TB Saracen Global Income & Growth Fund: Portfolio Update
Bettina Edmondston discusses the latest purchase in the fund….
We are long term value investors and our holding period tends to be over 5 years. In fact, a couple of our investments we’ve held since the fund launched in June 2011, i.e. HSBC and Johnson & Johnson. But we have a very strict sell discipline, which kicks in when valuation gets too stretched or the Worst Case scenario is too severe.
This was the case for Hugo Boss in July 2018 after rallying 60% from its lows in 2016. Its Year 1 PER reached 22x and its Year 5 PER surpassed 15x on our assumptions. We had the impression that the shares got ahead of themselves as investors expected a quick turnaround and recovery story with strong operational gearing. At the same time the dividend yield, while still respectable, reached a multi year low at 3.5%.
We therefore sold our holding.
Fast forward 15 months and things have changed. BOSS made some progress in rehabilitating its brand. But as expected, it didn’t all go as planned and in a straight line. Just under a month ago Boss had to lower its 2019 guidance amidst continued weakness in North America, unrest in Hong Kong and deteriorating consumer confidence globally.
The shares fell 30% in a month to a 10-year low valuation.
We had started to look at the shares before the profit warning as it had appeared on our proprietary stock screen. Interestingly, our assumptions had hardly changed compared to mid 2018. However, the worst case was still too severe and kept us from buying.
After the warning at the start of October, we felt that the market overreacted again and a lot of the potential negative news was now reflected in the price. Even on lowered estimates and a deteriorating outlook the valuation has reached levels that we haven’t seen since 2009/10, even lower than when the company first ran into problems in 2016.
The Year 1 PER was now 11x and the Year 5 PER 8.0x. Equally, the historic dividend yield of 7.4% is the highest since 2010. In addition, the Balance Sheet is ungeared.
We consequently bought a position for our fund.
We appreciate that the macro environment is becoming less supportive, especially in North America where Boss used to be over exposed to department stores and discount retailers. Equally, a large part of sales is generated in Germany, where consumer confidence has deteriorated.
However, Boss has a lot of self-help still available, including:
- expansion of e-commerce
- increasing store productivity and reducing complexity
- expansion in China where there is strong demand for BOSS
- continuing to right size its footprint in the US
- pushing its “athleisure” wear HUGO to over 50% of sales
We assume low single digit top line growth over the next 5 years. This compares to an average of 7% since 2009 and we believe is conservative. With all the initiatives mentioned above BOSS should manage to grow its top line over 5%.
We also have some margin improvement in our forecast over the next 5 years. However, our year 5 profit margin is 400bps below the 2010-15 average. We believe this is highly conservative.
We always say we can’t time the market. There might be further negative news to come for BOSS. However, we believe the current valuation reflects a business in decline which we believe is overly pessimistic.
Any slight improvement in the company’s trading will result in a significant rerating of the shares.
Bettina Edmondston, Global Analyst, Saracen Fund Managers