191. Investing in fast-food and defence via UK smaller companies

28 April 2022 (pre-recorded 26 March 2022)

Below is a transcript of the episode, modified for your reading pleasure. Please check the corresponding audio before quoting in print, as it may contain small errors. Please remember we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at your time of listening. For more information on the people and ideas in the episode, see the links at the bottom of the post.

[INTRODUCTION] 

Staci West (SW): Welcome back to the Investing on the go podcast brought to you by FundCalibre. This week we’re considering the UK Smaller Companies sector and discussing inflation, the UK consumer and the odd Friday night takeaway.   

Chris Salih (CS): Hello and welcome to investing on the go podcast. I’m Chris Salih and today we’re joined by Simon Moon manager of the Elite Rated Unicorn UK Smaller Companies fund. Thank you for joining us today, Simon.

Simon Moon (SM): Thank you for having me.

[INTERVIEW]

CS: So I believe the last time we spoke was about nine months ago and we talked about the outlook for UK smaller companies. And at the time you, you were quite positive on them. Could you maybe just talk us through the performance and how’s that borne out?

SM: Yeah, they’ve underperformed larger caps, unfortunately, and a lot of that’s due to what’s happened so far this year with the Russian invasion of Ukraine. I mean, commodities were already enjoying quite a strong streak towards the end of the calendar year. And obviously through this invasion, you’ve seen a real inflationary pressure on those and in the large cap index, commodities make up about, I think it’s 22% of the FTSE 100, whereas it’s just 11% in the Numis Smaller Companies index. So there’s a big disparity there. You’ve seen those companies be the real beneficiaries of significant inflationary pressures in the FTSE 100 and commodities.

CS: Well obviously we’ve had a lot going on – you mentioned the military crisis and also the inflation sort of hanging over markets. Could you maybe talk to us about some of the names you’ve been maybe looking to add during the sell or some of the opportunities that you’ve perhaps seen?

SM: Yeah, sure. It’s important to say that periods like that are very sort of, they’re a double-edged sword to go through, they’re very painful on a day to day basis. When you’re looking at, you know, companies you know and like and really can see the attractiveness of, just not being rewarded by the market or being sold off in sort of a pretty indiscriminate fashion, but that does also present some pretty decent opportunities as well. So I’ve add a few companies to the portfolio in the last few months. 

One of those would be Porvair, which was reinitiated. We used to hold this in the portfolio. This is a specialist filtration business, really very high quality industrial company. But its applications are scientific and they’re industrial as well, but very high-quality filters. And that was added because it was sold off and we knew the company well. And it was a really simple decision to add it back into the portfolio. You know, there will be some very second derivative effects, you know, from what is happening in Eastern Europe. But you know, by and large this company will go through this and come out the other side in a very strong and unaltered fashion. 

Another company we added which would be the beneficiary of the increased military spending is Cohort, which is basically sort of the military consultancy based in the UK. And you know, we see that there’s been a bit of a sea change in European countries with their appetite for military spending and you know, way of getting access to that is through the likes of Cohort, which is really quite an under the radar company which is exposed to those revenue streams as well. 

And then finally Braemar Shipping, which is a ship brokerage. Now that was added again, really attractive valuation, but also attractive backdrop as well. You know, ship brokers are beneficiaries of inflationary pressures within transportation. And those have been incredibly significant. And if you’re making a margin on those and you’re a high-quality ship broker, you most likely do better than you know, than you would’ve otherwise done before those inflationary pressures came through.

CS: And obviously a key part of your process is the face-to-face company meetings. And clearly for the past sort of couple of years, you really haven’t been able to do that for obvious reasons with lockdown. Now things have reopened, has it given you perhaps a boost in being able to sort of see people face-to-face and have you had to sort of sort of sharpen up your skills in terms of some of the things that you did before that you obviously haven’t done in the past couple of years?

SM: The one thing that the lockdowns sort of enforce and made an absolute necessity was everyone had to adapt to working remotely and it made everyone, it made all the management teams we speak to much more available, which was hugely beneficial to us. You know, whereas in the ordinary course of business, we would meet our investee companies twice a year, once in the interim results, once for the preliminary results. And if we needed to get into contact with them, we might be to set up an ad hoc meeting or phone call. It just, you know, the likes of Zoom and Teams video conferencing has just made it so convenient to have more either shorter or just more same length catch-ups with management teams. 

One thing I’m really looking forward to now the country is opening back up again, or has opened back up again, is seeing more companies on the ground, which has been, that’s been something we’ve felt we’ve missed over the last couple of years. And it’s a really important part- going and seeing the operations on the ground, you know, these tend to be trips we organise ourselves. We’re able usually to see over the quieter weeks in the summer, about 25% of our portfolio holdings, that’s really useful. Cause we’re meeting not just the executive management teams, but operational management teams as well.

CS: You mentioned earlier a company that you were you sort of had topped up your investment in, does it help things like Zoom to move quickly for things like that? 

SM: Yeah, absolutely. 

CS: Perhaps didn’t really realise beforehand it was such a, quite a useful string to your bow to have that immediate access and the opportunity to move quite quickly on companies like that.

SM: Yeah. That’s a really good point, Chris, you know, it makes everyone more available we found, or we certainly found that trend, maybe not everyone, but you know, it has enabled us because your inconveniencing people less than previously where management teams felt like they had to dedicate an entire week to coming to London or at least two or three days. And they would come and, you know, they would have all the logistical problems of going from office to office and whether that’s in the city or the West End, you know, it really wasn’t a great use of their time, but you know, if you can just, they only need to give you 45 minutes to an hour and no other considerations around getting places and so they tend to be very available if you need to speak to them.

CS: And obviously we talked about COVID earlier, touch wood, the restrictions have been lifted and maybe we are at the other side. Do you think we are now in an environment where UK smaller companies will do well or will high inflation and these geopolitical sort of fears, put a damper on things? I mean, where do you think we are now for the sector?

SM: I think that we’re facing significant opportunity, but I think in the UK there’s certain sectors. So the, I think the UK consumer, or the global consumer in fact, is in for a pretty challenging time. You’re seeing pretty pervasive effects of high energy costs, raw material and input costs generally. And they would all, they all tend to find their way to sort of squeeze the consumer. So what we’ve done is we’ve sort of limited that exposure within the fund over the last few months, we’ve reduced our consumer discretionary exposure by several percent. And it’s sitting there lower than the sector, but for a non-fund specific answer, I think that valuations are great. 

You’re seeing very attractively valued companies within the small co[mpanies] sector, which really have no exposure to geopolitical turmoil in Eastern Europe. But with either companies in their sector or just general outlook, which the market’s very good at being indiscriminate when it sells off companies. And as I said earlier, that’s presented us with plenty of opportunities and the opportunity for the small co[mpanies] market is that it can recover its value. It can recover its valuations.

CS: You mentioned something there, I just want to touch on it briefly. Do you have to sort of strike a balance between sort of looking at a company specifically without any other background noise of what’s going on in the market, but also looking at the backdrop of what’s going on globally as well? Do you find that’s something that you have to sort of work on?

SM: As stock pickers, we assess companies on individual metrics within those, whether they’re financial or more qualitative and, as part of that process, we look to the company’s positions within their market and the strength of their end market as well. And that strength is dependent on what’s going on in the world – that strength, that market, and the long-term trends for that. So we really, that really, I suppose, shades a colour on our view of other more quantitative aspects of that company.

CS: Okay. And just last, obviously, given we’re in the small caps it would be remise not to touch on a few more of these companies. So a couple of holdings caught my eye, firstly Tortilla Mexican Grill, and The Fulham Shore, which are both restaurant companies and also Premier Foods. What do you like about these companies specifically?

SM: Sure, of course. Tortilla is a fast-food chain essentially. It’s slightly fancier than fast food it’s burritos, there’s not much of an offering for Mexican food within the UK market. You know, they’ve seen a gap there and filled it at a very attractive price range. I think the average sort of item on the menu sells at between seven and nine pounds and it’s all freshly prepared but there is no real requirement to cook. So the capital expenditure on these sites of which they’re growing plenty of, I think there’s 60 odd currently, and they’re going to sort add at least 50% of that over the next few years. You know, they don’t require much capital investment cause there’s a centralised kitchen, which distributes on a daily basis all the fresh ingredients. And there’s a number of items that are made in the store, but they don’t need any specialist equipment to make them, and they don’t really need many or any highly qualified, highly trained chefs. So they’re managing sort of the struggle that a lot of restaurant chains are finding at the moment with recruiting the right people and enough of them. 

And it’s essentially an assembly line for very high-quality tasty food. That’s customisable there’s a really attractive price point. And they’re really well positioned to navigate inflationary pressure. So whilst I mentioned earlier that, I do feel the UK consumer is maybe facing a sort of tougher outlook towards the end of this year. I think that if you’ve got best in class at a good price point, you are pretty well protected from that. And if, you know, maybe people are trading down or you know, in price point terms, companies like Tortilla, like Fulham Shore will do well. 

Fullham Shore just for information, they run a couple of restaurant chains – one’s the Real Greek, one’s the Franco Manco pizza parlours – they had, actually both of these companies, you know Tortilla and Franco Manco had, and it pains me to say, a very good lockdown, being that the pandemic really did open up their offering to delivery, to take away, which really did increase exposure that they might not have had otherwise where people were quite desperate to not cook at home anymore and maybe have a bit of a treat by getting something delivered in or going and picking it up. So they both did very well. And again, you know, both growing stores at the right price tag, very high-quality offerings. And I just think the future’s very bright for both of those companies. 

You’ve mentioned Premier Foods. This is a portfolio of consumer brands which, you know, are everything from Mr. Kipling to Bird’s custard and Ambrosia, and very decent brands you recognise in the supermarket that have a strong and loyal customer following. This was added to the portfolio because it just represented tremendous value. I think it was less than 10x when it was added to the portfolio. We can see now that they’re able to grow not just in the UK, but they’re growing in the US and Canada as a they’re introducing Kipling’s and you know Ambrosia ice cream, and various sort of new takes on good, well-regarded products and flavours. So yeah, it’s a really interesting company to be exposed to. And it’s just, yeah, the strengths, the consumer brands within it. It’s very attractive.

CS: That’s great Simon. Thank you very much for joining us today.

SM: Thank you. 

SW: Unicorn UK Smaller Companies is a high conviction concentrated portfolio that invests in genuinely smaller companies rather than mid-cap stocks. A large proportion of the research at Unicorn is performed in-house, allowing Unicorn to identify companies often missed by its peers. To learn more about the Unicorn UK Smaller Companies fund visit fundcalibre.com – and don’t forget to subscribe to the Investing on the go podcast, available wherever you get your podcasts.

Please remember, we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at the time of listening. Elite Ratings are based on FundCalibre’s research methodology and are the opinion of FundCalibre’s research team only.