Investors’ Chronicle: Argentex, Stagecoach, Dixons Carphone

BUY: Argentex (AGFX)

A slight dip in revenues constitutes a creditable result given wider business disruption, writes Mark Robinson.

Currencies broker Argentex recorded a 30 per cent drop in adjusted operating profits to £8.7m at its March year-end, with financial performance constrained by flat interest rates as the points (yield) on forwards was close to zero.

Forward points allow the group to take a larger spread on trades and can lead to further revenue when clients initiate a swap to draw down on their forward contract. However, the trader continued to build client numbers and the number of corporates actively traded despite a challenging trading backdrop.

Group chairman Lord Digby Jones said that increased volatility at the start of the year “eventually translated into trading hesitancy”, while the overall number of trades and their average value decreased in the aftermath.

This is unsurprising given that commercial requirements for foreign exchange trades were temporarily curtailed due to the wider business disruption. And it is also worth remembering that 40 per cent of the business is linked to financial services.

However, the group revealed record client activity through the second half.

Lord Jones added: “As volumes return to the market, I am confident in the platform Argentex has built to meet this increasing demand.”

With more banks exiting the market, the commercial opportunity is growing, evidenced by the group’s expanded footprint in the Netherlands and Australia. A positive beat given a stop/start trading environment.

HOLD: Stagecoach (SGC)

The market has been bidding up travel companies in advance of a possible easing of restrictions, but will this benefit Stagecoach, writes Julian Hofmann.

A thicket of adjustments, discontinued operations, separately disclosed items and one-off charges made the full-year results for Stagecoach almost incomprehensible. On paper, at least, the balance sheet moved back into positive shareholder assets of £61m, though these were effectively comprised of goodwill and intangible assets.

The overall impression was that while passenger numbers will surely recover, management admitted it would be “some time before demand for our public transport services returns to pre-Covid levels”. Which is fortunate, in a way, as, judging by the state of the books, management will spend most of the intervening time in a staring contest with its banks.

To further that end, Stagecoach has negotiated covenant waivers on its debt until next year when these will be stress-tested again, in return for maintaining a minimum level of liquidity. A snapshot current ratio of 0.79 indicates that the balance sheet may not have enough current assets to meet its current liabilities, so securing a period of grace was a minimum requirement. Getting the liquidity in place meant halting capital expenditure, cutting the dividend and managing cash flow to generate a £39.5m reduction in headline net debt. Stagecoach also carries a pension liability of £263m.

Meanwhile, although the end of Stagecoach’s train franchises removes one source of continued risk, it leaves the company with a long tail of liabilities and contractual obligations in relation to the defunct franchises. These have a carrying value of £88.4m, which if settled tomorrow would increase consolidated net debt by the same amount, bringing it up to £401m. The pandemic did have some financial benefit for the company in that its radically reduced overall mileage meant a significant gain on its fuel hedges of £4m.

Overall, Stagecoach’s predicament puts it in special situations investment territory, in the sense that the likely drivers of a price recovery are linked more to management’s administrative actions, rather a fundamental pick-up in its markets. While Stagecoach’s high operational gearing will help it to recover, should that recovery come, it is impossible to rule out a major debt restructuring, or a dilutive placing to bring the balance sheet under firm control. Paradoxically, the prospect of either scenario, while disruptive, leaves a medium-term price recovery in play for the very boldest investors. Consensus estimates for adjusted earnings per share put Stagecoach on a forward rating for full-year 2022 of 19.

HOLD: Dixons Carphone (DC.)

Will the benefits linked to working from home and surge in home entertainment evaporate for Dixons when the economy returns to normal? Arthur Sants writes.

Dixons Carphone’s mission to become a successful “omnichannel” retail business has gained impetus through the lockdowns, as housebound consumers increased purchases of televisions, laptops and video game consoles.

The pandemic forced Dixons to speed up investment in its online business. The result has been a 103 per cent increase in online electrical sales to £4.7bn. The group puts this strong performance down to its Shop Live function, which allows online customers to chat with staff in stores and get real time advice over video. 

Strengthening online sales helped drive a 14 per cent like-for-like increase in electrical sales for the UK and Ireland to £9.6bn. However, the permanent closure of the small standalone Carphone Warehouse UK stores resulted in a 55 per cent drop in revenue for UK & Ireland Mobile, constraining overall sales. Some good news for investors is that cost savings have helped it increase free cash flow to £438m. This cash has enabled it to repay its furlough and pay its £144m VAT deferral, while also restarting its full year dividend at 3p. 

Analysts expecting adjusted earnings per share of 10.95p for the year ending April 2022, up from 10.7p in FY2021, according to FactSet consensus estimates. 

The overall electricals market has grown 25 per cent in the last two years and Dixons has shown impressive digital agility, gaining 6 per cent of the UK online market through FY2021. However, the long-term prospects of the group depend on the accuracy of its claim that peoples’ attitudes towards technology (and the way it is purchased) have “fundamentally changed”, or whether events over the past year amount to a pandemic induced transitory fad.

Chris Dillow: How the past misleads us

With bitcoin’s price having almost halved since its peak, it’s tempting to have a sense of schadenfreude towards cryptocurrency investors. But we shouldn’t be so smug, because one of the mistakes they made is a common but expensive one which many of us make in other contexts.

This is the recency effect: when we assess the investment outlook we attach too much weight to recent events, and so overestimate the probability of recent trends continuing. So, for example, high recent returns on cryptocurrencies led investors to over estimate the likelihood of high future returns.

Cryptocurrencies, however, are by no means the only example of this mistake.

For example, after last March’s stock market slump Steve Utkus at Vanguard found that his firm’s clients were more pessimistic about equities than before the crash and thought the market was riskier. Their assessment was coloured by the recent fall in prices — overly so, we now know.

This mistake can cause big losses. At the end of the tech bubble in 2000 shares had become dangerously overpriced because investors believed that high recent returns on tech stocks would persist. And, just as badly, bought into the stories used to justify the high valuations on tech stocks.

Professionals are as prone to the recency bias as retail investors. Banks overloaded themselves with mortgage derivatives in the mid-2000s because recent experience suggested these were safe — oblivious to the fact that recent experience did not contain a period of falling house prices, volatility and panic and so was a terrible guide to the future.

How can we reconcile all this evidence with another fact: that we also overweight the experience of our formative years — years which for some of us are far from recent?

Simple. The impact that evidence makes upon us is U-shaped with time. Experiences in our formative years and our most recent ones get overweighted, while those from a few years ago are underweighted.

But the recency bias is not always a mistake. Sometimes, it actually makes us money.

Cast your mind back to 2015 and imagine you were thinking of buying US shares. If you’d had a long historical perspective you’d have been reluctant to do so because they seemed expensive then — in fact, at a record high relative to the rest of the world. If, however, you’d looked only at the previous few months you’d have seen good relative performance and easily built a story of how US shares were attractive.

And this recency bias would have served you very nicely: since 2015 the US market has outperformed the rest of the world thanks to soaring prices of big tech stocks such as Amazon and Apple.

We have other strong evidence that the recency bias works — the simple fact that momentum investing does so. Momentum investors buy recent good performers and on average profit from doing so.

In fact, a different form of the recency bias might help explain why shares have momentum, a share’s 52-week high is a reference point for investors’ expectations: if a stock has hit this high recently, investors are loath to push it higher as they believe it to be expensive, even if the share enjoys some good news such as surprisingly strong earnings growth. This causes such stocks to be underpriced after good news — with the result that they drift up later.

You might think all this is hopelessly inconclusive: sometimes the recency bias works, and sometimes it doesn’t.

Not so. It’s a warning to us to know what we are doing. It’s silly to assume that the future will resemble the recent past and to believe that stories that purport to explain the current investment climate will continue to apply in future. What’s not silly, though, is to ride momentum intelligently. This requires an exit strategy, such as the rule to sell when prices fall below their 10-month (or 200-day) average: this would have got you out of Bitcoin at around $40,000 saving you a 15 per cent loss.

Sadly, however, it’s hard to distinguish from the outside between these two strategies simply because their recent returns will always be very similar when markets are rising. Which is why it’s hard to spot genuinely good fund managers — and to judge them on past performance even over a few years is itself a form of the recency bias.

Chris Dillow is an economics commentator for Investors’ Chronicle