SIF September review: Character profit warning (TAM, REC, SXS, RWA, CCT)

This week I’m invoking one of my least-used rules – the profit warning sell. Although last week’s profit warning from toy group Character (LON:CCT) has only resulted in a fairly modest share price fall, I still need to look at this situation to see if it triggers a disposal.

In addition to reviewing Character, I’ll also be carrying out my usual month-end review of stocks that have been in the portfolio for at least nine months. Four companies are on the list this month:

• Financial adviser platform Tatton Asset Management (LON:TAM)

• Recruitment group Robert Walters (LON:RWA)

• Precision instruments specialist Spectris (LON:SXS)

• Currency hedging manager Record (LON:REC)

I’ll take a look at each of these stocks in a moment, to see whether they still satisfy my screening criteria. But first, let’s take a quick look at the performance of the SIF virtual portfolio so far this year.

SIF Folio: September performance update

I’m pleased to report the portfolio has continued to outperform the market as signs of volatility re-emerge. Here’s how SIF has fared against the FTSE All-Share index over the last month:

And here’s how the portfolio has performed against the market so far this year:

To wrap up this section, here’s a snapshot of all the portfolio’s current holdings, before any changes that might result from this review.

Character (LON:CCT)

(Original buy report 20 July 2021)

Character Group is a toy manufacturer that’s probably best known for its Peppa Pig toys. It’s also one of a handful of companies (so far) toissue a profit warning due to supply chain disruption.

What’s happened is that “global logistical challenges” have combined with rising production costs in China. As a result, Character warned on 15 September that profits for the year ended 31 August 2021 will be up to 10% below market forecasts.

This is a retrospective profit warning and was issued after the financial year ended. The company has not issued any fresh guidance for the current financial year, but brokers covering the stock have started to trim their forecasts:

My rules say that I must sell a company’s shares following a profit warning. The basis for this is that historical evidence shows that an initial profit warning is often followed by a prolonged period of underperformance. Check out Stockopedia’s excellent Profit Warning Survival Guide for more detail on the data behind this claim.

My decision: I’m going to sell SIF’s holding in Character Group, in line with my rules.

That doesn’t mean I don’t like this business – broadly speaking, I do. Historically, Character has generated high returns on capital employed and strong free cash flow. Dividends have been attractive and the balance sheet routinely shows net cash.

A further attraction is that MD and finance director Kiran Shah owns 10% of the stock. 

However, it’s a tough market out there and things haven’t always gone Character’s way in recent years. 

I also think it’s reasonable to assume that the headwinds suffered by the company already this year are likely to persist into the festive trading season. The impact of any shortfall in stock availability in the coming months could be more severe for this seasonal business.

If this was a long-term portfolio I might be tempted to sit tight. I don’t think Character Group faces any existential risks. But SIF has limited time horizons and the outlook is decidedly unclear. I think it makes sense for the portfolio to sell.

Total return: -10%

Verdict: Sell

Spectris (LON:SXS)

(Buy report: 15 December 2020)

Precision instrumentation group Spectris (LON:SXS) joined SIF in December last year. The shares have performed well since then:

Full-year results in February showed some impact from the pandemic, with like-for-like sales down by 11% and adjusted pre-tax profit down 33Q% at £166.4m. Shareholders got a 5% dividend increase and a £200m share buyback.

However, the balance sheet remained sound and the outlook for the year ahead was confident:

“Group positioned well as markets recover – cost base reduced, capability retained, strong operating leverage opportunity, balance sheet optionality”

This bullish view triggered a series of broker upgrades.

July’s half-year results showed half-year revenue down by just 2.3% compared to the same period in 2019. Operating profit for the same period was up 14% compared to the pre-pandemic comparative.

The outlook remained confident and like-for-like sales growth is expected to be 10%-12% this year. 

My decision: When I bought Spectris in December 2020, the stock was trading on 21 times forecast earnings. Today, that ratio is 25x. I think this re-rating reflects confidence that the company’s earnings will recover strongly this year.

With the outlook for earnings growth slowing, I think the good news is in the price for now at Spectris. I’d argue this is reflected in the stock’s High Flyer rating. 

Even so, I remain a fan of this business and would probably continue to hold the shares in a long-term strategy. 

However, these shares no longer pass all of my SIF screening tests. 

The reason for this is that Spectris’s rolling PEG ratio of 2.9 is significantly above my threshold for holding of 1.8. 

For this reason, the shares will be sold this month.

Total return: +39%

Verdict: Sell

Record (LON:REC)

(Buy report: 08 December 2020)

Currency hedging specialist Record (LON:REC) was in the doldrums in 2020, after several years of lacklustre growth. 

Things started to look more interesting in September, when newish CEO Leslie Hill announced that Record had won a new $8bn hedging mandate. The deal subsequently helped to lift the company’s assets under management equivalent (AUME) to more than $80bn for the first time.

Record’s 2021 results showed a 37% increase in USD AUME and a welcome 8% increase in management fees, which rose to £24.9m.

Despite this, the group’s profitability metrics worsened last year, as management invested in headcount and new, higher-margin products.

Even so, with growth on the cards once more, investors appeared happy to back the company’s strategy. Record shares have re-rated strongly during the portfolio’s holding period. The stock even (briefly) touched a post-2008 high of over 100p in June, before retreating to the current level.

My decision: I admire Record’s profitability and strong cash generation. But new client wins have been sporadic over the years and fee margins have come under pressure. 

Record’s share price has pulled back sharply since June. This weakness means that the stock no longer passes one of the momentum tests in my screening rules:

Although it’s only a small shortfall, fixed thresholds are a characteristic of screening systems. At some point I have to pull the plug. For Record, this is it. The stock will be sold from SIF.

I’m happy to lock in a near-80% total return on this holding.

Total return: +76%

Verdict: Sell

Tatton Asset Management (LON:TAM)

(Buy report: 08 July 2020)

Asset manager and financial adviser platform Tatton Asset Management (LON:TAM) is now the portfolio’s oldest holding. The only news from the group since my last update is the acquisition of £650m of assets under management for £5.8m and a new distribution partnership.

These deals will broaden Tatton’s fund range and provide access to over 3,800 new financial intermediary firms.

Management have helpfully provided a clear breakdown of the expected impact on profit:

• FY22 (current year ending 31 March 2022): an additional £0.6m of adjusted operating profit

• FY23: Additional £1.5m of adjusted operating profit

My decision: I continue to like this owner-managed firm, which enjoys strong profitability and excellent cash generation. My only concern relates to the cyclical risk for investors. A market slump could see Tatton’s AUM hit by a double whammy of net outflows and market price falls. This could lead to a sharp fall in fee income.

However, Tatton continues to pass all of my screening tests and so will remain in the portfolio for a further month.

Total return: +83%

Verdict: Hold

Robert Walters (LON:RWA)

(Buy report: 13 October 2020)

I covered the latest trading update from recruitment group Robert Walters in my review in July. In short, this business appears to be performing well and benefiting from strong demand in its main markets.

My decision: Robert Walters continues to pass all of my screening tests, so will remain in the SIF folio for a further month.

Total return: +66%

Verdict: Hold

I’ll sell SIF’s shares in Character, Spectris and Record this week, along with those from my own portfolio. As always, I’ll make the trades after this article has been published. 

In the meantime, I’d very much welcome your views on the stocks I’ve discussed today. Are you buying, selling, or simply doing nothing in the current market?

Disclosure: At the time of publication, Roland owned all of the shares listed in the SIF portfolio.

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