Diverse Income Trust plc (LON:DIVI) Fund Manager Gervais Williams caught up with DirectorsTalk for an exclusive interview to discuss UK inflation, how market conditions impact how the fund is managed and some of the attractive stocks in the portfolio.
Q1: UK inflation has risen to over 9% now and a lot of commentators are saying we’re past the peak. What’s your view on the outlook?
A1: I think inflationary pressures have been very severe and my assumption is actually the forthcoming inflationary figures are maybe less severe although they may not perhaps fall back quite as politely as we would like to the levels they were previously.
I think this is going to be quite a difficult period but not so much that inflationary pressures are going to continue but the rising interest rates, as we’ve seen already, will have an effect on demand in time. As demand is reduced, I think that will also come through in a compression in profit margins.
So, I think there’s room for some significant downgrades for many companies going forward, which I think is going to be a challenging period for fund managers.
Q2: How does the current market environment impact how you manage your investment fund?
A2: The main thing is we need to actually find companies which are generating plenty of surplus cash. The reason why surplus cash is so important is because we fear that some companies are going to run out of cash. Customers and consumers are already quite short of cash, governments potentially could end up short of cash as well.
So, we’ve got to find companies which are not just viable but able to continue to invest in their businesses even at a time when others are struggling. That hopefully doesn’t just mean they maintain their business and their opportunities in the business; perhaps in some cases they can take advantage of the weakness of others to actually actively improve their businesses.
When we come to the end of this setback; share prices improve and they will deliver attractive returns for our clients.
Q3: If we can turn to a couple of your investments now in your portfolio, I’d like to start with iEnergizer Limited (LON:IBPO). They delivered a really strong set of full year results last week, revenues were up year on year over 32% and profit after tax up 52%. How do you view them?
A3: It’s still a very significant part of the Diverse Income Trust portfolio, in part because it’s performed strongly but most particularly what’s been thrilling about them is they don’t just deliver in terms of generating cash and profits but they have very high levels of service.
That’s meant that a lot of their early customers are still with them and as they’ve brought on new customers, they’ve been able to layer them on. That’s led to a very good growth in terms of sales, very good growth in terms of profits and cash generation and ultimately, that’s been reflected in a strong improvement in the dividends and that’s ultimately the cornerstone.
Companies which succeed ideally generate surplus cash and when they have surplus cash, they can pay dividends, which then drives their share price up. iEnergizer is a very good example of a company which has just been hugely successful in that regard.
Q4: Looking at Drax Group plc (LON:DRX). Drax are helping supply renewable electricity to millions of British homes, their Q1 2022 financials were very strong and they recently commissioned two new biomass pellet plants in the U.S. What’s your thoughts on this sustainable energy stock?
A4: Clearly, what we’ve seen over recent years is less investment in carbon based energy and new investment in many of the newer energy sources; obviously wind turbines and Drax’s bio sustainable biomass products.
Ultimately with the rise in energy prices, a lot of these companies are more profitable than they were previously albeit that they have to deal with the problems with logistics in terms of getting deliveries of their biomass to their plants.
The key is that the company is in a strong position, it’s moved ahead of other in terms of converting power plants into biomass and it’s got good energy prices coming through. So, it’s being reflected in its share price, which is already improved, the ability to generate cash, as with iEnergizer, and most particularly, quite a strong market position relative to others which we’re quite excited about.
Q5: Turning to Accrol Group plc (LON:ACRL) in the UK tissue sector, they seemed to have navigated recent supply chain disruptions and pricing pressure well. How do you see them?
A5: It’s interesting, if anything actually I think they had a tougher period perhaps 9 months ago when they had problems with their logistics, their contractor that delivers the toilet paper to the customers – mainly supermarkets in the UK – were struggling to recruit drivers and their delivery standards went down. Because their delivery standards weren’t so good, that led to them to having some real margin pressure and they weren’t able to get the cost increases through.
What’s happened more recently is they’ve resolved those problems, service levels have moved back up to where they were previously and they’ve got quite a large production capacity in the UK. We are now seeing real interest in particular in own brand products.
In terms of the share price, it’s been quite weak actually over the last 12 months but most particularly, from our point of view, the ability to generate cash going forward is still very attractive and that’s why it’s retained in the portfolio even though the share price has been disappointing over the last 12 months.
Q6: Concurrent Technologies plc (LON:CNC) are a tech company that has a strong order book, they’ve delivered consistent profitability and they also pay a regular dividend. Can you tell us more about them?
A6: It’s quite a small business. It’s only capitalised at around £50 million market cap but what’s interesting about it, is it has a very big market position. In particular, it supplies circuit boards for many military applications as well as telecoms, telemetry and other areas. Specifically, there’s a real opportunity for them with a new management team to really take advantage of that position going forward.
We think customers have been through a pretty tough time with deliveries over recent years and with their products, and particularly with their ability to be relatively early in terms of the upgrade cycle with military spend, we think they’ve got some exciting prospects in the next 2-3 years.
As I say, it’s a tiny business. It’s just got a very strong opportunity given that this is an area where most people haven’t been investing in for many years.
Q7: Now, Intercede Group plc (LON:IGP) are also very interesting. They’re in the high growth, cyber security sector and their results for the year ended 31st March 2022 showed an enormous amount of progress. However I notice their share price has fallen considerably in the last year. Is this a particularly good opportunity now for investors?
A7: There are quite a lot of companies which, during the last year or two, they’ve been a bit out of the limelight; they haven’t grown very much; and this company hasn’t grown much in the recent year or two.
Most particularly, security is going to be a really important area and they’ve got some amazing strong customers in terms of high profile US customers and such like, and we believe the opportunity for them to sell more of their product over a wider range of customer base is pretty interesting going forward.
As you say, the share price has been weak in the last 12 months, reflecting the stock market, reflecting the absence of growth but we think the opportunity is there for this business with the quality of its customer service and the opportunities in that area and we should see quite a substantial recovery in due course. That’s again why it forms part of the portfolio.
The nature of the Diverse Income Trust is that we’re looking to buy in companies like this which are able, in due course, to generate plentiful surplus cash and that will be reflected in time in dividends and dividend growth.
Q8: Man Group plc (LON:EMG) are the world’s largest listed hedge fund and so will be familiar to a lot of people. For the quarter ended 31st March 2022, net inflows were over $3 billion so they now have record Assets under Management and they’ve also paid a bi-annual dividend for a number of years now. Is it their positive performance that’s attracted you?
A8: What’s interesting about this company is that it adds value through stock selection. As you know, over recent years, investors have been able to make good money by just buying exchange traded funds (ETFs), index products and such like which as the stock markets performed, they’ve all generated very good returns.
With markets becoming much more unsettled, the ability to add value when stock markets aren’t going up much or indeed have been declining is becoming more important.
Man Group is an example of a company which is well positioned, they’ve seen a strong rise in their performance related fees, they generate cash and they’ve got a good momentum of new clients coming in. So, this is a company where, despite the fact that valuations have come down – being a stock market business some of its assets have fallen – ultimately, it’s growing at a faster rate and that’s quite exciting. Again, income and income growth are just the kind of characteristics, along with all of the mix of other industries we have in the portfolio, which adds value over the longer term and has actually generated some very good returns for the clients to date.
Q9: Are there any other stocks that you wanted to mention in the Diverse Income Trust’s portfolio that investors should look out for?
A9: I think it’s interesting how overlooked some companies can be. A good example of that might be Kenmare Resources plc (LON:KMR) which is an ilmenite business on the west coast of Africa, it has its own export facility and it’s invested hard over the last 15 years in bringing a new mine on stream. Ilmenite, which is the main source of titanium dioxide, is the whitening agent used in paint, and there’s a shortage of ilmenite around the world. What’s been interesting, just in the last few days, is Peel Hunt have upgraded their forecasts considerably. Kenmare is generating very substantial surplus cash. Clearly, it’s a resource stock in a way that Rio Tinto is and such like but we think the quality of the earnings and the scale of the opportunity is probably overlooked to some degree in the current valuation.
Another example is some of the financials, not just Man Group. We have other financials in the portfolio and Just Group plc (LON:JUST) is a company which when you’re saving and you’ve got an annuity, you can buy an annuity from them. If you want to get some capital release from a house after you’ve retired, they’re in the market to do that as well. Mainly, again the valuation reflects some of the tensions of falling interest rates and falling bond yields, which we’ve seen over recent years and this business tends to be better when bond valuations are declining and interest rates are rising. The share price, again, looks very overlooked. It has very high customer service levels and it’s just moved back onto the dividend list after a few years, good and growing surplus cash, as with Kenmare Resource, and as with all these other stocks in the portfolio.
It’s the nature of having a wide ranging portfolio across many different industries which we think is the key issue. We find enough of these companies which generate good and growing income, hopefully share prices appreciating along with a flow of dividends to shareholders and will be more sustainable than many others.
