The Sceptre UK Fund was down 2.7% in October, which was slightly better than the market. Activity in the fund was relatively low but we did raise our weighting in a recently acquired company to make it the largest holding at 15% of the fund.

Perhaps a good way to explain our approach to investing would be to describe the basic rationale that makes this company our “favourite” stock:

At month end, the market cap. of the stock was about £450m and, at year end, the company will have net cash of about £150m after paying dividends at the rate of about 5%. It has recently completed a large company wide IT upgrade as well as the construction of a new warehouse and distribution centre. The operating profit for this year is expected to be about £90m (analyst consensus) and the company is promising a further £5m of cost cuts during this final half year. Due to ample historic spend on asset maintenance, the recent major upgrades to IT/warehousing and a high assumed depreciation rate, the capital expenditure programme is significantly less than depreciation (and will continue to be for the foreseeable future). We therefore expect the company to generate between £70m and £80m of *“distributable cash” this year and in future years even if we assume zero growth. However, one of their core businesses is growing at a 30%+ rate and is already accounting for 15% of the total operating profits. In other words, assuming zero growth for the company is being extremely conservative.

The company is trading on a multiple of just over 6x our estimate of “distributable cash” with a net cash position of £150m and also owns a rapidly expanding division. That represents a cash flow yield of about 16%. We conservatively estimate the stock to be trading at about half of our estimate of its “fair” value. That is why we are very comfortable to have a 15% weighting and can afford to be patient whilst the company continues to generate cash and perhaps will announce its first share buy back programme in the new year.

*“distributable cash” is defined as free cash flow after interest, tax and capex but before any dividends or share buy backs.

Chris Broadhurst
CEO