Landslide

The UK general election has finally arrived and it’s little surprise that the Conservatives have won convincingly. Regardless of your political leaning this is good news for shares and is welcome relief from a December that has been pretty grim until now. Trump’s trade war shenanigans have been keeping investors on their toes over the pond. The medium term outlook is looking positive and I’ve got my fingers crossed for a Santa Rally.

The downside is that I’m facing quite a headwind from the sharply rising Pound. This does not come as a surprise. The chart has been suggesting further rises in the Pound were likely and a Tory majority outcome for the General Election was obviously going to be a catalyst for further rises. The Pound still seems likely to be fundamentally undervalued. This is a bit of a pain as most of the businesses I invest in are international and earn the majority of their revenues in Dollars. I have been increasing my exposure to businesses with earnings in Pounds to some extent over the last few months. However, this is more incidental than deliberate – my overall view is still that exchange rate movements are not significant enough and too difficult to predict to be worth trying to modify my strategy for. The Brexit trade negotiations create plenty of scope for renewed falls in the Pound.

I’ve made small adjustments to my strategy following some of my recent thinking on the extent to which I should be investing in smaller companies and companies of slightly lower quality but better valuation. My thinking on both of these topics is still quite mixed – the benefits are finely balanced against the risk that tampering will result in losing clarity and focus. In either case I’ve decided that I would benefit from diversifying my watchlist a little more, while keeping the rest of my strategy intact. So I’ve gone on a bit of an elephant cull, weeding out a few of large, high-quality but lower-growth companies and replacing them with some smaller, edgier businesses with more appealing immediate growth prospects and valuations. I’ve only done this to a limited extent, making just a handful of changes.

A couple of these new recruits have already made it into my actual portfolio. I have three trades to update on since my last trading update just over a month ago. Last month I sold Cintas for an 8% loss and replaced it with Gamma Communications. I held Gamma until fairly recently (selling was a mistake in hindsight) so don’t have much to add to my recent write-up. Two weeks ago I sold London Stock Exchange for a 20% profit as momentum seemed to be waning and replaced it with Dart Group. This week I sold my starter position in Burford Capital again for a 14% loss and replaced it with Liontrust Asset Management.

Dart Group

Dart Group’s main business is selling package holidays and flights under its brand Jet2. Most of its business is based in the north of England.

Dart is near the boundaries of what I would describe as high quality. It is a recent addition to my watchlist. I have loosely followed it for a number of years but have been put off investing by the fact it runs an airline, despite its excellent track record.

Quality

  • Business economics: airlines have famously bad economics, being hugely capital intensive and susceptible to changes in input costs and exchange rates. Dart is not an exception to this. Its margins are consistently in the high single digits and its returns on capital are not especially high. In its favour the balance sheet seems pretty strong with a healthy amount of net cash.
  • Track record: Dart’s track record is the main draw and over the last few years has really been excellent. Revenues, profits and the share price have all grown rapidly and consistently over the last few years. It’s 30-bagged over the past 10 years.
  • Competitive advantage: the markets for flights and package holidays tend to be very competitive on price as consumers actively shop around for the best deals. This puts a limit on how sustainable a competitive advantage Dart can have. However, Dart has been consistently taking market share from rivals, some of whom have fallen by the wayside, so it must be doing something right. There are a couple of aspects of its business model I find attractive and I think may explain some of its success. One is that it has a clear geographic focus in the north of England. The other is that its business is vertically-integrated across both being a tour operator and running an airline. This results in synergies (e.g. it can better predict demand for its flights and optimise load factors) and mean that it has greater control over the quality of its overall offer to the customer and its brand. It also invests heavily in brand advertising.
  • Growth prospects: the growth prospects look good. The historic trajectory is excellent and there are not obvious limits to how much more it can grow. There seems plenty of scope to expand its supply of flights and network of destinations. The failure of large rivals such as Thomas Cook should provide a boost. There is also plenty of scope for further geographic expansion away from its base in the North. On the downside, the business is cyclical and in a downturn the profits might take a significant hit.

Price

Momentum is excellent with some cracking recent trading updates. The share price has had a rocket under it recently, more than doubling over the last three months. The General Election outcome and associated impact on the Pound should provide a significant tailwind for Dart as it incurs significant dollar denominated costs. This provides useful diversification for my portfolio.

The valuation still looks pretty decent given the potential for continued growth. However, the cyclical nature of the business makes it very difficult to judge this well.

Liontrust Asset Management

Liontrust is a UK specialist fund management business. It has been around since 1995 and is still a relatively small business (worth around £500m). Some of its funds, such as the UK smaller companies Fund led by Anthony Cross, have very good track records.

Quality

  • Business economics: the economics of fund management are excellent. The business is very capital light, exceptionally scalable and highly profitable. Liontrust has margins of about 20% and consistently makes returns on capital in the thirties.
  • Track record: the track record over the last few years is excellent with consistent and rapid growth in revenues, profits and the share price.
  • Competitive advantage: fund management is a highly competitive market as investors can reallocate funds across providers with ease if they are unhappy with performance. Sometimes this can be quite dramatic e.g. Woodford. On top of this a lot of the value is in the staff (as many investors will base decisions on the specific fund manager rather than the firm’s brand) and staff may decide to leave for various reasons. These factors mean the competitive risks of investing in fund management businesses are high and have kept me away from investing in fund management businesses in the past. Liontrust seems to be in a good place at the moment. The hope is that, if it continues to grow successfully, the competitive advantage from its brand and customer relationships will also grow. However, I’m under no illusions that Liontrust is immune from these competitive risks.
  • Growth prospects: Liontrust looks like it has plenty of growth left in the tank. It is still reasonably small and is consistently attracting fund inflows.

Price

Momentum is excellent with decent recent results and the price is at all time highs. The valuation looks very reasonable all things considered.

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