Report on Q3 2019

Report on Q3 2019

1 Oct 2019

At the end of Q2 I wrote that part of my brain wanted to go on an equity buying spree but I wasn’t sure which part that was. It seems to have been the part that wants a quiet life because the FTSE 100 was unchanged over the last three months. The broader FTSE 250 rose by 2.4%, perhaps due to takeover activity.

Sterling rose by 0.7% against the euro which is effectively also unchanged. The political noise of the last three months happened in a wind tunnel as far as the financial world was concerned (though that may change, especially if Britain’s MPs continue to risk their own legitimacy).

As the global economic news continued to deteriorate government bond yields fell again. The US 10 year yield fell by about 0.25% to 1.75%. 10 year gilt yields dived from 0.86% to 0.55% and the German Bunds now have an even more negative yield (-0.30% to -0.57%). If these are unprecedented scary times, this is the reason.

In my recent post entitled “Equities are the new junk bonds” I pointed out that takeover bids had favoured shares in my own portfolio no fewer than four times this year.

I have been thinking some more about why this is happening and, by implication, how one might incorporate that into stock picking.

Unlike purely financial investors, corporate buyers hate uncertainty. They like to know what they are buying and are put off by the thought of unquantifiable liabilities. This is one of the reasons why companies in trouble are rarely rescued. It’s far easier and safer to buy the assets from the administrator.

The new accounting standard IFRS 16 is now kicking in and it invariably increases a company’s balance sheet financial debt – but it removes the uncertainty of obligations to pay future operating leases which were previously off-balance sheet. Now they are there for all to see.

A business with reliable cash flow that easily covers its seasonal working capital requirements, its minimum capital expenditure needs and its annual interest payments is potentially of interest and if it is perceived as badly managed that is not necessarily an impediment.

If times are tough, one has to take a view about whether a company’s problems are cyclical or secular. For instance are car producers flogging doomed products or will they bounce back one day? Are mobile phone and pay-TV operators operating a model that charges for content that customers will start to demand for free again?

I don’t have the answer but I would rather buy a company with poor management than a company with a dying business. The former can be changed much more easily than the latter.

I am an investor in Morrisons supermarkets. It has had mixed management over the years (though it seems better than average at present). I do not think that supermarkets are dying though they need to be adaptable (see Sainsbury’s shrewd purchase of Argos and M&S’s ludicrous attempt to buy into the mass home delivery market for contrasting examples).

Morrisons has a sound balance sheet, owns many of its stores and generates enough surplus cashflow to have paid bonus dividends for the last three years. In a world where most reliable investments yield nothing, I am happy to wait.

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