Investment Objective and Policy

Transcription

1 PHOENIX Fund Services PFS Downing Active Management Fund Short Report 31 July 2014 Investment Objective and Policy The investment objective of PFS Downing Active Management Fund is to generate capital growth from a portfolio consisting of companies within the Numis Smaller Companies Indices. The Fund takes a pro-active private equity approach to investing in quoted smaller companies. Investee companies will typically be capitalised between 20m - 150m. The Fund will aim to hold a concentrated portfolio of investments. The Investment Manager aims to identify investments that are valued on low price-cash flow ratios relative to peers, and will undertake rigorous due-diligence, modeled on that of a Private Equity style, to establish the robustness of management teams and company strategy. The Investment Manager will invest when the results of duediligence highlight strength of management, a corporate strategy that has been largely overlooked by the market and the potential for the company to demonstrate an uplift in valuation of at least 30% in the first year of investment. Investment Manager s Report for the year ended 31 July 2014 Performance In the 12 month period to 31 July 2014 the quoted share price has increased by 30% in the A share class and 30% in the B share class. In the last 6 months since the interim report was issued, the quoted share price has increased by 11% in both share classes. Since Downing assumed the management of the Fund in early 2011 the B Share class, where the majority of shareholders sit, have increased by 69%, or experienced 20% annualised compound growth*. Given that we target 15% annualised returns from each of our underlying investments we are comfortable with progress since we took on the management of the Fund, despite having to deal with legacy investments when we inherited it. During the year there have been changes to the portfolio due to companies attaining their target prices and we replaced these with new investments. Our top 10 holdings continue to account for a large percentage of the Fund and are the key drivers to performance. % gain in % gain in Period A Shares^ B Shares^ July 2011 July % +6.0% July 2012 July % +18.3% July 2013 July % +30.3% July 2011 July % +63.5% Compound annual return over 3 years +20.0% +21.2% Inception* NA +68.8% Compound annual return since Inception* NA +19.6% * Downing assumed full management of the Fund on 4 Feb The closest accounting date to this date is the interim results of 31 Jan 2011 on which these return calculations are based. ^ Gains based on quoted share price.

2 Investment Manager s Report Fund Activity In the year profits were taken in a number of holdings including Tracsis and K3 Business Technology. A number of smaller holdings were sold in their entirety when they became fully valued. These were refreshed with six new toe-hold positions that are currently in further diligence. One larger position (in H&T) was reduced as our ongoing diligence concluded that the position was overweight in light of the changing dynamics in the company s markets and the management team s ability to influence these factors. Update on existing companies with over a 5% weighting Inland Homes Inland Homes has two main sources of income; 1) Land trading (purchasing brownfield land, achieving planning consent and selling consented land); and house building. 2) Performance for the year has been strong and in a recent trading update management confirmed that they will report full year results that are ahead of market expectations. House-building has been developed successfully alongside land sales over the last couple of years but the group has now made the strategic decision to further increase the number of units constructed per annum to capitalise on favourable market conditions. 114 units were sold in the year to 30 June This was over double the 55 units sold in the prior year, which demonstrates Inland Homes commitment to this strategic goal. The group currently has 492 units under construction across nine sites and is targeting the completion of 500 units p.a. in the medium term. This strategic shift should allow Inland Homes to capture more margin within the supply chain and add to the momentum behind the current growth. We believe that this enhanced margin is not reflected in the current valuation. In order to support house-building operations the group has to grow its land bank with an increase of 57% in controlled plots to over 3,500. Planning consent for an additional 253 residential plots was also achieved during the year indicating sufficient consented supply for the groups short term needs. This reduction in land sales supports the shift in strategy with only 169 plots sold during the year against the 375 in Land sales are seen as a key marketing tool for the business as, with a larger player advertising a site, the group can leverage external marketing budgets and give new developments greater exposure. The group will continue to acquire further land to expand its land bank and lock-in long-term value. Inland Homes has a resilient balance sheet and is well placed to capture the strong demand from house-builders, housing associations, as well as private homeowners and investors. The share price has increased 45% from 31p per share to 45p per share over the 12 months to 31 July At these levels we consider the company sits at a discount to our calculation of intrinsic value. SCISYS To recap on previous reports, SCISYS is a highly skilled and respected IT consultancy, that also sells software products to the media and broadcast, space, government and defence sectors. It is an impressive business punching above its weight, with clients such as BMW. Consequently, the business continues to generate surplus cash and is supported by a strong balance sheet that potentially has two undervalued freehold assets. In the last 12 months, there have been a number of contract wins that complemented the forward order book. In particular contracts with Eumetsat and the European Space Agency added EUR8m, and the Dira! product support and maintenance contract added a further EUR4m to the order book. Looking deeper into the business, it is clear that they have now fully finished their restructuring from which they are benefiting improving operating margins. These increased from 5.3% to 6.8% between 2011 to The gains were driven by boosting staff utilisation, greater emphasis on cross-selling of own IT software and a de-emphasis on third-party software and hardware re-sales. A further rationalisation of 1.2m in overheads is expected in 2014 pushing margins towards the IT consultant industry standard of 9%. Looking ahead we will focus on the company s ability to drive organic sales growth which is being targeted by the newly promoted CEO, Klaus Heidrich. Klaus has been with the business for over 8 years. However, it is worth noting they are also looking to bolt-on vertical acquisitions. They have a track record of successful integration, most recently with MakaluMedia last year. In a trading statement dated 24 July 2014, SCISYS announced that they expect to report higher EBITDA consistent with market expectations and to show further operating margin improvement in the full year results to 31 December SCISYS share price was up 35% over the period since July Tracsis Tracsis, which is one of the Fund s earliest holdings, is a provider of software solutions to the transport industry predominantly rail and road. When the Fund first invested in the business in 2011 the turnover was 2.6m and the company was making c. 450k of profit from a capital base of 6m. Although a small company we were very impressed with its ability to generate cash (at that point it held 2.5m in cash) from its software contracts selling to train operating companies. Moving ahead nearly 4 years, the company has a turnover of 21.5m and 5.0m of profits on a capital base of c. 18m. It also holds over 7m of cash on its balance sheet. Given that the company has grown its profits by 10x since 2011 and improved its ability to generate a return on its capital base then it isn t surprising that the business has been transformed over the period. The management team have acquired a number of complementary businesses and at the same time grown organically. Undoubtedly being part of the UK s renewed investment in the rail network has meant that Tracsis has been a niche player in a growing market certainly in the right place at the right time. Reflecting the 10x growth in profits, the share price has increased by 7.2x since we first invested. Our Fund has supported the company along the way and has increased its holding. At the period end the holding was 5.67% of the Fund, or c.4x its original book value, which when added to the realised gains has returned the Fund 333% on invested monies. We are not complacent with Tracsis and continue to monitor it very closely. On the premise that the biggest risk to the Fund is the current portfolio, those holdings over 5% demand a considerable amount of attention. Since we first invested in Tracsis we have been encouraged by the ability to monitor and track the company. Given that it sells into

3 Investment Manager s Report train operating companies for the life of a rail franchise we can understand the long term implications of contracts c years out. As the company acquired new businesses (eg. MPEC, which provides condition monitoring equipment to the network) the business has become more complex (as MPEC sells boxes, not software on long term contracts) but our knowledge of the rail industry and how to find publicly available information relating to Tracsis has improved significantly. Although reading Network Rail s annual reports may not seem relevant to little Tracsis, the detail within these types of public documents is extremely powerful when it comes to our portfolio monitoring. The result of this is that we continue to believe that the current share price does not reflect the future potential and cash generating abilities of the company. Over the year Tracsis has: Upgraded its market expectations twice (last time by 30%) Bought Datasys (a rail management software company for 4.15m) Extended a pilot with a major North American train operating company Won several significant new contracts Strengthened the Board with a new Chair and Non-Executive Director In the year the share price of Tracsis increased by 103% from 162.5p to 330p. Sprue Aegis Sprue, a manufacturer and distributor of fire safety products in UK and Europe, was introduced to investors in January at the time of the Interim Report. Since that time the company has raised working capital for its European operations, and moved from the ISDX market up to AIM. This was in line with our expectations. The significance of the French smoke alarm market is becoming increasingly apparent (where legislation is being enforced in early 2015 that stipulates that every house in France must have a smoke alarm or house insurance will be invalid). Current penetration of smoke alarms in France is less than 5%. Sprue under exclusivity, provides all B&Q s fire solutions products - B&Q are owned by Kingfisher who also own the largest DIY network in France Castorama. We have not factored-in the roll-out in France in our own forecasts however it could provide some attractive upside. Since we invested in late 2013 the share price has increased by 116%. New Investments with a greater than 5% weighting During the period the Fund acquired a 5.76% position in Office2Office "Office. This also reflects a 5.0% holding in the shares of the company. On a superficial review of Office, it may not appear to be an attractive investment. One of its divisions sells everything from paper clips to toilet paper into businesses. The company used to be Her Majesty s Stationary Office (which later became The Stationary Office). First the company was owned by private equity, then moved onto the London Stock Exchange in The perception that margins in these commodity products are very low is well founded. Margins within office products have declined from c. 7% to 1% over the last few years as online offerings became a cheaper solution for corporates. However, we chose to look through the negative headlines and perceptions and found a company that, despite recession, strong competition and margin pressures had a fairly resilient business model. Not only does Office have a procurement division but it also has a document and managed communications business. All aspects of the business have long term relationships with clients, typically on 3-5 year agreements. The document services and managed communications business has significantly higher margins than the business services division (c. 12% vs. 1-2% net margins). In addition these areas have experienced c. 20% pa. growth. The procurement division has long term contracts with clients such as RBS to supply office products. Meanwhile the managed communications service, for example, has contracts to service Saga responding to callers who want brochures in response to an advert for a cruise; and handling everything from the call coming in, to the brochure production and distribution. In addition the electronic waste and closed loop recycling of sensitive documents includes a long-term contract for the managed destruction and recycling of all sensitive government documents; controlling the process and then selling the recycled paper back to government. We had been researching Office for a number of months prior to investment but had dissuaded from investing because of legacy management and inability of the company to pay-down debt. However a revitalised management team have cut costs and more importantly shown an ability to generate cash. In the last set of results costs had been cut and 7.1m of free cash generated in the period. We like companies that have an ability to generate cash and have a sustainable return on capital. We don t like significant debt. However, where there are clear opportunities to improve return on capital and reduce debt, which have already been evidenced, then we will carry out more diligence. Understandably the market has chosen to overlook Office for all the reasons we have mentioned. However, we believe that there are clear levers that the management can use to improve the returns to shareholders. We will monitor this situation closely and work with management where appropriate. Since the period end, there has been a recommended offer for Office2Office from a Private Equity buyer. This bid is subject to certain shareholder and regulatory approvals. The bid has valued the company at an 88% premium to the entry cost of the fund. Outlook We do not forecast what market or economies might do. Instead we concentrate on what we know and our ability to understand the intrinsic value of the companies in which we invest. The majority of the risk and rewards are dependent on the performance of the existing portfolio, which is where our main focus lies. We believe we have a collection of very good companies that, over the longer term will deliver our absolute target returns. Stock markets, particularly in smaller cap, have been in negative territory for most of In contrast the Fund delivered positive returns in the period. We have confidence that the key drivers in the portfolio will continue to deliver. We will inevitably face periods where the Fund will underperform indices however our goal, which is clearly achievable from this asset class, is to generate 15% per annum over the longer term.

4 Fund Facts Accounting and distribution dates Fund performance Net asset Net asset value value Net asset (pence (pence value % Accounting Distribution Class per share) per share) change Final 31 July 30 September A Accumulation Interim 31 January 31 March B Accumulation C Accumulation ^ (2.70) ^ Launch price 08 May 2014 Net asset values No. of Net asset Net asset shares value (pence As at 31 July value ( ) in issue per share) Class A Accumulation ,489 42, , , , , Class B Accumulation ,583,052 2,735, ,654,396 5,033, ,340,789 5,726, Class C Accumulation 2014^ 3,921 4, ^ Launched 08 May 2014 Price history & distribution record The table below shows the highest and lowest prices on a calendar year basis in pence per share since launch. Past performance is not necessarily a guide to the future performance Net distribution Highest Lowest (pence Year (pence) (pence) per share) Class A Accumulation ^^ Class B Accumulation ^^ Class C Accumulation^ 2014^^ ^ From launch date 08 May 2014 ^^ To 31 July 2014

5 Fund Facts Ongoing charges Expense type 31 July 2014 % Class A Accumulation Investment Manager's charge 1.75 Other expenses 0.66 Transaction charge 0.02 Ongoing charge 2.43 Class B Accumulation Investment Manager's charge 1.00 Other expenses 0.66 Transaction charge 0.02 Ongoing charge 1.68 Class C Accumulation^ Investment Manager's charge 1.50 Other expenses 0.66 Transaction charge 0.02 Ongoing charge 2.18 ^ The ongoing charge is annualised based on the fees incurred during the accounting period. Synthetic risk & reward indicator The Risk and Reward Indicator table demonstrates where the Fund ranks in terms of its potential risk and reward. The higher the rank the greater the potential reward but the greater the risk of losing money. It is based on past data, may change over time and may not be a reliable indication of the future risk profile of the Fund. The shaded area in the table below shows the Fund s ranking on the Risk and Reward Indicator. Typically lower rewards, lower risk Typically higher rewards, higher risk The Fund is ranked 4 because funds of this type have experienced average rises and falls in value in the past. Please note that even the lowest risk class can lose you money and that extreme market circumstances can mean you suffer severe losses in all cases. Risk warning An investment in an Investment Company with Variable Capital should be regarded as a medium to long term investment. Investors should be aware that the price of shares and the revenue from them can fall as well as rise and investors may not receive back the full amount invested. Past performance is not a guide to future performance. Investments denominated in currencies other than the base currency are subject to fluctuation in exchange rates, which can be favourable or unfavourable. Sector classification of investments Sector % of fund Sector % of fund Industrials Technology Technology Industrials Consumer goods Financials Financials Consumer services Consumer services 7.13 Consumer goods 7.09 Basic Materials 3.15 Net other assets Health Care 1.55 Net other assets 8.66

6 Fund Facts Major holdings The top ten holdings at the end of each year are shown below Holding % of fund Holding % of fund Sprue Aegis 7.81 Dart 9.32 Science in Sport 6.14 Inland Homes 9.30 Inland Homes 6.10 SCISYS 6.13 Tracsis 5.68 Tracsis 5.91 Office2Office 5.68 H&T 5.76 SCISYS 5.07 Accumuli 4.75 Accumuli 4.05 K3 Business Technology 4.75 Mecom 3.94 Universe 3.51 Idox 3.80 Ludorum 3.27 Universe 3.77 Games Workshop 2.68

7 General information Authorised status PFS Downing Active Management Fund (the Company ) is structured as an Investment Company with Variable Capital ( ICVC ), under regulation 12 (Authorisation) of the OEIC Regulations (Open-Ended Investment Companies Regulations 2001 (SI 2001/1228)). The Company does not intend to have an interest in immovable property. The Company is authorised and regulated in the UK by the Financial Conduct Authority ( FCA ) as a UCITS Retail Scheme under the COLL Sourcebook. The Company was incorporated in England and Wales on 19 September 2007 under registration number IC The Shareholders are not liable for the debts of the Company. Buying and selling shares The ACD will accept orders for the purchase and sale of shares on normal business days between 8:30am and 4:30pm. Instructions to buy or sell shares may either be in writing to: PO Box 10879, Chelmsford, Essex CM1 9QW Or by telephone to: A contract note will be issued by close of business on the next business day after the dealing date to confirm the transaction. Report and accounts This document is a short report of PFS Downing Active Management Fund for the period ended 31 July The full Report and Accounts for the Company is available free of charge upon written request to Phoenix Fund Services (UK) Ltd, PO Box 10879, Chelmsford, Essex CM1 9QW. Other information The information in this report is designed to enable you to make an informed judgement on the activities of the Fund during the year it covers and the results of those activities at the end of the year. Risk profile The Fund has little exposure to credit or cash flow risk. There are no borrowings or unlisted securities of a material nature and so there is little exposure to liquidity risk. The main risks it faces from its financial instruments are market price, foreign currency and interest rate risk. The manager reviews the policies for managing these risks in order to follow and achieve the investment objectives. Directory Authorised Corporate Director (ACD) & Registrar Phoenix Fund Services (UK) Ltd Springfield Lodge, Colchester Road, Chelmsford, Essex CM2 5PW Telephone: Fax: Website: Customer Service Centre PO Box 10879, Chelmsford, Essex CM1 9QW Telephone: Fax: downing@phoenixfundservices.com Directors of the Authorised Corporate Director P.J. Foley-Brickley (appointed 8 January 2014) D. Jones (appointed 1 April 2014) R.W. Leedham D.W. Munting A.C. Reed (retired 31 March 2014) D.C. Tibble Investment Manager Downing LLP Ergon House, Horseferry Road, London S1P 2AL Depositary National Westminster Bank Plc Trustee & Depositary Services 135 Bishopsgate, London EC2M 3UR Auditor KPMG Audit Plc Chartered Accountants & Registered Auditors 15 Canada Square, London E14 5GL PHOENIX Fund Services Phoenix Fund Services (UK) Ltd. Registered in England No Authorised and regulated by the Financial Conduct Authority.