Investors’ Chronicle: Gooch & Housego, Braemar, Pennon

BUY: Gooch & Housego (GHH)

The company’s adjusted operating profit jumped by almost 60 per cent in the six months to March 31 and statutory profits were weighed down by restructuring charges, writes Nilushi Karunaratne.

Gooch & Housego generated a 5 per cent rise in revenue at constant currencies in the six months to March 31, due to increased demand for lasers used in semiconductor and microelectronics manufacturing, as well as its products for medical diagnostics systems.

In the larger industrials business — which accounts for 45 per cent of total sales — revenue increased by 4 per cent at constant currencies to £26.6m. Higher sales of industrial lasers in Asian markets more than offset lower demand for sensing modules as large infrastructure projects were delayed.

Meanwhile, over in the life sciences division, revenue shot up by 11 per cent at constant currencies to £13.5m as the pandemic spurred demand for ventilators. Gooch & Housego acquired medical device specialist ITL in 2018, which makes a product that improves respiratory function and oxygen uptake as part of a ventilator system for patients in intensive care.

Overall, the company’s adjusted operating profit surged by 57 per cent in the first half of the year, to £5.4m, with higher sales volumes and cost cutting pushing the margin up by 3.2 percentage points to 9.2 per cent.

Gooch & Housego is consolidating its acoustooptic and precision optic manufacturing sites as part of this cost push. This process is expected to be “substantially complete” by the end of September, laying the groundwork for £1.8m of savings in 2022.

The reorganisation did lower overheads in the first half of the year, but £3.1m of restructuring charges pushed Gooch & Housego’s statutory operating profit down by almost two-fifths to £1.2m.

Excluding lease liabilities, net debt has come down by just over a quarter from the September year-end position to £4.7m, or just 0.3 times cash profits. The balance sheet is therefore in good trim to support further acquisitions and the company is “actively exploring” opportunities in the life sciences sector.

Looking at the second half of the year, the company has flagged currency headwinds, although it expects that some pandemic hurdles such as travel restrictions will ease. House broker FinnCap is anticipating a full year adjusted operating profit of £13.7m, up from £11.2m in 2020.

The shares are currently trading at a pricey 31 times consensus 2022 earnings. However, Gooch & Housego’s near-term outlook is improving as industrial and medical laser demand recovers, and in the long-term, it will benefit from structural growth drivers for its “photonics technology” such as the rollout of 5G.

HOLD: Braemar (BMS)

The shipping company’s sales and earnings were largely consistent with last year despite pandemic difficulties, writes Alex Hamer.

The pandemic brought rough seas to all industries, but shipping has come out of a tough crossing with its sails intact. 

For shipbroker Braemar, its position in both the oil tanker and bulk cargo markets meant its 2021 results show a company able to manage in difficult conditions. When things looked most dire in an economic sense, cash was pouring in for the tanker industry as storage was the key issue in the global crude market. Now that industrial demand has recovered, dry bulk cargoes are driving earnings. 

Braemar saw rates on tankers go up to $300,000 (£212,696) a day when the “contango” (when the spot price is lower than the forward price) hit following the oil price crash in April 2020. Chief executive James Gundy told Investors’ Chronicle this was unfortunately shortlived. 

“We saw the spot market going towards $250,000, $300,000 a day and it fell down to $15,000 a day,” he said. “The tanker market has not necessarily fully recovered yet.” 

Yet it was an intense period while it lasted. “In March, April, May last year, it was 18-hour days. We were booking deals left, right and centre,” Gundy said. 

He became chief executive in January after running the shipbroking division, which provided more than two-thirds of Braemar’s sales in the 12 months to February 28. 

The company’s full-year results do not reflect a massive collapse, partly because of the initial cash injection from the contango, but also because of the ramp-up in dry cargo shipping rates as China and then the rest of the world bounced back from the pandemic, and bulk cargo, such as iron ore, was needed in great quantities. 

Braemar’s underlying operating profit for the period was £8.9m compared with £11m the year before, and it brought back its dividend at 5p per share. 

Debt was also cut back thanks to the £6m sale of part of its stake in consulting business AqualisBraemar, and net debt stands at £17.5m compared to £31m at the end of February 2020. 

House broker FinnCap is forecasting a climb in adjusted EPS to 24.1p in 2022, from 21.2p the prior year. Braemar is in a good position to benefit from the continued high demand for bulk products, but still has high oil and gas exposure, adding to volatility concerns.

BUY: Pennon (PNN)

Pennon has purchased Bristol Water Group for £425m, announced a £1.5bn special dividend and £400m of share buybacks, writes Nilushi Karunaratne.

Investors had been patiently waiting to see what Pennon would do with the £3.7bn of cash proceeds from the sale of its waste management business Viridor. The water utility has now announced the acquisition of Bristol Water Group for £425m, a £1.5bn special dividend and a £400m share buyback programme.

The remainder of the proceeds have been put towards repaying £1.1bn debt, contributing to the company’s pension scheme and investing in green projects. As a result, Pennon is now in a net cash position of £64m, versus £3.3bn of net debt at the end of March last year.

Bristol Water will increase the scale of Pennon’s water supply activities, boosting the customer base by almost 50 per cent to 3.5m and adding 16 per cent to the group’s regulatory capital value (RCV). The acquisition is subject to approval from the Competition and Markets Authority, but if it is completed, Pennon will have paid a 44 per cent premium to Bristol Water’s RCV.

RBC Capital Markets analyst Alexander Wheeler said that this was “quite a high price”, and that Pennon would need to demonstrate “how it can gain additional value from Bristol Water, a company which has struggled to produce a meaningful RoRE [return on regulated equity] over AMP6 [the previous five-year regulatory period which concluded at the end of March last year].”

Pennon believes it can eke out efficiencies as it did with its 2015 acquisition of Bournemouth Water, pointing to opportunities for operational improvements, and savings from centralised control functions, shared support services and economies of scale.

More certain shareholder returns come in the form of a 355p per share special dividend, which is being combined with a share consolidation that will see investors receive 2 new shares with a nominal value of 61.05p for every three existing shares they own. Subject to shareholder approval, Pennon says this consolidation will “reduce the number of ordinary shares in issue by approximately the same percentage of market capitalisation returned via the special dividend.” The intention is for Pennon’s share price to be undisturbed by the payment of the special dividend.

The bumper payout will add to the 21.74p per share dividend declared for the 12 months to 31 March, which has halved versus a year earlier. Yet if you strip out the portion of the 2020 dividend that relates to Viridor, the annual payout has increased by 3 per cent.

Bristol Water is expected to add 3p to this year’s dividend post-share consolidation, and Pennon is still aiming to grow the annual payout 2 per cent ahead of CPIH inflation through to 2025. 

Chris Dillow: Retail investors’ advantages

Why bother picking stocks yourself? Why not entrust the job to fund managers? They have teams of analysts helping them, more time to research stocks and better access to brokers and other experts than you do.

The answer is that although fund managers have these advantages over you, you have some offsetting edges over them. But you might not be exploiting these as much as you should.

To see one of these, consider one of the best-performing and most popular funds, Lindsell Train’s Global Equity Fund. It manages £8.7bn invested in 25 stocks. That’s an average position of £350m. Such huge positions, however, mean there are many stocks it cannot buy: £350m is equivalent to over a third of the value of most FTSE 250 companies. Of course, it could take smaller positions, but doing so would make little difference to its returns. If a £50m stake were to rise 50 per cent, it would add less than 0.3 per cent to its total return, which is less than the difference between a good and an average day.

Of course, most funds are smaller than Lindsell Train’s and have more positions. But even so, they face the same problem — that it is hard to build a significant position in smaller or mid-cap stocks and harder still to sell without moving prices against themselves.

Fund managers therefore lack agility. They cannot quickly move from being a value investor to a growth, momentum or defensive investor. This matters because, as MIT’s Andrew Lo has shown, equity strategies “wax and wane”. What works in one period doesn’t work the next. For example, small caps have recently outperformed big stocks and value has outperformed growth, in both cases after months of underperformance.

Because of this lack of agility, David Blake at Cass Business School found in 2015 that there was a “negative relationship between fund size and performance”. Since then some big funds have bucked this trend, thanks largely to some big stocks — most notably US tech firms — doing extraordinarily well. Whether this can persist is probably doubtful.

Retail investors, however, don’t have this problem. We can quickly dump underperformers and get out of waning strategies by using exit strategies such as stop losses or the rule to sell when prices fall below their 10-month average. Funds cannot do this.

They can improve their agility somewhat. But at a cost. The LSE’s Christopher Polk and colleagues have found that even average fund managers have a handful of good stock picks that do beat the market. But the average fund doesn’t outperform. This, they say, is because they hold far more than a handful of stocks in an effort to maintain some sort of liquidity. In doing so, however, they dilute returns.

Again, retail investors need not do this. We can take concentrated positions and confine ourselves to our best ideas, topping these up with a tracker fund. We don’t need to hold dud stocks merely to diversify.

Some investors, though, don’t do this. Instead, they over-diversify by holding 30 or more stocks. They choose to make the mistake that fund managers are compelled to, and so dilute away returns.

Retail investors have another advantage. The collapse of Woodford’s equity income fund showed that unit trusts cannot hold illiquid assets such as small or unquoted companies because they cannot sell these if investors want to withdraw money from the fund: they could close to withdrawals (as M&G Property did), but this does not win friends.

We retail investors don’t face the danger of unexpected cash calls — or at least we can put cash aside to deal with such emergencies. We can therefore buy illiquid assets more safely.

The natural way to do so is investment trusts that hold property or private equity. These are risky: if they face increased selling their share price falls relative to their net asset value. But if we can tie up our money for a long time we can hold on through such dips. Which could be useful partly because unlisted stocks could well outperform older listed ones, and partly simply because investors should be rewarded for taking liquidity risk.

We have another advantage. Many fund managers have to be fully invested or nearly so. But we don’t have to be. Which could be a very good thing. Equity investors always face correlation risk — the danger that all shares fall at once. But with interest rates likely to rise in coming years we now face more general correlation risk — that assets such as bonds, equities and gold will fall at the same time. The easiest way to protect ourselves from this is simply to hold cash. Many fund managers don’t have this option.

Remember a basic fact — that most fund managers fail to beat the market consistently. This isn’t because they are incompetent or because the market is more efficient than you think. It’s because they face some big handicaps to investing well. We retail investors don’t have these and so are freer to invest wisely. But do we really make best use of this freedom?

Chris Dillow is an economics commentator for Investors’ Chronicle