Trade buyers are circling around UK plc, swooping upon lowly valued assets in a cheap currency. This isn’t an entirely bad thing for the UK stock market because it is evidence of value, which buyers with longer time horizons can see.
Andy Marsh, co-manager of Artemis Income, used Anglo American as an example of a stock where the market has become “somewhat fixated” by short-term performance and ignored the long-term value.
But things are turning around slowly. International investors are appearing on the share registers of specific companies, for example.
It is not just international investors, however. British corporations themselves evidently believe their own shares are cheap and have been buying them back in droves. Tesco’s share buybacks have eaten significantly into its share count and it is far from alone.
At £4.6bn, Artemis Income fund is the largest fund in IA UK Equity Income sector and 60% of the companies in its portfolio by value have bought back shares in the past year.
Trustnet spoke to Marsh and Nick Shenton, who run the fund in tandem with FE fundinfo Alpha Manager Adrian Frost, about executive pay, M&A activity and share buybacks.
Performance of fund vs sector and benchmark since inception
Source: FE Analytics
Please describe your investment process
Marsh: Our mantra is cash flow first, dividends second. We are looking for mispriced long-term cash flows and we’re seeking duration of cash flow. We invest in companies that are creating durable value for all stakeholders, not just shareholders. We have diversification across the fund so as not to be overexposed to any one factor or sector.
Shenton: One example of long duration is Informa, the world’s leading operator of events where industries go to meet, such as the Miami Boat Show or the World of Concrete. When you go to these events and see 50,000 people congregating, you realise this is a strong business which should be around for many years to come because it has unique assets.
Does the size of your fund constrain your investment universe?
Shenton: People were asking that when I joined Artemis in 2012 and we have to prove that’s not the case. We want businesses that are large enough that they’ve got a track record and we can understand them but small enough that they’ve got scope to grow. We don’t go near small-cap.
Marsh: Our sweet spot is in the bottom half of the FTSE 100 and our median market cap is around £8bn. These are companies that are large enough to be relevant, often globally, but not so large they can’t grow. If you look at the FTSE 100, 65% of that index is in the top 20 stocks and we have just north of 20% in those names.
What is your view on the spate of international buyers bidding for British businesses?
Shenton: We think it's a signal of long-term value. Most of the entities bidding for UK companies are trade buyers, so these are people who understand the industry and want to own these assets for a long time. It's not private equity using leverage and looking for an exit within five or six years.
Take Anglo American for example. Until BHP’s bid, people were ignoring the long-term value of its assets, particularly in copper. Then a trade buyer signalled value and the shares rose 15% in two days and people started looking at it in a completely different way.
What have been your best and worst performers over the past year?
Shenton: 3i Group has been a tremendous performer and not just over the past year, although it was up 70% and that's unusual. It has one particularly outstanding asset, the European discount retailer Action.
Marsh: One of our most disappointing performers over the past 12 months has been Dr. Martens. The brand has significant global recognition but relatively low penetration of sales across big markets like the US, Europe and Asia.
What we underappreciated was some of the challenges around executing on that growth potential. We continue to own the shares because we still think the revenue opportunities are there, but its ability to convert that revenue into profits has not been as substantial as we expected.
Have many of your portfolio companies been buying back shares?
Shenton: This is a trend we see across the whole UK market. BP and Shell are gobbling up their own shares and 60% of our portfolio by value bought back shares in the past year.
When companies buy back shares on a very cheap valuation, it can create outsized returns. If you're trading at 5-6x price-to-earnings and paying a mix of dividends and share buybacks, you can eat into your share count very quickly.
An interesting example is Tesco, which trades at a 10% free cash flow yield and a 4% plus dividend yield with the balance of cash being returned to investors through share buybacks. Last year we increased our ownership of Tesco by 5% without lifting a finger, just because of share buybacks.
Are there any themes in the portfolio?
Shenton: Turning the threat from technology into an opportunity is a golden thread that runs through. Several companies were trading at low valuations because investors thought they would be disrupted by technology, but actually, they were able to use technology to become better businesses, learn more about their customers and create value for them.
Pearson fits into that camp. It is the world’s leading assessment and qualifications business and is a disruptor in the market for English language qualifications in India. Pearson gets results back to people within a couple of hours so they know whether they have passed the standard of English test to emigrate to a country such as Canada, whereas competitors take days. Personalisation of learning using artificial intelligence is another huge opportunity for Pearson. It doesn’t look expensively valued. It has a free cash flow yield of over 6% and very limited debt.
Do you incorporate sustainability into the fund?
Shenton: We think there’s a great imperative on active managers to be truly active – to create value with the companies. We engage heavily with our businesses on all matters. They call us directly; they know who to speak to at Artemis. We think it’s really important that we lead as fund managers – with the support of a good stewardship team – because we’re the ones who should understand the opportunities and threats to the business.
What do you enjoy doing outside of fund management?
Marsh: I’ve spent years driving my football-mad boys around the country for matches and I have a son who’s just signed his first professional contract with Crystal Palace.
Shenton: With a group of friends, I set up a sports club 12 years ago. We’re trying to play as many different sports as possible.