August 2019 Portfolio Update

I thought that July was bad but that was just an entrée. So much for enjoying a relaxing August on holiday without a thought for my portfolio. Instead the Burford short-attack kicked me in the nuts and made me re-consider whether I should be investing in individual companies at all. The problem is not so much the companies themselves as the emotional strain attached to a whip-sawing share price and a fire-hose of news telling me just how messed up the global economy really is. And that's without considering our own self-inflicted attempt at market destruction in the UK. Just a terrible month then with little to redeem it.


Burford Capital Bought at 1366p - August 19

Yeah. No. Really let's not go there. Probably one of the most spectacularly ill-timed trades in the history of the market and all because I was about to go on holiday. Let's move on.

Things I thought about buying (but didn't)



Bodycote Sold at 694p - August 19 - 23.8% loss

After the weak interim results last month I came to the conclusion that the business was just facing headwinds from too many directions. The problem, as I see it, is that economic conditions are fragile on several fronts and Bodycote is rather dependent on the automotive market. In addition profits fell by 6% in H1 and yet FY expectations are for a drop of just 1.8%. Given a year-long decline in expectations, from 56.65p to 53.79p, I suspect that this number will continue to steadily fall throughout H2. In this way BOY may avoid putting out an actual profit warning but they'll still end up making less profit than in 2018. Anyway I've decided to cut my losses.

RM Sold at 237p - August 19 - 1.2% loss

With RM I've been expecting its growing divisions to more than offset declines elsewhere but it seems that this is a more challenging prospect than expected. RM Resources provides over half of all sales (and a smaller fraction of profit) with these both falling sharply due to the challenging UK market. RM Education offset this decline somewhat with profits growing 19%, despite a 6.5% drop in sales, due to lower costs and higher margins. In addition RM Results also grew sales and profits although from a lower base. However there's a timing issue at play here with IFRS15 adoption boosting the figures in H1 only for these benefits to reverse in H2 - leading to a negative impact on revenue and profits overall. So I think that the FY results won't back up what seem to be strong H1 results and RM will continue to tread water as it transitions towards long-term growth. So I'm putting my funds elsewhere.

Things I thought about selling (but didn't)

Pretty much everything.



Following a rather disappointing update in July, indicating that FY profits would be at the lower end of expectations, we have these pretty good interim results. On sales up almost 10% profits are up 9%, which is in-line with forecasts, along with a special dividend worth almost 3% of the share price. This is against a backdrop of some markets becoming challenging, such as Greater China and the UK, while others are growing well, such as the US and India. A hallmark of the business is that they are quick to reduce/increase fee earners in order to allocate costs effectively, with the total count falling by 1.3% in the first half, although that won't do much good if we fall into a global recession. Looking forwards Q3 for China was very strong last year and the region is currently depressed by the US tariff issues and unrest in Hong Kong. With around 70% of their business here coming from international clients it's pretty certain that the next quarter will look ugly in this part of the world. We'll find out more on 9th October. What remains impressive is the ability of the business to generate cash; so much so that this is the 5th consecutive special dividend even while there have been investments made in new business systems and growth in the American regions. So it strikes me that PAGE remains a very well run business with strong geographic diversification and a solid balance sheet. Yet recruitment companies are amongst the first to feel the pain when a downturn comes and the scales feel pretty balanced on this score. Over the medium term I have no doubt that they'll continue to reward shareholders though and remain happy to be one of them. (Results)

H&T Group

Talking of recession this listed pawnbroker should benefit if the economy weakens and it should definitely do well as the gold price climbs. So how do these HY results look? Pretty steady really with earnings up around 8% and EPS hitting 15p (compared to forecasts of ~34p for the year). With a consistent second-half weighting in the last few years I see this as an in-line result. Operationally both pawnbroking and lending are growing with the margin on personal lending rising sharply from 37.5% to 54.1%. I like this as it suggests that they're being more conservative in their loans and yet this isn't denting growth too much. Where I thought the business might have fallen back is in FX sales, given the weak pound and increasing competition, but it seems that HAT is doing fine here as well. The only negative area seems to be retail sales where margins fell due to lower-margin watches being sold, increased repair costs and aged stock items requiring higher discounting to shift. There seem to be a lot of moving parts to this side of the business, with people trying to pawn items of both high and low quality, but it should be an area of expertise for H&T. Keeping on top of this core market is important at the best of time but doubly so now that the shop estate has expanded by 35% with the addition of 65 Money Shop stores. The board talk about transferring the Group's success factors to these new locations, as well as learning from their strengths, so there should be benefits both ways if this process is managed effectively. So far the directors have managed the business well, and it's hardly expensive on a P/E of ~10, which is enough for me to keep my holding here. (Results)

Muddy Waters short report

Well I derived no pleasure from reading this short-selling dossier (particularly as the share price was plummeting at the same time). The report itself seems to make some good points and, if nothing else, highlights how much trust is involved in believing the accounts. Given that this is in short supply (and for good reason given the many frauds committed on AIM) it's no surprise that investors have been falling over themselves to dump the stock. Anyway the key point being made is that Burford are using fair-value gains to take profits early and before a case has concluded. Then, when the case has concluded, they are rolling back these already-booked gains from the unrealised figure and adding them entirely to the realised column. This does have the effect of hiding the gross fair-value gains being taken in any period since the actual net value being shown has had the realised gains netted out. I hadn't grasped this point before but equally I'm not sure that Burford should do things differently since I want to know the total realised gain for a case and not just the part which was realised at the end. I guess that Burford could stop marking up any cases while they are in progress (valuing them at the cash invested value only) but that wouldn't necessarily be more accurate either - although it would be more pessimistic.

To my mind this profit recognition is the key weakness that has allowed Muddy Waters to get a grip. However they make some excellent points around corporate governance - of the lack of it. For a start the CFO is the wife of the founder/CEO and the company has been through a number of CFOs in succession with none staying for long. Given the delicacy of judging what non-cash accounting profits to book this is a red flag. In addition non of the executive directors sit on the board while all of the "independent" board members have been in place for near enough a decade. This is all a bit too cosy for comfort and again requires investors to deploy a large slug of trust that all is above board. An additional angle to this is that Muddy Waters believes that operating expenses are unacceptably high and that the executive directors may well be paying themselves egregious remuneration - but that it's impossible to tell because they don't publish the salary or LTIP numbers. A spin-off effect of these costs is that, potentially, Burford is vulnerable to a liquidity crunch as there's not enough cash-flow to cover operating expenses, financing costs, debt and funding commitments. If true that's a big concern!

Overall it's a successful short report in that it raises serious questions, on a number of fronts, and a number of shareholders have decided that it's better to be safe than sorry. All told I haven't taken any action one way or the other and don't intend to until Burford publishes their response. For sure a stop-loss would have saved me a lot of pain here but that's water under the bridge. More usefully I'm not sure that I should be investing in businesses that aren't backed up by actual free-cash flow. While they're not immune to problems I think that companies with a simpler corporate structure, and accounts that rely much less on management judgement, are far less likely to come under shorting attack - which can only reduce my stress levels! (Report)

Burford response

This reply from Burford is pretty good given the turn-around time. A key claim, made up-front, is that they're solvent and have a reasonable debt profile. I don't think that the first point was ever in much doubt but they have to reassure given that they want investors to retain confidence in the company (and they can't trade while insolvent). After this each of the statements from Muddy Waters is taken in turn with varying levels of success. With the Napo/Jaguar case it seems that Muddy Waters have got the wrong end of the stick and I don't believe that Burford would collude with Invesco over such a small investment. It doesn't make sense even if the case is overly complex in the way that Burford has realised profits from its investment. Related to this is the issue of non-monetary considerations and other investments with complex return profiles. Again this looks like a bit of a red herring with Burford stating that they have less than $1m of non-cash recoveries outstanding and around 4% of recoveries that haven't yet been paid in full. A third point being rebutted is that Burford has acquired businesses and then folded their investments into Burford's own pool to boost returns while ignoring historical costs. With the response being that this is categorically not the case it's hard to see that this point has merit.

After this we have Burford's response to some very specific cases (Akhmedov, Progas and Neptune) where Muddy Waters have used these to pick holes in the treatment of costs and losses. The problem is that Muddy Waters have made errors in certain places which rather undermines their arguments. So Burford again appears to have the upper hand here. It's curious then that with the final point, which Burford describe as a "convoluted morass of text", I think the short selling report wins points. One area concerns the booking of unrealised profits and how this can be abused - which this response doesn't address. Then there's the reality of the top four performing investments providing the bulk of the returns. This is a bit of a surprise, given the number of cases now in progress, and does suggest (rightly or wrongly) that such profits may be hard to come by in the future. It's a good question to ask and I don't think that Burford really refute the criticism. Finally we have the remaining issues over corporate governance (AIM listing, Guernsey based, CEO and CFO being married) which aren't addressed at all here. These are all red flags and I can see investors remaining unconvinced while the situation remains unchanged. So a decent response but hardly a knock-out blow. (Response)

Muddy Waters response

There's an awful lot of emotive language in this response and frankly I can do without that. Still Muddy Waters make the very reasonable point that Burford could be a lot more transparent about the level of fair-value gains that they have taken up to this point. It would also be very helpful for them to reveal the gross level of fair-value gains taken over all periods in order to show the actual balance of unrealised and realised gains. It may be that the numbers all look fine but this is an area of uncertainty. The other big question is whether Burford are growing fast because there is a strong pool of litigation opportunities out there or whether they are doing it to hide the fact that gains from ongoing cases have been exhausted? This really is the crux of the shorting case: either the numbers are being made up to keep the plates spinning or Burford are showing reasonable gains as cases progress. The unbroken track-record of rising profits does give me some pause here since the timing of litigation receipts is fundamentally unknown and lumpy. And yet do I believe that the company is a fraud? I really don't know. There are plenty of red flags but do they amount to a smoking gun?

What is interesting in this response is that Muddy Waters add some sections on the history of Burford and possible issues with cash receipts that weren't in the original report. This is a bit strange, given that they're quite informative, but they are the most novel parts of the document. On the former it's interesting that Burford listed as a closed-end fund and then in 2012 morphed into an operating company with a quite different profile for potential investors. Was this really done by Bogart and Molot just to create a fraud over the last seven years? It's not impossible although they'll be shafting a large number of their colleagues at the same time - if these lawyers really are invested in the company. On the second point there appears to be a mismatch between cash flows and investment realisations which is unexplained. Into this void Muddy Waters posit that Burford are buying and selling securities to falsely boost cash-flow but I have no clue whether they're just blowing smoke on this one. Still it seems to me that Burford need to respond to these criticisms in some manner without wasting a lot of words on the evils of shorting and how they're going to take everyone to court. (Response)

Muddy Waters response

Well this is a somewhat interesting meta-analysis of the language used by the Burford directors. The meat of the document is that Burford are using aggression, evasion and persuasion in their responses rather than directly answering the questions that have been put to them. This certainly chimes with my feelings about the comments made by Burford in that while they address the shorting case quite reasonably they're also full of lawyerly language. Thus the content comes across as evasive and qualified when I'd much rather receive straight answers and simple statements of denial. This is rather annoying because it makes me feel that the board are hiding something even if Muddy Waters haven't found it and don't have a watertight case themselves. It's also annoying because I do think that Burford have a business that is making real returns and could be a lot larger in the future. The way things are going though it could take a while for the upside to reveal itself. (Response)

Burford governance update

This is a welcome update with the company directly responding to investor concerns - although it's a shame that the share price had to more than halve in order to stimulate this action. On the listing side the board are pursuing a secondary US listing on either NYSE or NASDAQ. If this does not prove practical then they'll go for a premium listing on the LSE Main Market. Good news. There is also progress on the board composition in that they are looking for two new independent directors and the CEO, at least, will be joining the board. The final change concerns the CFO position where the current incumbent is married to the CEO! With immediate effect they are replacing her with Jim Kilman who used to work at Morgan Stanley. On the upside it's great that they've made this change and that they've got someone who knows the business well (he has been acting as a senior adviser). On the downside he's hardly a new, independent face who'll conduct a root-and-branch review of their valuation practices. I guess that this will have to wait until they make a permanent appointment. Still I welcome all of these changes. (Response)

Henry Boot

Given that this property development and construction company has been around for more than 130 years I think that it has a resilient business model. Nevertheless the share price has fallen 30% in the last 18 months as the record profits seen in 2017 have fallen back by around 10%. This is pretty reasonable as the price-to-NAV premium had inflated to a heady 70% as investors got over-excited. Now, with these results, there's almost no premium with the NAV rising 7.4% to 233p and the share price at 236p. If things turn really ugly then history suggests that we could see a discount of up to 20% appear but the board appear to be handling uncertain conditions effectively. In H1 earnings fell almost 10% to 14.2p (compared to FY expectations for 28.9p) but that's excluding completion of The Event Complex in Aberdeen - a very large project which completed just after the period end. In addition investment property sale receipts will reduce borrowing to essentially zero by the end of the year (from £50.3m) which puts the group in a strong position. I like the fact that the group has several different segments (land promotion, property development, house-building and construction) which are trading well and offer useful diversification. Looking forwards revenue will decline, due to conclusion of the TECA scheme, but margins on replacement schemes should increase to offset the decline and maintain profit levels. So we're unlikely to see great medium-term earnings growth but the share seems fairly priced, with a handy 4% yield, so I'll continue holding. (Results)

IG Design Group

A nice and solid trading update with sales and profits both showing sequential growth. The integration of Impact continues to proceed well and this is really looking like a smart acquisition. With a supply agreement reached with one of the US's largest retailers it seems that IGR has made a well-timed push into the American heartland. While the update contains no trading numbers the expectations for this year are pretty subdued with just 3.6% rise in earnings forecast by analysts. By the tone of the jungle drums I suspect that this will be usefully exceeded once the crucial Christmas period has passed and the fruits of previous investment are known. (Update)

End of month summary

Amusingly I thought that last month was pretty bad when I was down 3.0% overall. Well "hold my beer" is all I can say given that my portfolio fell by a hefty 6.0% during August. Take that July. The clear star here was Burford with the Muddy Waters short-attack leading to a halving in share price. Great if you're short, not so much fun if you're long and on holiday. However Burford was only responsible for 2.9% of the decline - the other 3.1% all came from companies that fell out of favour during a quiet month. As hoped for HAT did well following its results while LTG and SCT remained in demand despite their lack of news-flow. The fallers list is over twice as long sadly with DOTD, BKS and CRW all falling by double-digit amounts for no clearly defined reason. The fall in Craneware, more than any other share, is a particular surprise given its exposure the resilient US healthcare market since this can only be a plus as GBP weakens. All will be revealed with the FY results on Tuesday.

Winning positions for the month: HAT 14%, LTG 9%, SCT 9%, QTX 4%, BOWL 3%, SDI 3%, WJG 1%, SOM 1%

Losing positions for the month: SBIZ -1%, III -1%, RFX -2%, ADT -2%, K3C -3%, GAW -3%, PPH -4%, RWA -5%, KWS -5%, PCA -5%, GAMA -5%, KETL -6%, PAGE -7%, BPM -7%, FDM -8%, CRW -10%, BKS -10%, DOTD -13%, BUR -53%

No point dwelling over what I should or could have done but I will say that August has won my sh!t month of the year award. I really hope that it retains this crown for many months to come as I'm not sure that I can handle (psychologically, emotionally and financially) another period like it. Suffice to say that I am pondering moving further into cash, to keep the 6.4% YTD return that I still have, but it does feel like I'm closing the gate too late.

Disclaimer: the author holds, or used to hold, all of the shares discussed here

comments powered by Disqus