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The quiet income achievers defying Brexit gloom

25 July 2019

Ken Wotton, manager of the LF Gresham House UK Multi Cap Income fund, highlights some of the stocks that are showing strong growth potential despite overwhelmingly negative sentiment to the UK equity market.

By Ken Wotton,

Gresham House

The UK market is at an inflection point, with the benign environment of the first half of 2019 giving way to heightened political and macroeconomic concerns. UK investors continue to face headwinds, the possibility of a general election and the upcoming Brexit deadline – not to mention external trade tensions.

With uncertainty weighing on investor sentiment, UK equity income funds are witnessing consistent net outflows – now totalling almost £20bn since the UK’s vote to leave the EU in 2016[i]. A resolution to the Brexit issue may give businesses and investors greater certainty, which could encourage asset allocators back to UK equities. However, we are likely to see greater sentiment-driven volatility until this point.

While uncertainty comes with intrinsic challenges, volatility also creates attractive opportunities for the long-term investor. Income-focused investors should not ignore the UK equity market, as we continue to identify numerous resilient companies exhibiting strong growth potential. As always, we seek companies with a stable competitive advantage, high quality management and niche expertise. Such firms may also be well placed to take advantage of the current economic situation.

In consideration of this, four largely under-the-radar companies that income-focused investors should pay heed to are detailed below.

XPS Pensions Group is a consultancy for defined benefit (DB) pension schemes, specialising in actuarial valuations. Its service-oriented, technology-led platform has made it a leading second-tier player in a market where top-tier firms have failed to invest in improving technology and service to trustees. As a result, XPS Pensions Group is gaining market share from these large competitors. It is also looking at other smaller sector peers to further consolidate the market by acquisition.

While the number of DB schemes is not growing, existing vehicles still have considerable assets. The runoff from current DB pensions is set to take more than 60 years, during which trustees’ regulatory obligations will continue. In the current low-yield environment, liability valuations are increasing, contributing to growing deficits across DB schemes. These factors will continue to drive demand for consultants such as XPS Pensions and should insulate the company from Brexit-related turmoil and the broader economic slowdown. Recent share price weakness provided us with an opportunity to increase our holding at a prospective dividend yield of more than 6%.

Motor insurance company, Sabre Insurance operates a diversified, multi-channel distribution strategy, selling policies through a broad network of brokers and three direct brands – Go Girl, Drive Smart and Insure 2 Drive. Its specialism lies in pricing difficult-to-insure policies, such as luxury cars, for which mass market insurers lack sophisticated data.

For the last 20 years, the company has generated strong profit margins, paying out regular and special dividends while incrementally growing its top line. Its business model has proven to be resilient through all stages of the economic environment.

We participated in the AIM IPO last month of Argentex, a corporate FX services business providing advice-driven hedging solutions to UK companies. It operates in a large market traditionally dominated by incumbent banks and brokers, which are losing market share to smaller ‘independents’ providing value-added insight and quality customer service. Argentex has demonstrated the ability to attract, develop and retain a high performing sales force that has driven robust profit growth to date. The company has a clear strategy driving market share growth and a scalable business model able to deliver good profitability and cash generation.

Argentex takes no directional or speculative risk on trades, only executing FX strategies for clients and earning commission. Periods of currency volatility or instability can act as a catalyst for corporates to implement hedging strategies, which was evidenced by an uptick in transaction activity for Argentex ahead of key Brexit dates. It is well positioned for periods of political or wider macroeconomic uncertainty, where FX volatility could drive transaction activity and revenue growth.

Ten Entertainment Group is the second-largest tenpin bowling operator in the UK, with 43 sites and 1,000 bowling lanes under its Tenpin brand. This investment capitalises on the shift in consumer preferences within today’s ‘experience economy’, a trend which we believe will persist irrespective of the economic environment. Bowling offers a relatively low-ticket price and low-frequency of purchase from the average customer relative to other discretionary leisure activities.

This indicates a ‘good value family experience’ that should prove a resilient niche area of consumer spending. Through continued capital investment and measured site expansion, we are convinced Ten Entertainment offers compelling profit and dividend growth potential, which led us to recently top up our position.

 

Ken Wotton is manager of the LF Gresham House UK Multi Cap Income fund. The views expressed above are his own and should not be taken as investment advice. 

[i] https://www.ft.com/content/e9411bc5-c818-3c81-affc-730285195944

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