SIF Folio: Dividends Add 29% & D4T4, CARR And MACF Are Under Review

1st Oct '19 by Roland Head

6 comments 3053 reads

It’s the end of another month, so it’s time to review stocks which have been in my SIF fantasy fund for nine months or longer.

Three companies are in the spotlight this week:
- Big data software group D4T4 Solutions (LON:D4T4)
- Agricultural and engineering group Carr’s (LON:CARR)
- Packaging group Macfarlane (LON:MACF)

Here’s how these stocks have performed during their time in the portfolio:

I’ll come back to them in a moment, but first I want to take a slight diversion to a topic that’s close to my heart: dividend income.

Dividends add 29 percent

Stockopedia’s Fantasy Fund system doesn’t currently recognise dividend income. However, I do track the income generated by my picks.

I can tell you that the (virtual) income received since I launched the portfolio in April 2016 has had a big impact on my total return to date.

Below on the left is a screenshot from the SIF fantasy fund page. This shows total return to date on the nominal £1m starting value, excluding dividends.

On the right is a screen capture from the excellent new Stockopedia Folio system, which automatically breaks out dividend income to show the contribution it makes to total returns:

(The initial value of the portfolio was £1m)

At the time of writing, the portfolio is worth £1,426,314.11 with dividends, and £1,330,378.78 without dividends.

Dividends have added 9.6 percent to my total return over 3.5 years. That won’t be too surprising -- it’s just under 3 percent each year.

What’s more surprising is to realise that this dividend income has increased my total return to date by 29 percent.

I think these numbers are a useful reminder of the power of dividends, which can of course be reinvested or withdrawn to suit your requirements. That’s not true of capital gains, which must always be traded to be realised.

Diversion over. Let’s get back to this month’s threesome under review.

D4T4 Solutions (LON:D4T4)

(Original coverage 04/12/2018)

Shares in this ‘big data’ software company got off to a flying start when they joined the SIF folio last December. Progress has cooled since April, however. Note that the stock’s gradual decline is also starting to be…

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siestainvestor

1st Oct '19

What does SIF an abbreviation for? It is not obvious from the article!

Skweeka

It's just the name given to his portfolio 'Stock in Focus' - see bio top right

Gromley

Interesting observations on Macfarlane (LON:MACF) Roland.

You're probably aware that I had a bit of a spleen-vent on the subject of IFRS16 here and funnily enough it was MacFarlane that brought the ('debt') implications to my attention in the first place.

But there is more, you say :

I think this change is interesting -- it seems to suggest that this business is more capital-intensive than we thought.

The numbers suggest that certainly but I don't believe it is true. I cannot really see this accounting construct as capital, it's capitalised future expenses and seems bonkers - I was in two minds about the debt element but this looks a lot more clear cut to me.

Supposing a company pays £100k of rent per year. If they have a 10 year lease remaining they would appear to have £1m of "capital" tied up, but if they only had 2 years remaining on the lease it would only be £200k (in fact perhaps nothing if it then became classified as a short term lease). Presuming the business continues to operate into the third year , they will still be paying rent. (Whilst we are getting used to rents coming for retail real estate, I don't think that is true for commercial real estate in general).

And while we are on the subject, should we not also capitalise the business rates they will have to pay over the duration of the lease?

Anyway rant aside, it was actually the decision to take MacFarlane out of the SIF that intrigued me.

Getting back to Macfarlane, this stock no longer passes all of my screening tests, in part because of the impact of IFRS 16 on various quantitative metrics.

Looking at your screen I can see four fails

RS 1y > 0 - Probably nothing to do with IFRS16 (although very tenuously the IFRS numbers could have knocked sentiment)

Earnings Yield % >= 8 - The enterprise value has increased by 20% as a result of IFRS, I think this would have been borderline on the old numbers.

Piotroski F-Score >= 6 - MACF scores 5 and without looking at the other elements that might be affected, I know it loses one point because debt has apparently gone up year on year. In reality debt reduced,but MACF did not restate the prior year numbers for IFRS16 (there was no obligation to do so)

Net Debt < Net Profit This would have been a narrow fail anyway (although I cannot see that MACF ever passed this test, so how did it get in?) As reported the numbers give profit of £9m vs "debt" of £45m

I do absolutely understand the point that this is rules based approach, but I can see a couple of challenges here.

During the transition period; you are actively discriminating in favour of companies that have yet to produce any IFRS16 numbers, but there is no reason to believe that discrimination provides any positive factor. (probably no negatives either, but could result in missed opportunities)

Once the transition is out of the way I can still see challenges that might imply that the screen needs to change - given that almost every company will be impacted to some degree.

Less companies will pass the earnings yield test in your screen.
Less companies will pass the Net Debt < Net Profit test.

(Once both the PY & FY numbers are under IFRS16, I think Piotroski will return to normal).

So to be selecting the same "types" of investments in the future, you might have to relax those criteria slightly. However, even if you do so you will be implicitly discriminating against companies that have long leases for property and/or equipment.

In the current environment that would certainly be a good thing for "retailers", but I cannot imagine you are picking up too many of those currently anyway. For other sectors and possibly retail in the future I cannot really see that would be a rational discrimination.

I don't know the answers there, but I do think that IFRS16 is going to prove to be quite a profound change by anyone screening directly or indirectly on 'debt' and potentially 'capital'.

Roland Head

2nd Oct '19

Hi Gromley,

Thanks for your detailed comments, you make some interesting points. I also enjoyed your IFRS 16 piece and thought it covered the key issues well.

IFRS 16: Debt and capital creation?

I agree that the implications of IFRS 16 are potentially significant for screen-based systems and could cause some disruption. I'll come back to this in a moment.

Debt: As regards debt 'created' by IFRS 16, I think it's fair to assume that a contractual obligation to make payments for years into the future is equivalent to conventional debt. It's not the same as business rates, which would cease if the business ceased. Lease liabilities remain regardless of the state of the business, just like debt.

Obviously this is a bit simplistic. How do leases compare with debt in terms of recourse and seniority? Are any of the leases guaranteed? We don't know the answers without much in-depth research, but for equity holders I think it makes sense to take a conservative view and assume that all quasi-debt obligations rank ahead of equity.

Capital: What about capital employed? I agree that the 'right of use assets' and corresponding liabilities mandated by IFRS 16 are not a perfect representation of capital employed.

For property, considering outstanding lease terms as capital employed is perhaps not ideal. A company whose property is on a 20-year lease will appear to be more capital intensive than one whose property has a 10-year lease. This probably wouldn't be true for a property that was bought with conventional debt, such as a mortgage.

However, I think the IFRS 16 rules work much better for depreciating assets such as plant and equipment. The capital value of these assets does naturally depreciate with time. This is already reflected on the balance sheets of companies that use conventional debt. IFRS 16 now mirrors this.

I'm no expert, but it seems to me that IFRS 16 is a step in the right direction. After all, these assets do represent both capital employed (by the lessor) and debt-like obligations (for the company). The business couldn't function without this level of capital, so I'd argue that we should include these elements in our view of capital employed.

Macfarlane (LON:MACF) and the SIF screen

Getting back to Macfarlane, I agree that some of the screen fails can be linked to IFRS 16 and some cannot.

Even a single fail is enough to require me to sell a stock, so regardless of how we treat the impact of IFRS 16, I think the decision to sell can be justified, based on my rules.

Do I need to change the rules? You're right that there could be some wider implications of the IFRS 16 rule change, especially relating to statutory net debt. I may need to modify my screening rules to reflect this.

I'm still working out the best approach to take here, but I'll aim to comment on this in more detail in my articles over the next few weeks. Thanks for bringing this to the foreground for me!

Regards,

Roland

Old ManFit

the link "https://app.stockopedia.com/fa..."

doesn't work, it 404's back to the home page

Hi Old ManFit,

Stockopedia Fantasy Funds aren't yet available on the new version of the website.

To access the SIF fund (and all others) you'll need to switch back to the old version of the site.

The correct link for the Stock in Focus fund is:

https://www.stockopedia.com/fantasy-funds/stock-in-focus-portfolio-6449/

Regards,

Roland

SIF Folio: Dividends add 29% & D4T4, CARR and MACF are under review

Dividends add 29 percent

D4T4 Solutions (LON:D4T4)

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Roland Head

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