A catalyst for Dairy Farmers?
First action to close the discount on DFoB loan stocks
A boring note on one of my own investments today. I’ve just noticed that Dairy Farmers of Britain slipped out an important announcement on December 24th:
“A number of important Board-proposed changes to our capital structure to better reward and support committed members has been passed from this month’s Regional Chairmen’s Committee to full Council for consideration next month and implementation – subject to approval – early in the New Year. Foremost amongst these are:”
“To give all members the opportunity to reach the 4ppl investment level at which capital retentions cease as rapidly and economically as possible by buying loanstock at market value and transferring it into their MIAs at face value;”
“To encourage expansion by setting a fixed level of production rather than rolling annual average as the base for calculating the 4ppl MIA minimum funding requirement; and,”
“To provide retiring members with the flexibility to leave their capital in their interest-earning MIAs, access it over three years from the third anniversary of their notice, and earn substantially better returns than those resigning to sell their milk elsewhere.”
For outside investors in the loan stocks (see here, here and here) the relevant point is the first one. In essence DFoB plans to let its members buy loan stock at the market price (currently around 60p) and return it to the company at face value (which is £1). I assume they mean the loan stocks that trade on Sharemark.
MIA stands for Member’s Investment Account. As I understand it, the co-operative funds itself by keeping back a small amount of what it pays a farmer for milk until that farmer has a set amount of capital in the business (4 pence per litre of milk sold in a year). The MIAs turn into loan stock when a farmer leaves the co-operative. Under the DFoB plan, new farmers would be able to turn loan stock back into MIAs, thus buying out the retiring members.
It makes a lot of sense and may mean that DFoB is waking up to how low its loan stocks are trading on the secondary market. Its plan should be tempting to farmers - why pay £1 in deductions when you can buy at 60p in the market? If this does happen, it should produce an increase in demand for DFoB loan stock on Sharemark.
There are three caveats. First, DFoB members may not have the spare cash to invest in their co-operative up front. Second, they may not understand or be interested in the arbitrage that is on offer to them. And third, this is an outline plan that may not happen, or may not be open to external holders of loan stock.
As I have written before, I think that these bonds offer compelling value, often yielding 15 per cent or more to maturity. To realise that value quickly, however, DFoB would have to do the sensible thing and buy back loan stock itself.
Disclosure: I own Dairy Farmers of Britain Loan Stock 2012, 2015 and 2016. As ever, please note the disclaimer above and remember that I am not advising you to buy or sell anything.
Prospects for 2008
My thoughts - for what little they are worth
It’s that time of year when every brokerage feels compelled to make its forecast for what the markets will do this year. It’s all a bit of a waste of time. The stockmarket responds to new information that it hasn’t yet priced in and, over a single year, the shocks could be in either direction.
The best stockmarket forecast is the same every year. Take the ten-year risk-free bond rate, add on a risk premium of 2-3 per cent, and the 7-8 per cent figure that you get (there are lots of studies with different figures) should approximate to long-run equity returns. That is an average - returns are almost certain to be higher or lower in any given year.
While the market is near impossible to predict in the short-term, it is possible to make a few useful observations about the fundamentals:
- P/E ratios are not far from their long-run average
- However, corporate profits are taking up a record share of national income in most developed countries, and are probably close to a cyclical high
- A credit squeeze, US slowdown, losses in the financial sector etc means I can’t believe that profits will rise much this year.
If earnings don’t go up, the only way the stockmarket can make strong progress is if P/E multiples expand, and I really can’t see why that would happen.
The other fundamental of note is the weakness of the dollar and, increasingly, of sterling. Given the size of current account deficits in both countries, the overvaluation of sterling, and a slowdown in both economies, I think there is a good chance the trend will continue.
That should (a) boost profits at Anglo-American exporters and (b) mean that overseas investments (especially in Asia) produce positive returns for sterling and dollar investors - even if those markets stagnate in local currency terms.
It promises to be a difficult year. I won’t be putting new money into mainstream stock investments and will try to keep my market beta down. All my new pension money will go into funds that track Asian markets. I’d be interested, however, if anyone can make a strong bull case for 2008?
New Year’s Resolutions
Things I would like to do better in 2008
Happy New Year - I hope everybody had a good holiday (even better if your holiday hasn’t finished yet).
I have a couple of investing resolutions for the New Year, things that I know I do badly, and would like to improve.
(1) Trade better - I make two kinds of mistake when it comes to actually buying and selling shares. On one hand, I sometimes fixate on a price, and refuse to sell out lower. On the other, I am sometimes undisciplined when I see the price of a share I have been watching start to move, and rush in.
My resolution: to ignore nominal prices and focus on what a share is worth; never to trade in a hurry; and only to chase a price higher if I have previously decided I am willing to do so.
(2) Justify my decisions - To beat the market, systematically and adjusted for risk, one has to buy undervalued shares. For a share to be undervalued the market’s assessment of it must in some way be wrong.
Growth or value is not enough - it has to be growth or value that the market has missed or, for some reason, is discounting incorrectly.
My resolution: if I can’t clearly say why a company is cheap - and why that low valuation is wrong - then I don’t want to invest in it.
Those are just two of my many bad habits, but correcting either of them would be progress. Does anybody else have any investing resolutions? Either way, here’s to a healthy and prosperous new year.
My portfolio in 2007
Not a vintage year but not too bad
Today is my last day at work (hooray!) so I’m also going to make this my last post of 2007. Merry Christmas and a happy and prosperous New Year to you all.
I’ve been trying to estimate my portfolio return for this year, which given my slipshod accounting is not as easy as it should be. It depends on how I value my illiquid holdings (especially Getmapping) but I reckon I’m up about 10 per cent.
Star performers have been Dairy Farmers of Britain 2016, which has delivered a total return of 30 per cent on my purchase price, and is a large part of my portfolio. Split capital trusts also did well earlier in the year, especially Martin Currie Income & Growth and Recovery Trust.
Dog of the year is definitely Armorgroup which has lost 60 per cent. I also bought CML Microsystems too soon and am off about 40 per cent on that position. Fortunately they are not large holdings.
I’ll post again in 2008, which promises to be a nervous year for investors. Season’s greetings, and thanks for reading.
The Xmas volume dodge
One way a fund manager can improve his annual performance
So - your smallcap fund is a little below the benchmark this year, and your bonus depends on a minimum of second quartile performance. Between now and Dec 31st you need to beat the market by 0.5 per cent.
Fortunately there is an easy way to do it: buy a little more of the most illiquid stocks in your portfolio during the year’s most illiquid trading period, between Christmas and the New Year. With most of the other managers who might sell to you on the ski slopes or stuffing themselves with mince pies, even a small trade can often move the market.
It’s self-defeating - any performance boost this year just puts you in a more difficult position for next - but with this year’s bonus on the line it might be worth a try.
I’m sure that managers are too principled for this kind of thing, and I have never seen any academic work on returns between Dec 25th and 31st to prove the point one way or the other. The temptation for those in the office on Friday Dec 29th, however, is obvious.
Newport Networks (NNG)
Distressed sellers maybe, but I wouldn’t want to be a distressed buyer
This line in yesterday’s FT market report caught my eye:
“Newport Networks, the telecommunications equipment maker, slumped 54 per cent to a record low of 1.37p after a distressed seller dumped large chunks of stock at prices as low as 1p. Traders said a growing number of hedge funds and private investors who use derivatives were being forced to liquidate at almost any price. Newport, chaired by Welsh billionaire Sir Terry Matthews, listed at 71p in 2004.”
I’m always interested in distressed sellers, especially in a company whose founder was behind Newbridge Networks (sold to Alcatel for $7bn in 2000), so I thought I’d check it out.
What’s clear is that Newport has so far been a failure: sales of £1m in 2006 collapsed to only £76k in the first half of this year.
It does appear to have an interesting set of products, however, which shareholders have spent £50m on developing (if anybody understands the technology maybe they could post a comment).
Given the cash outflow of £8-10m a year I will be steering clear - Newport is going to need a lot of new funds - but were I a venture capitalist I’d take a look.
A lot of technology companies (Indigovision is a good example) only take off after years of heavy losses. The early shareholders rarely make a profit, but those who buy in at the moment of greatest gloom benefit from all the prior investment, and sometimes reap a handsome return.
Provident Financial (PFG)
Why it might be good to be a subprime lender in a slowdown
There is an interesting market argument going on about Provident Financial, which specialises in small, short-term, unsecured loans to subprime customers.
On the one hand, PFG will suffer higher default rates if there is an economic slowdown next year, and two-thirds of its capital comes from banks and the financial markets. It is exposed to the credit crunch.
On the other hand, as banks and other lenders reliant on securitisation disappear, there will be more customers left for Provident and less pressure on prices. The company pushed that line in its trading statement yesterday.
It is instructive to look back at what happened to Provident in the last UK recession. Pre-tax profits went from £31.7m in 1989, to £36.2m in 1990, £34.1m in 1991, £44.5m in 1992 and £62.5m in 1993. I think that gives credibility to PFW’s assertions about the resilience of its home credit business in a slowdown.
Credit Suisse have the stock on 11.1x their 2008 earnings estimates and a dividend yield of 7.9 per cent. If the shares fall much further I’ll be tempted.
The Winterflood Tax
Marketmakers are the curse of the smallcap market
As a retail investor, there are lots of institutions in the stockmarket that wind me up: mealy-mouthed investor relations departments, spivvy investment banks, and lazy retail brokers who just type your order into a computer.
But the most irritating of all are the marketmakers who set bid and offer prices in smallcap shares, and who are supposed to provide liquidity in return for their huge spreads. I call this the Winterflood tax, after Winterflood Securities, one of the largest retail marketmakers on the LSE. I reckon I have paid them several thousand pounds in my investing life to date.
Many smallish AIM stocks have a spread of 4-5 per cent, which takes a big chunk out of potential investment returns. The compensation for this is that marketmakers are obliged to always make a bid and offer price.
If that actually meant anything it wouldn’t be so bad, but as soon as a stock gets into trouble the marketmakers just close for business. Look at the examples below of a few genuinely small, troubled or illiquid stocks:
- AgCert International (AGC) - Bid at 1p, offered at 1.5p, Normal Market Size 10,000
- Transense Technologies (TRT) - Bid at 25p, offered at 28p, NMS 5,000
- E-Pay Asia (EPY) - Bid at 2.5p, offered at 3.25p, NMS 3,000
So marketmakers’ liquidity support for AgCert amounts to them being obliged to buy £100 worth of stock and sell it at a 50 per cent spread. They might reply that many deals are done inside the quoted spread - but at those prices they are not obliged to provide any liquidity at all.
Two changes are badly needed. First, the LSE should move to order-driven trading for all shares, no matter how small. Ignore the marketmakers’ bleating. Second, retail investors should be allowed to enter bids and offers directly to the order book, so that they can offer liquidity in small shares themselves.
At present, as in so many other ways, small companies and retail investors are short-changed for the benefit of the institutions that make up the market.
Weird financial alchemy at Rightmove (RMV)
How to create £500m out of thin air
I posted a little while back on Rightmove, the property website, which I consider to be overvalued.
On Tuesday they announced details of a financial restructuring which will mean a company with £33.2m in total assets suddenly has £500m in distributable reserves.
Here are the main points:
“The Proposals seek to create additional distributable reserves to allow the Group to pursue a progressive long term dividend policy and, subject to market conditions, an ongoing share repurchase programme.”
“The Proposals in summary are: A scheme of arrangement whereby shares in Rightmove plc will be swapped for an equivalent number of shares in Rightmove Group plc, a new holding company. This will be followed by a reduction in capital of the new holding company to create distributable reserves.”
“The Scheme and the Rightmove Group Reduction of Capital are expected to increase the distributable reserves available to the holding company of the Group from £15.4 million as at 30 June 2007 to approximately £500 million.”
This is what I think is happening. Rightmove will be acquired by a new company in exchange for shares, but because RMV has a market cap of £576m versus its net assets of £33.2m, the new company will have about £540m in goodwill. The offsetting liability will be £540m in share capital.
Persuade a court to reduce the capital of those shares and, Bob’s your uncle, you have £500m in distributable reserves.
The purpose of all this, presumably, is to let Rightmove pay out all of its earnings as dividends, or borrow money and give it to shareholders.
In Ben Graham’s day, when people cared about such things, this was called “watering the stock”. It is an object lesson in why one should always strip out goodwill when looking at net asset value because the manoeuvre adds nothing - precisely zero - to the value of the company.
The rules of Sharemark
Why auctions should not have a fixed cut-off time
Emma Vigus, who runs Sharemark, has kindly posted a comment on the site which is worth reading in full.
She wants to clarify a few points: first, that the frequency of Sharemark auctions differs between companies and can easily be adjusted; second, that the number of brokers who can deal on Sharemark is increasing; third, that in her view, there are incentives to offer liquidity on Sharemark; and fourth, that the system does not encourage last minute bids.
More brokers is good news, as the more investors who can access the market, the greater the demand for shares. In my personal experience, one broker said they could not deal, and a second could in theory but were told not to by their compliance department. I eventually opened an account with the Share Centre, Sharemark’s parent.
On the third and fourth points, I have to take issue. Emma writes:
“…we believe that there is an incentive to provide liquidity, because orders entered earliest will be filled in priority to later orders. Auction-based systems are proven mechanisms for trading less liquid securities, Sharemark is not the only mechansim of its type… they are widely used internationally.”
“Finally we do not believe that we encourage late bidders, although as with all auctions it makes sense to monitor the auction and a late price adjustment may be required to ensure your order is filled.”
I disagree with this. I think it is only rational to enter an order on Sharemark at the last minute and that undermines the incentives to provide liquidity.
Sharemark runs normal ascending-price auctions. Buyers and sellers enter bids, and the level at which the most shares will trade is where the price clears, with the earliest bidders or sellers at that price getting priority.
The fatal flaw is that there is a fixed cut-off time for entering orders: often 3pm in the afternoon on the day of the auction. At a Sotheby’s sale the auctioneer will keep going until there are no more bids. Auction periods on the London Stock Exchange have a random ending time within a 30 second window. Even eBay has its automatic bidding system to reduce the effect of last minute orders.
Sharemark auctions, however, end at a fixed time. If you bid at the last possible moment, therefore, it follows that you cannot be outbid.
Now apply a little bit of game theory. If everyone knows that the last bidder cannot be outbid, everyone will try to delay their bid until the last minute. Even if someone were willing to pay more than that last bidder - and I have sometimes wanted to - they will not have a chance to enter their bid.
The effect is less pronounced in the more liquid auctions where there are plenty of sellers as well as buyers and price formation is more transparent - but it is still there.
« go back — keep looking »Were I in charge of Sharemark, I’d introduce a series of one minute extensions if there was an order placed in the previous minute, and maybe combine it with LSE-style randomisation of the end. I bet the result would be more orders and higher prices. How about it Emma?
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This website is about my investments and opinions on shares. It does not constitute advice and you should not rely on any material in this website to make, or refrain from making, any decision or take, or refrain from taking, any action. Where I have positions in a share I mention I will disclose them. Rogue Analyst is not authorised under the Financial Services and Markets Act 2000.
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