Lowland Commentary, December 2018
In December, Lowland’s net asset value declined 6.5% while the FTSE All-Share benchmark declined 3.8%. The weakness in equity markets was predominantly because of concerns regarding slowing global economic growth. For example, there has been weakening economic data from China, the US economy will begin annualising corporation tax cuts and Eurozone economic growth has slowed notably from 2017. This resulted in slowing, but still positive, global economic growth and meant that those sectors that are more cyclically exposed (such as financials and consumer discretionary) underperformed.
For the UK specifically, small and medium sized companies underperformed large companies. Smaller companies are on average more exposed to the domestic economy and the uncertainty surrounding Brexit has led to these companies performing poorly. As a result, they are currently trading at a material valuation discount to the broader market.
The best (actively held) performer during December was Palace Capital, a property company that owns office and leisure assets predominantly outside of London. The shares had performed poorly in recent months and the move upwards is on little news. The shares still trade at a material discount to net asset value and management think there is good scope for rental growth.
The largest detractor from performance was aerospace components manufacturer Senior. The company reported what were perceived to be disappointing results as they are facing short term pressure on margins and cash generation as a result of winning new work on aerospace programmes (that require an upfront investment). This resulted in a relatively minor earnings downgrade and the shares performed poorly as a result. Despite the short term earnings pressure on a longer term basis, this new work should lead to better sales and earnings growth and therefore we remain comfortable with the holding.
The largest trade during the month was reducing the position in Royal Dutch Shell. This had become a large holding (approximately 7% of the portfolio as at the end of November) as we had added to the shares following the previous oil price fall in 2014 and they have subsequently re-rated. When we were previously adding to the shares there were questions around dividend sustainability (at the trough the shares traded on an over 8% dividend yield). The question mark over the dividend has now been largely resolved due to cost-cutting and the shares have re-rated to a just over 6% dividend yield. Therefore, we have reduced the holding to free capacity in order to invest in better value opportunities elsewhere. We have, for example, taken a small initial position in one of the UK housebuilders (Taylor Wimpey) as the shares are approaching book value.
December was a disappointing end to what was a difficult year for both the Trust and the UK equity market as a whole. This has left the portfolio valuation looking low relative to where it has been in recent years. The average price/earnings of the portfolio (on a 12-month forward basis) is now 10.5 versus 11.3 for the FTSE All-Share benchmark. Therefore while there is a considerable degree of uncertainty surrounding the domestic (and global) economy in 2019, valuations are already factoring in a high degree of caution.