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

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I think these numbers are a useful reminder of the power of dividends, which can of course be reinvested or withdrawn to suit your requirements.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 mirrored in its StockRank:

What lies behind this price action? A year-end trading update in April and subsequent final results in June struck a cautiously optimistic note, and confirmed that performance was expected to be in line with expectations.

I suspect some shareholders were disappointed that management didn’t upgrade guidance for the year ahead. 

2018 saw the group deliver an impressive 57 percent increase in adjusted earnings. In contrast, forecasts for the current year suggest earnings growth of just 2.1 percent. Forecasts for FY21 indicate eps growth of 3.5 percent. 

Is D4T4’s growth engine running out of steam? One person who should know is co-founder John Lythall, who ran the company from 1985 until 2016 and remains a non-executive director. Mr Lythall sold 1.2m shares in early July, reducing his holding from 5.5 percent to just 2.6 percent.

Two fellow directors, COO Mark Boxall and Chief Data Officer Matthew Tod, also logged big sales. Mr Tod has since resigned and will leave at the end of September. 

I also note that D4T4 is about to get a new CFO. The firm has been without a permanent CFO since 4 July, even though the previous incumbent gave notice in April.

My view: I’m not suggesting that anything is amiss. But the picture no longer looks as enticing to me as it did when I bought the stock. We have:

• A big founder share sale

• Boardroom turnover

• Earnings expected to flatline over the next 18 months

• The shares trade on 17 times forecast earnings and yield just 1.4 percent

In fairness, I should say that the balance sheet remains debt-free. Last year’s 25 percent return on capital employed was also impressive. However, I don’t see a compelling case for buying the shares at current levels, unless you have an in-depth understanding of the business and see hidden value. 

D4T4 Solutions now fails five of my 15 screening tests, mainly due to its higher valuation and slowing earnings growth. I also note that the StockRank has fallen from 94 at the time of my purchase to just 71 today.

I’m quite happy to take profits at this point and allow events to unfold without me.

Verdict: Sell
Total return: +25pc

Carr’s Group (LON:CARR)

(Original coverage 11/12/2018)

In April, Paul Scott described Carr’s as “a rather dull agriculture and engineering group”. His view was that most investors could probably find more exciting opportunities.

I must admit that over the last nine months, Paul’s scepticism has proved justified. Carr’s share price has gone nowhere much except down and the SIF folio’s holding is currently running a 13 percent loss.

Where the stock does score very highly in my view is as an income investment. Adjusted for splits, Carr’s dividend has not been cut since at least 1993, the farthest back I can find records. During that time, the dividend has grown from a split-adjusted 0.39p to 4.5p. My sums suggest that gives a compound annual growth rate of about 10 percent per year, over 25 years. Not bad.

I think that what I’ve learned is that this is not a stock that’s likely to be suitable for shorter holding periods.

Trading: Since I bought the stock last December, Carr’s trading has been in line with expectations of modest growth this year. Brokers covering the firm have remained remarkably consistent/resolutely uninspired over this time, depending on your view!

My view: With Carr’s stock now trading on nine times forecast earnings and offering a dividend yield of 3.5 percent, the shares look reasonable value to me for a patient income investor.

However, this stock has been range-bound over the last five years, and I can see no obvious catalyst for a re-rating. It’s certainly a dull picture and I see that the StockRanks are starting to lose faith:

Carr’s lacklustre profit growth and share price performance means that it fails a number of my screening tests. I have no choice but to sell the stock from the SIF folio.

Verdict: Sell
Total return: -13pc

Macfarlane (LON:MACF)

(Original coverage 18/12/2018)

Let’s finish with a winner. My timing was lucky when I added small-cap packaging group Macfarlane to the SIF fund in December. After the autumn sell-off, the stock bounced back quickly in early 2019:

As it happens, February’s final results showed that sales rose by 11 percent to £217m in 2018, while underlying pre-tax profit climbed 20 percent to £11.2m. These numbers were said to be in line with expectations, but they represented an impressive ninth consecutive year of profit growth.

Chairman Stuart Paterson confirmed guidance for “further progress in 2019” despite difficulties in the retail sector. Analysts covering the stock were sufficiently impressed to tweak their forecasts higher. 

Macfarlane’s recent half-year numbers also triggered a small tweak to this year’s forecasts and a bigger increase for next year:

My view: Although I believe that packaging carries some cyclical risks, I see it as a sector that is likely to benefit from modest structural growth over the coming years.

Macfarlane’s valuation remains reasonable, in my view. The shares trade on 11.4 times rolling forecast earnings, with a 2.7 percent dividend yield. My only slight reservation relates to the group’s gearing, as reflected by the new IFRS 16 regulations.

Is leverage higher than we thought? The new accounting rules require companies to show a right of use asset and a matching lease liability on their balance sheets. This has been reflected in a big increase in Macfarlane’s reported net debt:

This increase reflects £29m of finance lease liabilities which the company has added to its balance sheet. These are said to represent buildings and plant, such as printing presses. 

Adding the corresponding right of use assets to the balance sheet has increased the value of Macfarlane’s Property, Plant & Equipment (PP&E) from £8.7m to £39.5m. Management say that right of use assets are valued to reflect the total lease liability, less accrued lease payments. I think we can view this as a loose approximation of the value of these assets.

This ‘missing’ PP&E was previously accounted for with operating leases, which show up as an operating cost only, with no balance sheet presence. I think this change is interesting -- it seems to suggest that this business is more capital-intensive than we thought. It also suggests a higher degree of leverage (relative to profits) than was previously apparent.

All else being equal, I expect the group’s return on capital employed to fall as a result of this accounting change. 

I should caveat these comments by saying that I’m not an accountant or an expert on lease accounting. My comments reflect my view only -- and if I’ve made any glaring errors, please feel free to point them out.

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. 

Given the firm’s consistent performance and confident outlook, it may be too soon to sell. But I’m going to stick to my rules and will be selling the stock from SIF this week.

Verdict: Sell
Total return: +30.7pc

As always, I’ll sell these shares from SIF and from my personal holdings after this article has been published. 

I’ll be back next week, hopefully with news of a new stock for the SIF folio.

Disclosure: At the time of writing, Roland owned shares in Macfarlane, D4T4 Solutions and Carr’s.