being severely impacted.  Our current expectations are that Half Year 2020 organic revenue growth should be between 0-2%.  We are implementing significant mitigation plans to manage our costs, and at this stage expect the drop-through impact of the lost revenue to be between 25%-30% across the business.  As a result, our operating profit for Half Year 2020 will be £125 million - £225 million² lower than expected.

We are working to protect our cash flow and are pro-actively managing our capital expenditure and working capital.  We have significant headroom against a 4x net debt/ EBITDA covenant in our US Private Placement Agreements and we have substantial liquidity with a £2 billion committed Revolving Credit Facility³ maturing in 2024.  Stable outlooks have recently been reconfirmed on our A/A3 credit ratings."

Revenue for 2019 was £25.2 billion, the update indicates a 25% - 30% loss of revenue but it is not clear over what time period. Assuming the whole year that would put the 2020 revenue around £17.6 billion, similar to 2015 revenues, roughly where the share price is at the moment.

Based on the update, most of the impact has occurred in March, as for 5 months ending in Feb, revenue was up. For 1 month losses were material enough to result in projection of operating profit being £125m - £225m lower than expectations. EBIT consensus projections on the Compass website for 2020 are £1950bn, which breaks down roughly as a £163m per month. That's not going to leave a lot of spare change if the bad end of the losses plays out.

Net debt was last reported as £3.3bn, the update states that they need to keep net debt/EBITDA to 4x, which implies EBITDA needs to be greater than £800m to keep out of trouble with the bank. 2019 EBITDA was £2.5bn

Coronavirus March Meltdown

February and the first week of March have seen a sizeable slice of value taken off of the stock markets, thanks mainly to the COVID-19. Oil prices are taking a hammering and the recent failure of OPEC to come to an agreement to cut oil production is only likely to exacerbate the decline in oil prices. Add in a bit of hard Brexit and there's a pretty potent mix, for the UK markets in particular.

China seems to be slowly coming back online, but we are seeing increasing numbers of infections reported across other regions. In the UK the FTSE has seen a couple of days of selling that appear to be particularly panicked, so I thought it would be interesting to see what has sold off, and by how much. There is a googlesheet here with the data and charts.

The FTSE100 has lost around 13.5% over the last month or so, the red line on the chart below shows the index performance.

Perhaps unsurprisingly travel, miners, retailers and financials are all taking a hit, losing more than the index. Utilities and supermarkets all holding up. I find it interesting to see which businesses have more resilient share prices, and wonder which are getting caught up in the selling, and are unlikely to see much impact from the virus when the dust has settled. Smith & Nephew for example is a healthcare company selling medical devices and wound dressings, and is down 10%.

I also wonder whether those more resilient share prices are actually the companies in which I want to invest. After all if a global pandemic, oil price crash and resurrections of a hard Brexit don't make a dent in the prices, they are probably the sorts of companies I'm after.

February 2020 portfolio update

COVID-19. Cheeky little feller, causing a bit of a nuisance.

The markets are thrashing around trying to work out how to price it in, and have gone from exuberance to despair in a few days. A somewhat predictable reaction, with apparently indiscriminate selling. I imagine we will see selling continue for at least a couple more weeks, with some small relief rallies in between, until the headlines get more positive, or stocks all go to zero. Fingers crossed for a vaccine being developed quickly (preferably by Glaxo 😎).

Anyway nothing bought or sold during Feb, and as there's a whiff of panic in the air I'll keep my cash in my wallet and hope to pick up some bargains once the selling eases up.

Portfolio performance
The portfolio was down -8.3% in February, losing less than my chosen benchmark the Vanguard FTSE All Share Accumulation which was down -8.9% over the same period.

Best performers this month:
Dignity +1%
Craneware -0.3%
Next Energy Solar -1%

Worst performers this month:
AB Dynamics -23%
SAGA -23%
Abcam -17%

Rule number 1: don't lose money

With the markets having a few wobbles I thought it a good opportunity to ponder what happens to investments when share prices drop.

A certain Mr Buffett with his folksy wisdom often wraps deep insights into absurdly simple language. He insists that the first rule of investing is to not lose money. And that the second rule is not to forget rule one. Clearly losing money is never fun, but we can recover this fairly quickly if the price picks up, can’t we?

The table below illustrates why Buffett’s words are key:

Loss	Gain required to breakeven
-10%	11%
-20%	25%
-30%	43%
-40%	67%
-50%	100%
-60%	150%
-70%	233%
-80%	400%
-90%	900%

It shows us that a loss of 10%, needs an 11% uplift to get back to where we started. No problem. But a 50% loss requires a 100% gain to recover the loss. Percentages can be a little slippery, so to put it into more concrete terms:

Starting investment value = £100

10% loss = £10

New investment value = £90

A 10% increase of the new value of £90 only takes us to £99, not the original £100. For this we need an 11% uplift.

Starting investment value = £100

50% loss = £50

New investment value = £50

A 50% increase of the new value of £50 only gives a return of £25 so only takes us back to £75. To get back to the original £100 we need a 100% increase.

A chart shows these nasty consequences clearly:

We can use the same arithmetic to get another perspective on gains and losses:

Starting investment value = £100

Gain of 100% = £100
New investment value = £200

A loss of 50% = £100

Taking the value back to £100

A more dramatic example in my view is the 233% gain in the chart above, which needs only a 70% drop to wipe out all of the gain.

A google sheet is available here with this chart and some sample calculations.

A significant loss recorded against an investment could therefore take a while to get back into positive territory. But also a significant gain could be wiped out with what appears to be a much smaller loss.

Based on the above, losses can have a disproportionate impact on gains, and a portfolio. And it should be evident that a see-saw of gains and losses would end up with an investment losing money. The extent to which this could happen is modelled in the chart below. This shows the result of a successive gains and losses of 10% iterated 100 times.

The values start at 100 and drift slowly down to 60.5, despite the percentage gain being the same 10% gain or loss each time.

The trend is clearly downward. This is simply because the loss is always calculated from a larger number than the gain. This would be the same for any consistent repetitive gain/loss over time.

Of course the stock market doesn’t behave like this and the impacts are not played out like this. However, it is hopefully enough to give pause to also focus on avoiding losses in addition to making gains.

January 2020 portfolio update

The UK markets were drifting sideways during the start of January, and US markets predictably continuing their upwards march. Then everything went a bit George Romero with the appearance of  Coronavirus. Shares started getting sold off in what appeared to be a rather indiscriminate way, but with Asia exposed equities bearing the brunt.

If the news media are to be believed, we have an impending apocalypse, so share prices are the least of our worries. Perhaps a more likely scenario is a short-term health scare that is resolved over the next few months. If a few bargains present themselves I might as well indulge, after all if we return to normal, I'll have bought some shares at a discount. If the end is nigh, it won't matter anyway, checking my portfolio is likely to drift down the to-do list in favour of barricading the windows and hunkering down over my last tin of beans.

Portfolio performance 
The portfolio was down -0.6% in January, losing less than my chosen benchmark the Vanguard FTSE All Share Accumulation which was down -2.8% over the same period.

Best performers this month:
National Grid +7%
Fulcrum Utilities +7%
AB Dynamics +5%

Worst performers this month:
Craneware -26%
SAGA -21%
888 Holdings -18%

January share purchase: NICL
AIM listed soft drinks company Nichols (NICL) joined the portfolio this month. Nichols have a portfolio of products, the most iconic of which is Vimto. They have sat on the watchlist for a while, and my interest began to perk up when the share price started drifting downwards after bumping against a previous high point. Then just before Christmas the company released an update stating that in one of their markets, the Middle East, Saudi Arabia and UAE were applying a 50% tax to soft drinks. The share price predictably tanked by around 20%. Given that this region generated just under 7% of revenues in 2018/19, it seemed a typical market over-reaction.

Nichols have some great operating numbers: ROCE over 20% in each of the last 10 years, along with double digit net margins, no debt, plus a dividend well covered by free cash flow that has increased by an annualised 13% over the same time. They have been able to generate these sorts of returns by outsourcing the production of their main brand - Vimto - and by doing so greatly reduce the capital requirements of the business. Vimto is also licensed for production in other confectionery products, again with minimal capital.

Revenues and profits have been ticking upwards over recent years, while the share price has remained fairly flat, possibly due to it getting an excessive premium which it needed to justify. The Middle East taxation issue shouldn't put too large a dent in either top or bottom line, even with a bit of additional marketing in the region. 

The business was founded in 1908 and was listed on the AIM market in 2004. John Nichols, the grandson of the founder of the company remains on the board as Chairman, and owns 2m shares which amounts to a 5.5% stake in the company, worth around £27m as at the time of writing. Other members of the family also own shares and are employed by Nichols, so they have an interest in ensuring the ongoing success of the business.

2020 Goals & strategy review and update

Taking a look back at previous performance with a critical eye is a good discipline, I find it helps to reset. It's useful to find those areas of success and failure, to pat oneself on the back and dust off any hubris at the same time. But it is inherently backwards looking, so with the 2019 review out of the way it's time to look ahead and to think about goals, my strategy for achieving them, and how to track progress against them.

Long term goals
My investment goals posted at the start of last year were modest, but realistic:

• Don’t lose money
• Increase capital by more than the rate of inflation
• Build a conservative dividend paying portfolio

And I would also wanted to beat the UK stock market, as measured through the FTSE All Share. The reason for this final ambition was simply one of risk vs. reward. If I was unable to beat an index fund  by picking individual stocks, then I should buy the index fund as this would provide better reward for (arguably) less risk (see my post on index funds for more thoughts on this).

The above long term goals are fine I believe, and do not need to change. However, I think they do need more detail which is below:

Don't lose money.
Hopefully self explanatory...

Increase capital by more than the rate of inflation.
The price of the shares that I own is going to fluctuate, but over the long term, if I have invested in quality businesses they should increase in value. So long as they increase in value faster than inflation, should I decide to sell them, I will end up with more money than I started with - in real terms. Perhaps an unambitious goal, but very much linked to the first one above.

Build a conservative dividend paying portfolio.
This is the key goal for me, as I want to use this investment to generate income in the future. I want the portfolio to have a relatively low level of volatility, and to be consistently paying dividends, and for those dividends to be growing. The dividend growth will be partly organic - through the businesses in which I'm invested growing their dividends, and I will continue to increase the amount invested to also increase the dividend return.

Not every investment will be dividend focused. If I notice an interesting business, that is attractively priced, I may invest - but these will generally form the smaller, non-core elements of the portfolio. 

Goals for 2020

The shorter term goals for 2020 are unexciting, which is essentially to do more of the same. Investing in quality, low risk businesses that pay dividends.

My strategy for the upcoming year is to continue to build a low risk portfolio of dividend paying stocks. As at the start of January 2020 I am invested in 24 businesses but only around 12 of those I consider to be core holdings. I would rather continue to diversify before building the existing core holdings. Some of the small positions I have I will add to if the prices are appropriate, others I will keep as smaller holdings as I think they have greater risk. I would like to get to around 30 core investments with roughly equal amounts invested into each. I will continue to search out lower risk businesses that look to have certain indications of quality - high returns on capital, good margins, good cashflow, and preferably low debts. The portfolio will continue to maintain larger holdings in relatively low risk investments, with a few small racier positions to complement them.

Selling activity is likely to be limited, but if the business no longer meets my investment criteria it will leave the portfolio. As a result the portfolio churn will hopefully be minimal.

Valuations

I have also considered what value my portfolio might be and what dividends it should pay at the point that I decide to retire. Perhaps surprisingly the value is of lesser concern, I have plotted a path on the chart below which indicates an annual growth rate of 8% which is just over the total return of the FTSE All Share for the past 10 years. This doesn't seem to be an unrealistic target but time will tell if I'm able to keep up.

Of greater concern are the following:

• rate of investment
• dividend payments

If I want the portfolio to generate income, then I need to pay attention to dividends. They need to be sustainable over the long term, the businesses in which I invest should have demonstrated that they can manage their capital sensibly and are not forced to cut dividend payments, and they should return a dividend that increases over time. 

This is deeply connected to my ability to increase the amount invested in my portfolio. I can't control the prices and movements in the underlying value of the portfolio. Nor can I control the capital allocation decisions made by the management of the companies in which I'm invested - so I don't control the dividends either. However, I can choose to invest each month, and will track my progress of this against a realistic target. Although I can't control them, I can model dividend income based on a few assumptions, such as suggested here. Assuming I continue to invest I can model the potential increases in dividend payment as the following:

• If the dividends paid on my investments increase by 2.5% each year then my retirement portfolio will receive in dividends the same amount I intend to invest each year. In other words at the point of retirement the portfolio would still grow at the same rate but without any additional funding from me, it would happen entirely through dividends.
• If the dividends increased by 10% each year, then my retirement portfolio would pay out annually 2.5x the amount I am investing.

So in the 2.5% increase scenario, if I invested £10k per year, at retirement in 20 years, my portfolio would pay out £10k in dividends each year.

In the 10% increase scenario, if I invested £10k per year, at retirement in 20 years, my portfolio would pay out £25k in dividends each year.

I won't know a realistic figure for a few years, so I will track progress against the 10% increase intially:

If I want to hit the 10% increase target, I was 19% adrift at the end of 2019. As above, time will tell if this is a realistic target.

So with 2019 behind us, bring on 2020. Happy investing.

Annual review 2019

With 2019 behind us and a new year to look forward to it’s time to appraise my investment decisions and performance for 2019.

Investment goals:

• Don’t lose money
• Increase capital by more than the rate of inflation
• Build a conservative dividend paying portfolio

Through doing the above, I will hopefully also outperform the FTSE All Share Index. I have chosen the FTSE All Share as a benchmark as it most closely matches the pool of companies from which I’m investing. It is also the most likely vehicle into which I would invest if I decide to stop stock picking and passively invest in a tracker fund. All costs related to buying, selling and maintaining investments are included in the details below.

My specific benchmark is the Vanguard FTSE All Share (Accumulation) tracker.

Portfolio performance

During 2019 the portfolio has increased in value by 23.6%. This compares to an increase of 19% in my benchmark.

Total return

	FTSE All Share Tracker	Portfolio
2018	-9.6%	1.6%
2019	19%	23.6%

Compound Annual Growth Rate

	FTSE All Share Tracker	Portfolio
2018	-9.6%	1.6%
2019	3.7%	12.1%

Dividend yield

At the end of the year the dividend yields of both benchmark and portfolio were the following:

All Share Tracker yield: 4.08%
Portfolio 2019 trailing yield: 2.5%
Portfolio total yield from January 2018: 3.1%

Of the portfolio growth, 85% was from capital, 15% from dividends.

In summary, I'm pleased at the portfolio performance over the year, but most markets across the globe were on an upwards trend after a significant sell off during Q4 2018. I think a good chunk of positive sentiment was a recovery from that sell off. In the UK specifically we had Brexit to contend with, and the election of the Conservatives with a large majority helped to clarify the path forward for this a little. Since we won't have the same positives buoying the markets in 2020, and we have heightened expectations after a good run in 2019 it wouldn't surprise me to find returns a little lower in 2020.

Portfolio analysis
The best performer in the portfolio was Computacenter, with a 78% increase, 6 other holdings increased by 20%+. Overall 17 out of 24 holdings finished the year in positive territory. Some of the portfolio were only purchased over the last few months, so I'm not expecting to see much movement from those.

Summary of 2019 portfolio performance

Portfolio holdings and 2019 performance

The large international stocks lost a little ground when Sterling started to climb out of the doldrums and have mostly traded sideways since. I’m comfortable holding these for the long term and am unconcerned by a little volatility. If prices continue to drop then I will be looking to top up.

I don’t imagine Computacenter will put in the same performance next year, but it is a well run and growing business, and I have no qualms continuing to hold.

The poor performers were Fulcrum Utilities, Saga and Dignity which have a more detailed write up below.

The contribution of each holding to the final position at year end was as follows:

Contributions of holdings to portfolio performance in 2019

Once again the outlier is Computacenter, but there are another 9 companies contributing between 5% and 10%. The under performing holdings don't have such a significant impact as the investment is smaller. My risk averse strategy of keeping riskier holdings smaller until they prove themselves I believe to be correct and has helped contain the impact of the poor performers. I would be comfortable increasing investment into those smaller holdings that are providing a positive contribution.

The contribution of each holding since the start of the portfolio in 2018 is below. It also shows the split of capital vs. dividend for each holding:

Historical contributions showing split of capital and dividends

Over time the dividend contribution should increase even if capital moves around. I intend to increase the dividend yield during 2020, but not at the expense of quality. Finding quality investments that offer a higher yield than the 2019 2.5% yield should be possible and several on the watchlist meet this criteria.

Poor performers and lessons learnt.

The worst performer was Fulcrum Utilities. Whilst I looked at the financials and the business prior to purchasing, what was missed was the share price movement. Price was slowly declining when I purchased, and that continued during the following few months until it bottomed around it’s current price. It has since moved sideways for a number of months. It has potential in my view and I’m optimistic about a couple of strands of it’s business: smart meters and electric vehicle charging points. I intend to continue to hold but will be keeping a close eye on this one.

The two other notable laggards are Saga and Dignity. Both of these were purchased a while ago and followed the same pattern. Both were companies that had a drop in share price following bad news, and were purchased as a contrarian recovery play. The inadequate thought put into the transactions has been rewarded with a significant reduction in value. The only saving grace is that I had the good sense to keep the investment small. The share price of both companies has staged a decent increase over the year and I will keep both for as long as that price momentum holds.

Saga is, in my view, un-investable. It is not a business but a collection of activities, based around the notion that after a certain birthday people need/ want to be treated differently. This is nonsense. Watching my 70+ parents and in-laws fit and well and using the latest technology, illustrates the flawed concept on which Saga is built. There is now a stake in the company by Elliott Advisors, an aggressive Hedge Fund activist investor from the US. Their involvement would indicate that they see value in the company that is greater than the current share price. They have made noises to break up the company into separate travel and insurance business, which could then be either sold off or streamlined. There may be further recovery here, but we will part company if it stalls.

Dignity is a great sounding investment idea. Relying on people dying is about as certain an income stream as I could imagine. However the business has not been effectively managed. An acquisition spree was funded by borrowing, and that strategy was taking too long to generate returns, at the expense of a deteriorating balance sheet. In addition there has been significant regulatory scrutiny. Cancelling the dividend and a period of introspection are both the correct paths forward for better long-term prospects. Having worked in businesses needing a significant turnaround I am aware of the extent of the internal disruption that it can cause to a business. For this reason, and the extent of the borrowing, Dignity is also to be sold when the momentum behind it’s price recovery slows.

During the year I added in cost of capital calculations to the stock selection criteria, and an indicator of recent price movements vs. the share price 52 week high. I now have a list of businesses I’m comfortable investing in that I’m gradually growing. I have been aggressively rejecting watchlist candidates that don’t come up to scratch, and only intend to buy from this list. And only when the price looks attractive. The increased analysis, and change in approach I’ve adopted resulted in 1 of the 13 investments this year significantly under-performing. This could have been avoided had I waited until the dropping price showed signs of stabilising.

Buying and selling

So far this year I've made the following purchases:

• Tritax Big Box (January)
• Manx Telecom (January)
• Fulcrum Utilities (March)
• Abcam (April)
• Reckitt Benckiser (April)
• Somero Enterprises (June)
• Craneware (July)
• AG Barr (July)
• Network International (August)
• Telecom Plus (September)
• Foresight Solar (October)
• Next Energy Solar (November)
• AB Dynamics (December)

These were all new additions to the portfolio, I haven't topped up any existing holdings.

Manx Telecom was acquired shortly after I invested, leaving the portfolio for a 32% profit. I have not sold any other shares.

Conclusion

I’m pleased with investments this year, with a good performance from the portfolio. It has balanced the performance from last year so that across the two years I have a solid return.

Who knows what the coming year will bring. Macro-economic conditions continue to look wobbly, Brexit could once again take centre stage later in the year with concerns over trade with the EU, and US elections in the Autumn will probably cause a stir.

Looking forward to more investment fun in 2020.