personal investment blog

Report on Q3 2015

Report on Q3 2015

2 Oct 2015

According a chap on Bloomberg TV, $11 trillion was lost from the value of global equities in Q3. The FTSE 100 fell by 10.2% and the FTSE 250, as usual doing better, fell by 5.8%. In the three years since I set up this website, the FTSE 100 is up by just 5.6% and the FTSE 250 by 42.2% which is a shocking disparity.

The FTSE 100 is the top 100 companies by market capitalisation and contains many international banking, pharma, oil, mining and commodity businesses. The FTSE 250 is companies ranked from 101 to 350 and contains more domestic household names. I suspect that these companies are of a more easily manageable size and have more scope for growth. That may be a story worth looking at more closely but there is an interesting question to ask at once: if you own a tracker fund (as I do in a small way) what is it tracking?

Most UK tracker funds follow the FTSE 100 or the FTSE All Share. Over the last five years, the FTSE 100 is cumulatively +8.4% and the All Share is +15.2%. These returns exclude dividend payments. The tracker fund should retain the dividends (after it has taken its fee) to boost the fund performance, so tracker funds should really beat the index (shouldn’t they?).

These performance statistics indicate that the question of what your fund is tracking is rather important. And guess what? Over the last five years the FTSE 250 is up by 57.5%, an amazing outperformance of the other two indices.

Over the last ten years it looks like this: FTSE 100 + 11%, FTSE 250 + 110%, FTSE All Share +21%. These are remarkable numbers. You might wonder why there are so few 250 trackers on offer. It might be because it’s much easier and cheaper to track an index that consists of 100 large shares rather than 250 medium-sized ones.  Or you might prefer your own conspiracy theory.

Government bond markets did not share the sense of near-panic that infected equities. German 10 year Bund yields fell from 0.84% to 0.61%. UK 10 year gilt yields from c.2.1% to 1.8%. Nothing much to smell there, other than a persistent whiff of deflationary commodity prices.

Panic normally produces a slightly fanatical mob pursuit of gold. Gold had just fallen below $1400 an ounce when I wrote about it in April 2013. In Q3 2015 it fell below $1100. Whatever is going on now is not yet apocalyptic panic.

Selling pressure has made a mess of many blameless share prices (as well as many culpable ones) in the last quarter. The bad investment over which I extend to myself the most sympathy is Drax, which has been caught by every alligator in the swamp. We knew about the warm winter and falling energy prices. We knew that the government had withdrawn subsidies for its third biomass conversion unit. “Regulatory headwinds” were then compounded in the last budget in which a carbon tax on carbon-based energy was extended to non-carbon based energy. This threat to the continued existence of satire knocked a further 30% off the Drax share price.

Year to date, Drax has fallen from 460p to 250p. But here’s the oddest thing. On 28th July the H1 results were released and kicked off with this bombshell:

“Drax has performed extremely well over the last six months”

Imagine what would have happened to the shares if it had merely performed “fairly well” or” in line with expectations”.

Revenues rose by 18%, EBITDA by 18% and underlying profits by 8%. I am far more interested in cash flow that accounting profits. Operating cash flow rose by 211% to £199m. This was boosted by lower working capital as the company ran down its coal stocks (as it switches towards biomass). Clearly working capital improvements are unrepeatable and can reverse and for seasonable reasons cash flow is weaker in H2: but even if cash flow is zero in H2 (highly unlikely) the group has already covered its capital expenditure budget and its dividend.

The dividend, in line with group policy, was raised by 8%, in line with underlying profits. Capital expenditure peaked at £300m in 2013, fell to £200m in 2014 and is guided to be £150m in 2015. The company is approaching the end of a £650-700m project to convert from coal to biomass. Given the erosion of government support for these projects, such expenditure is unlikely to occur again in the foreseeable future. Drax has fairly minimal net debt, a prospective dividend yield of 5% and an earnings yield that could be in double digits. I am nursing losses but want to buy more.

The other day (21 September) I wrote about which dividends could be trusted. (I could have but didn’t include Drax). One of my picks was Sainsbury. By chance, it issued a positive trading update on 30 September and jumped by 13%. The lesson to draw from this is as follows: cheap stocks respond very well to good news. It is also worth bearing in mind that expensive shares react very, very badly to bad news. That is why investors should always favour value over popularity. 

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