In May Lowland’s NAV fell 4.2% versus a 3.0% fall in the FTSE All-Share index. At the sector level industrials were the largest detractor as the imposition of US tariffs on both Chinese and Mexican imports led to concerns about lower global economic growth. This impacted some of Lowland’s broader industrial holdings including IMI (-13.8% during the month) and Morgan Advanced Materials (-9.3%), as well as XP Power (-13.4%) which produces roughly 40% of all products in China (about half of which are shipped directly to the US). A sharp downward movement in bond yields also meant the fair value of the debt was revalued upwards and this detracted 0.4% from NAV during the month.
At the stock level the largest contributor (that is actively held) was Castings. This reported good results from its foundry division (partly as a result of orders being pulled forward ahead of the original ‘Brexit’ date of the end of March). As a result earnings were ahead of expectations. We continue to hold the position as the UK lacks foundry capacity and Castings is among the market leaders, with a strong net cash balance sheet.
The largest detractor was building materials company Low & Bonar, which reported a disappointing trading update. While we participated in the emergency rights issue earlier this calendar year as in our view there is a core building materials business that is capable of generating good (mid-teens) operating margins, the underlying trading conditions have worsened and the balance sheet even after the rights issue is difficult.
During the month the largest individual purchase was adding to the existing holding in GlaxoSmithKline. After many years of little earnings growth, the company can return to (modest) growth driven by strength in their vaccines and consumer health divisions. Within their pharmaceutical division one of their largest respiratory drugs has had generic competition enter the market, meaning that earnings can be re-set to a lower base from which to grow in future years. The holding in Direct Line was also added to. While the motor insurance market is difficult currently (as claims inflation is outpacing price increases) Direct Line is managing to maintain margins and we therefore think the current 9% dividend yield is sustainable.
It is a particularly difficult period to have conviction, with the dual uncertainty of tariffs (industrials are approximately 25% of the total portfolio) and domestic uncertainty (best illustrated by Sterling which has fallen from ~$1.30 to $1.26 during the month). Where we have been adding to holdings it has (broadly) detracted from performance as it is our inclination to add to ‘value’ within the portfolio and these companies have tended to continue to de-rate. The difference in valuation levels between defensive and cyclical companies has reached extreme levels. The value opportunity is clear in certain sections of the market but we will continue to add slowly, recognising that it is detracting from performance.