SIF Folio: Brexit trading decisions + a surprise return for Carramp;rsquo;s?

When UK voters shocked the market by opting for Brexit in 2016, the resultant sell-off was sharp and brutal. Most stocks bounced back as quickly as they fell, but not all.

Stockopedia founder Ed Croft’s annual NAPS portfolio suffered from this dislocating event. The NAPS returned just 5.4% in 2016, compared to a 12.5% return for the FTSE All-Share. In contrast, the six-monthly SNAPS version of the portfolio delivered an 13.9% gain for the year, beating the market.

The big difference between the two was that the SNAPS selected a fresh set of stocks at the start of July, after the Brexit vote. The NAPS selections were held unchanged throughout 2016.

Ed’s conclusion was that if the market plays a joker card, it can make sense to deal yourself a fresh hand. With this in mind, it would be easy for me to argue that it’s unwise to add new companies to my SIF folio at the moment.

Not only has Parliament’s planned Brexit vote been postponed, but the European Court of Justice ruled on Monday that the UK could cancel Brexit and stay in the EU. Without wanting to get into a political debate, it now seems that we could end up with anything from full EU membership to a hard Brexit.

I nailed my colours to the mast two weeks ago when I said that I thought a no-deal “cliff-edge Brexit is increasingly unlikely”. Time will tell. But I think that whatever happens, two years of worry mean that the eventual decision is unlikely to have the shock value of the original Brexit vote. I think that at least some of the downside risk is already priced into the UK market.

I intend to continue buying and selling stocks as usual, both within my personal holdings and in the SIF fantasy fund.

I’d be very interested to hear what you are doing with your folio — are you making allowance for Brexit, or is it business as usual?

My screen delivers another surprise

The Stock in Focus screening results have dwindled to about 10 stocks in recent weeks. Last week, software firm D4T4 Solutions (LON:D4T4) surprised me as a completely new entrant.

This week I received another surprise, when small-cap Carr’s (LON:CARR) appeared at the very top of my screening results. This agricultural feed and engineering firm is one I’ve owned before. Between August 2017 and May 2018 it delivered a flat result for the folio.

My rules don’t place any restrictions on owning shares more than once. And I’m always tempted by defensive stocks which might help to reduce the folio’s heavy cyclical bias. This week I’m going to take a fresh look at Carr’s to decide whether it should be one of my final picks for 2018.

A strong set of results

Carr’s reappearance in my screen follows last month’s final results from the firm. These earned a positive write-up from Paul Scott in the SCVR, which you can read here. I won’t repeat Paul’s commentary. Instead, I’ll try to explain why these recent accounts mean that this stock now passes all of my tests.

When I last reviewed the shares in May, they failed three of my screening rules:

Earnings yield: Carr’s operating profit rose by 53.5% to £16.4m last year. This growth wasn’t reflected in the half-year and trailing 12-month (TTM) figures, which were depressed by the group’s much weaker 2017 results.

Calculating the stock’s earnings yield (EBIT/EV) using 2018 operating profit gives an attractive yield of 9.5%, comfortably above my 8% minimum.

Debt: Recent newsflow suggests that lenders are putting pressure on some heavily-indebted companies to reduce leverage. Kier (LON:KIE) and Interserve (LON:IRV) are two notable examples. Carr’s was never in this league, but its modest debt load did rise in H1 2018. This increase caused the stock’s F-Score to fall below my minimum of 6/9.

A strong performance in H2 enabled the company to reduce its borrowings. At current levels the group’s net borrowings are only around 1.3 times net profit, well below my maximum of 4x net profit.

Coincidentally, I see that Paul Scott suggested on Monday that we should look for shares with a net debt/EBITDA ratio of 1 in these uncertain times. I’m happy to report that Carr’s passes this test, too.

Relative strength: Back in March, the share price had lagged the FTSE All-Share index over the previous 12 months. That situation has now reversed. Carr’s stock is up by 20%, during a period when the index has dropped 10%:

The issues which caused the stock to be sold from the SIF Folio in May have now been addressed. Carr’s passes all 15 of my screening rules with flying colours.

This firm is also highly regarded by Stockopedia’s algorithms:

Is value a concern?

Value: The only area of potential weakness appears to be value, with a ValueRank score of just 64. Let’s take a closer look at the stock’s value ratios:

I’ve already discussed Carr’s earnings yield of 9.5%, which I think is very attractive. But based on other valuation measures, the shares don’t seem so cheap. Although I’m not bothered about the lowish dividend yield, I would like to understand why free cash flow didn’t match earnings more closely last year.

On checking the figures, it seems that acquisitions are to blame. The group spent £1.5m on acquisitions and £2.6m on deferred consideration for previous deals.

My sums show that stripping out these costs gives free cash flow of about 9.3p per share, This more closely matches last year’s earnings of 13p per share and would give a price/free cash flow ratio of about 16.

For a business such as Carr’s which operates in fairly mature niche markets, acquisitions and sector consolidation are one route to growth. Although such regular deals always carry a certain risk, I’m prepared to accept this given the firm’s stable track record and low debt levels.

Quality: A Quality score of 90 reflects consistent profitability. Although ROCE isn’t especially high, I have no real worries here given the strong balance sheet:

Momentum: The Momentum score of 99/100 highlights an unusual degree of optimism about near-term growth. This seems to be driven by a confident outlook in both the UK and US agricultural markets. Conditions are also said to be improving in the group’s engineering business, which is focused on the energy industry.

The broker consensus trend also looks pretty encouraging:

My decision

Broker forecasts suggest unusually strong earnings growth of 12% this year. These forecasts put the stock on a rolling P/E of 10.6, with a forward yield of 3.1%.

I’m reassured by last year’s improved results and by the stock’s composed performance during recent weeks. I intend to add the shares to the SIF fund and my own holdings this week, following publication of this piece.

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