Income Report / Income Report: Hunting through the LIC space for value (FOR, WLE, CDM, LSF)

By Market Matters 24 July 19

Income Report: Hunting through the LIC space for value (FOR, WLE, CDM, LSF)

Market Matters Income Report 24th July 2019

A very bullish day playing out locally following comments this morning from Westpac’s well regarded Chief Economist Bill Evans who brought forward his forecast for the next cut to October from November -- saying by then the labor market will have deteriorated sufficiently from Reserve Bank estimates to prompt a move. He added another cut in February that would bring the cash rate to 0.5%.

That’s clearly a big call and with markets very much focussed on lower interest rates that was enough to prompt aggressive buying across the markets, the yield areas in particular are being well bid.

At lunchtime, the ASX 200 is trading up +50pts or +0.75% to 6774.

ASX 200 Chart

The Income Portfolio had a reasonable week, climbing 0.48% helped by a market that edged higher. The Estia (EHE) position dragged performance on the announcement of a class action against the company, however this was mostly offset by a bounce in Whitehaven (WHC), while no dividends were paid in the week. The portfolio continues to outperform its benchmark of RBA + 4% for the first few weeks of the financial year, adding 0.97% thus far vs the benchmark at 0.30%. Since inception the portfolio is up 17.46% vs the benchmark of 11.22%.

For those interested in investing for income in a low rate environment, Market Markets does run an Separately Managed Account (SMA) which is open for investment. The portfolio is based on the MM Income Portfolio below. The SMA has now passed its first anniversary and performance has remained sound printing an overall gain of 10.16% for the year to June 30. The June update can be viewed - Click Here.

Hunting through the LIC space for value

Since launching the MM income note we’ve only written two articles looking at this sector.

1.     November 2018: Why we’d sell WAM: Click here

2.     March 2019: How could a change of Government impact LIC’s: Click here

In the last week or two, we’ve had a number of questions about specific Listed Investment Companies (LIC’s) & Listed Investment Trusts (LIT) while we’ve also had the AFR covering Geoff Wilson’s toughest year in a decade - his flagship WAM fund returning 2% for the 12 months.  We wrote back in November of 2018 that it was likely to be a difficult period for the market as well as WAM more generally as they transitioned to a new structure away from a dominate Chief Investment Officer in Chris Stott. That said, we have a lot of respect for Geoff Wilson and the business he runs – he’s a stock broker turned successful fund manager and has built a phenomenal business, and ultimately everyone goes through lean periods.

Below we’ll look at a few LIC’s & LIT’s catching our eye for various reasons.

1 Cadence Capital (CDM) 77c: This is absolute return fund that is actively traded and has the ability to short the market. They go ex-dividend in April & September each year and have paid 7cps fully franked over the past 12 months, with high consistency in dividend payouts. This equates to a yield of ~9% plus franking or ~13% gross - looks attractive on first read through, however their performance over the past 12 months has been poor, the portfolio  down -20.6% before fees.

Their top 20 holdings as at June 30 account for 67% of their portfolio. The yield over the past 12 months on those holdings equates to 2.20% excluding franking. If we’re generous and assume the portfolio has a natural yield of 4%, they are then paying 5% of capital back to shareholders annually to ensure the dividend yield remains attractive. Weak performance amplified by capital returns and it’s easy to see why the LIC has underperformed the market by ~40% on a 1 year view. Clearly this has been a poor performer, however the fund now trades at a 15% discount to the value of its assets making it cheap.

We like buying things at discounts and if you believe performance will turn, then investors can benefit from 1. Portfolio performance & 2. the closing of the discount to the value of their assets. However don’t get suckered in by the yield, it’s a manufactured payout.

On the positive side, the company is doing an on market  buy-back and Directors are buying stock. On the negative side, they clearly don’t practice what they preach in terms of a disciplined exit criteria for stocks positions.

MM is neutral / positive CDM from current levels if performance can improve.

Cadence Capital (CDM) Chart

2 WAM Leaders (WLE) $1.16:  A listed investment company from Wilson Asset Management that holds large cap Australian shares. Performance has been pretty much in-line with the market pre-fees with the portfolio increasing +10.9% to June 30 versus the market which has increased 11.50%. They go ex-dividend in April & October each year and will pay 5.65c fully franked for the past 12 months, which equates to a yield of ~5%, about in-line with the market.  All in all, it’s a fairly vanilla fund.

The current opportunity here is the current 7% discount the LIC is trading at relative to assets – and given they hold large cap / liquid assets, this discount is real.

MM is positive WLE  from current levels given the current discount to NTA

WAM Leaders (WLE) Chart

3 Forager Australian Shares Fund (FOR) $1.19: This is actually a Listed Investment Trust (LIT) run by Forager Funds. The LIT structure essentially means that the end investor pays the tax and all distributions flow through the trust annually, while an LIC has more room to massage income / dividends over different periods. Like Cadence, the portfolio returns here have been poor over the last few years,  and last year in particularly with the fund down 19.66%, however it was also trading at a premium to asset value and it now trades at a discount. That led to  -39% underperformance versus the market for FOR over the 12 months to June 30.

Unlike Cadence, FOR has stayed true to label which I think is important. FOR seek deep value opportunities and unfortunately in some instances, the depth of value has swallowed them (Freedom Insurance is one of their lemons over the past 12 months). That said, I do rate their investment philosophy and now, after a horrific 12 months, FOR is representing value. While this is an LIT, so it simply passes through dividends received on their holdings, the look through yield on their portfolio sits around 2.6% with room to grow, so clearly not a near term income investment (but should become one over time as the businesses they hold move out of survival mode)

FOR now trades at a 12% discount to its assets however given how illiquid their portfolio is, this makes sense. We doubt this discount will close.

MM has some faith in FOR as a deep value turnaround story

Forager (FOR) Chart

4 L1 Capital (LSF) $1.43: Not a traditional income oriented listed investment company however we couldn’t help but cover it. This listed on the ASX back in April of 2018 amid much fan-fare. They planned to raise between $100m to $600m & ended up more than doubling that to $1.3bn – a huge LIC raise and it’s hard not to be critical of the massive upscaling of the deal.

Since then, it’s been all down-hill as the previously celebrated fund managers perfected the art of being wrong on both the long & short side of the market. In just  8 months they dropped over 36% - and since listing have underperformed the market by 50%.

They don’t pay a dividend, and are unlikely to do so anytime soon. Their pre-tax NTA is $1.67 however given capital losses accrued, their post-tax NTA is $1.77. This is a significant 26% discount.  

LSF versus the ASX 200 (LSF is the white line)

MM has some faith in LSF as a turnaround story, but really what a disaster it’s been.

L1 Capital (LSF) Chart

Conclusion

WLE looks good value given its prevailing discount to NTA, and particularly versus WAM which still trades at a significant premium
The other stocks offer value, but ultimately, it will come down to the performance of the manager, and simply put, some of the returns outlined above are disastrous

On that cheery note, have a great day!

James & the Market Matters Team

Disclosure

Market Matters may hold stocks mentioned in this report. Subscribers can view a full list of holdings on the website by clicking here. Positions are updated each Friday, or after the session when positions are traded.

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