SGEM.L Regulatory News (SGEM)

ScotGems Plc - Final Results

PR Newswire

London, March 5

From: ScotGems plc

LEI: 549300GQHCPU9P1NYM13

Date: 6 March 2019

Results for the year ended 31 December 2018

The Directors of ScotGems plc (“the Company”) are pleased to announce the Company's results for the year ended 31 December 2018.

Highlights

The Company’s objective is to provide long-term capital growth by investing in a diversified portfolio of small cap companies listed on global stock markets across a range of sectors.

The Company was 72.3% invested by 31 December 2018.

Chairman’s Statement

I am delighted to present the second Annual Report and Accounts of your Company for the year ended 31 December 2018.

Shareholders will remember that the Company was launched on 26 June 2017 and raised a net £50.3 million. Subsequently an additional £3.2 million was raised through further small placings of shares. As at 31 December 2017 approximately 36.7% of shareholders’ funds was invested in equities, as the Investment Managers made slow and careful progress in selecting companies that met our exacting criteria, both for the prospects of growth and the quality and integrity of the management. I am pleased that at 31 December 2018 the proportion invested had increased to 72.3% and as at 4 March 2019 had further increased to 77.1%.

During 2018 the share price fell by 0.5% and the Net Asset Value (“NAV”) by 2.8%. This compares to falls in the MSCI AC World Index, the MSCI AC World Small Cap Index and MSCI Emerging Markets Index of 5.7%, 10.5% and 11.5% respectively.

Since inception the share price has fallen by 7.5% and the NAV by 6.9%. This compares to falls in the MSCI AC World Index, the MSCI AC World Small Cap Index and MSCI Emerging Markets Index of 2.6%, 6.3% and 5.2% respectively.

I recognise that we have recorded a modest loss in the period since launch, however may I remind shareholders that it is our intention to create a long-term portfolio of between 20 and 30 companies the market capitalisation of which is less than $2.5 billion at the time of investment. In that sense the short-term performance figures, in my view, are a poor guide to the long-term potential of these investments. The Investment Managers have set out below a detailed description of the existing portfolio as well as describing their philosophy in selecting the particular companies in which ScotGems invests.

As I mentioned in the Interim Statement in September, the High Court confirmed the cancellation of the balance of the Company’s share premium account which had arisen from premiums paid on the Ordinary shares at launch. An equivalent amount was credited to the Company’s Special Reserve, which is distributable, and may be used to buy back the Company’s shares.

During the year the discount has narrowed from approximately 2.9% to 0. 6%. It is not currently the Board's policy to buy back shares. The premise on which the Company was founded was to make long-term investments in quality companies.

The Annual General Meeting will be held on 30 April 2019 at the offices of our Investment Managers, First State Investments, and I look forward to seeing many of you there. Of course there will be a presentation by the Investment Managers and an opportunity to question them in more detail about individual investments that the Company has made.

Investment Management Report

We continue to build the portfolio. The portfolio now contains 22 companies, most of which we can add to at more attractive valuations. There are other companies, not currently held in the portfolio, which we would like to buy if their valuations weaken. The cash held has been evenly split into British Pounds, Singaporean Dollars, and US Dollars (the US Dollar balance is held in US Treasury Bills).

It was a tough year for Emerging Market Equities. Share prices of businesses operating in countries with shaky institutions and large external imbalances were hit the most. Our opportunity set in markets such as Turkey and Argentina is limited in any case. Lack of robust political and judicial institutions often mean that crony capitalism (crony capitalism is an economic system characterised by close, mutually advantageous relationships between business leaders and government officials) thrives in these countries at the expense of honest self-made private entrepreneurs. Unfortunately, share prices in countries like India and Taiwan, where we have traditionally found many well stewarded private companies, still remain expensive.

The primary quality we look for when choosing companies in which to invest our clients' money is stewardship. We are only interested in backing management teams who run their companies with a long-term ‘owner-manager’ mind-set. We obsess over the history of key people at our companies, assessing their attitudes towards minority shareholders, employees, suppliers, government and the environment they operate in. Any sign of mistreatment is a red flag to us because if a company cuts corners in one area, it is likely to do the same in other areas, which could ultimately have negative repercussions for minority investors. For this reason we believe the most effective way to mitigate against unpredictability and risk is to back honest family-led management teams with a record of growing robust businesses.

Unfortunately, many companies listed on public stock exchanges suffer from a ‘principal agent’ conflict. The interests of management teams as ‘agents’ are not aligned with the shareholders of the companies, as management’s compensation is often linked to short term incentive plans. It is therefore quite rare for us to find the true qualities of ‘stewardship’ we are looking for in a management team, and often we find them in companies with a large dominant shareholder.

Well-stewarded family-controlled businesses, aiming to preserve and expand wealth for the future, are in the fortunate position of being able to ignore external and internal pressures to maximise immediate returns. Their managements are not obliged to look over their shoulders in fear of an opportunistic take-over bid or to gear up their balance sheets to a dangerous extent. Nor are they likely to be subject to the temptations of poorly designed incentive schemes. Hence they can take a much more holistic and longer term view in decision making than most companies with open shareholder registers. In an intensely competitive environment, a longer time horizon and a willingness to take short-term pain for the sake of long-term gains becomes a key competitive advantage.

RCL Foods (RCL), a South African food producer, is a good example of this dynamic. RCL is majority-owned by Remgro, a family conglomerate with a reputation for long termism and strong business ethics. RCL historically focused on chicken and milling, until a few years ago when the strategy pivoted towards branded foods. Cash flows from the commodity businesses were channelled towards the higher-valued branded business. These cash flows were highly cyclical though, which was disruptive for the branded business.

Management addressed the issue by reducing the cyclicality of the commodity business. It meant giving up some potential upside and profits in the near term in order to offer long term stability for the small, but growing, branded business. A decision like this is only possible because of the multi-year time horizon of the major shareholder, Remgro, who has the vision to see that in ten years’ time a branded foods business will be a lot more valuable than a commodity food business.

Voltronic is a Taiwanese business that manufactures uninterruptible power supplies, equipment that offers emergency power in the event of a mains outage. The company was founded a decade ago by Alex Hsieh, a proven entrepreneur, whose previous venture was acquired by a multi-national competitor with deep pockets. Voltronic’s success owes to the fact that management have won the trust of customers by sticking exclusively to original design manufacturing (ODM), which means it does not have its own brand that would compete with its customers. The same cannot be said for other ODM companies, who have launched their own brands in an effort to boost revenues. This strategy will invariably impact the competitors’ long-term ability to win tier one ODM contracts. Alex Hsieh meanwhile is only interested in the long-term sustainability of the business, recognising that the outsourcing trend is in its infancy, and that if he continues to hold the trust of leading international brands then Voltronic will be a much larger business in the future.

Our willingness to invest for the long-term means that we focus more on judging the quality of the people behind the business than the business itself. Often at the time of purchase, these businesses might be going through a difficult phase. These difficulties usually make them unpopular and allow us to acquire shares at a relatively cheaper price. Our expectation is that as long as our judgement on the ‘people’ is correct, these businesses will recover or evolve into something more robust.

Singapore-listed Delfi is one such example. It is the largest chocolate confectionary company in Indonesia by market share. The business was founded in the 1980s by John Chuang, an entrepreneur who has adopted a conservative and honest approach towards business in a challenging market. Delfi was successful for a long time, until a few years ago when it started to experience difficulties. With the formalisation of retail, the market changed. This opening was exploited by aggressive local players, as well as by multi-national chocolate brands which appealed to growing Indonesian middle class aspirations for premium brands. Delfi started to lose market share.

John Chuang realised the family business needed to upgrade its capabilities in order to compete, which meant recruiting talented board directors and professional managers. Testament to the reputation of the family and the willingness of the owner to develop a culture of true autonomy and meritocracy, Delfi was able to attract a number of high-quality professionals. These professionals replaced family members and loyal company servants, who had taken the business as far as they could. These decisions can be painful and rare in the context of family owner-managers, who often construct glass ceilings for professional managers. The events signalled that the Chuang family were willing to separate ownership and management, as they prioritised the long-term health of the business.

The changes initiated by John Chuang are now in full swing; underperforming brands have been cut, premium products have been introduced, and an improved route-to-market strategy has been implemented. Such improvements will take time to translate to profit growth, and in the meantime we have been able to acquire shares in the company at a reasonable price. In our view, Delfi now has a good combination of quality professionals (‘agents’) running the daily operations of the company; and a dominant shareholder (‘principal’) who is focused on the long term to ensure sensible capital allocation.

Companies already held in the portfolio and deemed investable are constantly scrutinised by the team for anything that might break our investment thesis, with the investment thesis itself under constant review. A company we held briefly last year was PZ Cussons, a branded home and personal care business, whose largest markets include Indonesia and Nigeria. The company needed to upgrade its capabilities to compete more effectively with local brands in emerging markets. We were encouraged by changes at board level, and expected further developments at an operational level. However, the company made it clear to us that the controlling family shareholder was happy with the status quo, at which point we questioned our thesis and exited the position, fortunately for no loss.

In an ideal world all of our companies would have a family steward, with a track record of strong business ethics and proven conservatism, as the controlling shareholder. In reality we are still unable to unearth families that we trust and want to back in some countries. Nigeria is a case in point. In this context the next best thing is a local subsidiary of a multi-national with an identifiable value system and corporate culture. This is why we invested in Unilever Nigeria.

In recent years Unilever’s Nigerian business has followed its parent company in embracing health trends, whilst at the same time it has localised its management and supply chain operations. Its management team is properly empowered by the parent company to think like owners and ignore the short term in order to build the foundations for long-term growth. Such autonomy was lacking in the past and partly explains why the market cap of Unilever Nigeria ($600m) is tiny in comparison to Unilever’s operations in India ($40bn) and Indonesia ($30bn).

The long-term success of a bottom-up investment process like ours relies on an investment culture which embraces open and honest debate, where fresh ideas are routinely encouraged. New investment ideas typically involve months of work and debate before we are able to judge whether there is genuine stewardship and a business model worth backing. When a new company fits our criteria, we begin investing with small positions, conscious of valuations, and we build conviction over several years.

CONTRIBUTION

Positive

Profitability at Youngone Holdings increased as a result of improvements at Scott, the sporting brand that the company acquired in 2015.

The convenience store operator Philippine Seven did well as the management team continued to execute its strategy of nationwide coverage in the Philippines.

Haw Par is the holding company of the Wee family of Singapore. Its assets include the pain ointment Tiger Balm, which continues to grow in Asia and developed markets.

Sentiment towards Turkey stabilised somewhat following a painful few months. During the crisis we purchased shares in Coca-Cola Icecek, which bottles Coca-Cola in Turkey, Pakistan, and Central Asia.

Voltronic’s business continued to perform well as a result of market share gains.

Top Five Contributors – Year ended 31 December 2018

Negative

RCL Foods’ business model continues to show positive signs of change, with its branded business recording decent growth. Negative sentiment towards South Africa impacted the share price and South African Rand.

Delfi is in the middle of a turnaround led by new management. There was some short term pressure on the results because of product portfolio rationalisation and additional brand investments. Encouragingly these initiatives are now showing up in recent financial results. 

The low-cost hospital operator Narayana Hrudayalaya recorded lower profits as a result of investments in new hospital capacity.

Long4Life, the investment company of proven entrepreneur Brian Joffe, was also impacted by negative sentiment towards South Africa. 

We are encouraged by Vinda’s continued market share gains within the tissue category in China but the share price weakened on general concerns regarding Chinese consumer sentiment.

Top Five Detractors – Year ended 31 December 2018

For further information contact:

Stewart InvestorsInvestment ManagerTel: 0131 473 2900

PATAC LimitedCompany SecretaryTel: 0131 538 6603

The Statement of Comprehensive Income, Statement of Financial Position, Statement of Changes in Equity and Cash Flow Statement follow.

Statement of Comprehensive Income

Statement of Financial Position

Statement of Changes in Equity

Share premium. The share premium represents the difference between the nominal value of new Ordinary shares issued and the consideration the Company receives for these shares.

Capital reserve. Gains and losses on the realisation of investments, realised exchange differences of a capital nature and returns of capital are accounted for in this Reserve. Increases and decreases in the valuation of investments held at the year end, and unrealised exchange differences of a capital nature are also accounted for in this Reserve.

Revenue reserve. Any surplus/deficit arising from the revenue profit/loss for the year is taken to/from this Reserve.

Special reserve. Created from the Court cancellation of the share premium account which had arisen from premiums paid on the Ordinary shares at launch. Available as distributable profits to be used for the buy back of shares. The cost of any shares bought back is deducted from this reserve. The cost of any shares resold from treasury is added back to this reserve.

Cash Flow Statement

Principal Risks and Risk Management

The Board believes that the principal risks to shareholders, which it seeks to mitigate through continual review of its investments and through shareholder communication, are events or developments which can affect the general level of share prices, including, for instance, inflation or deflation, economic recessions and movements in interest rates and currencies.

Other risks faced by the Company include breach of regulatory rules which could lead to suspension of the Company’s Stock Exchange listing, financial penalties, or a qualified audit report. Breach of Section 1158 of the Corporation Tax Act 2010 could lead to the Company being subject to tax on capital gains.

In the mitigation and management of these risks, the Board regularly monitors the investment environment and the management of the Company’s investment portfolio, and applies the principles detailed in the guidance provided by the Financial Reporting Council.

Statement of Directors' Responsibilities in Respect of the Annual Financial Report

In accordance with the Disclosure Guidance and Transparency Rules, we confirm that to the best of our knowledge:

The financial statements contained within the Annual Report for the year ended 31 December 2018, of which this statement of results is an extract, have been prepared in accordance with applicable United Kingdom Generally Accepted Accounting Practice (United Kingdom Accounting Standards, comprising FRS 102, and applicable law), give a true and fair view of the assets, liabilities, financial position and net loss of the Company; and

The Strategic Report includes a fair review of the development and performance of the business and the position of the Company, together with a description of the principal risks and uncertainties that it faces.

In addition, each of the Directors considers that the Annual Report, taken as a whole, is fair, balanced and understandable and provides the information necessary for shareholders to assess the Company’s performance, position, business model and strategy.

Going Concern

The Directors believe, in the light of the controls and review processes reported in the Report of the Audit Committee on pages 40 and 41 of the Annual Report and bearing in mind the nature of the Company’s business and assets, which are considered to be readily realisable if required, that the Company has adequate resources to continue operating for at least twelve months from the date of approval of the financial statements. For this reason, they continue to adopt the going concern basis in preparing the accounts.

Related Party Transactions

Related party transactions with the Directors, for the year ended 31 December 2018 are disclosed in the Directors’ Report on page 29 of the Annual Report. At the year end no amounts were due to the Directors (2017: £16,500).

The AIFM, the Investment Manager and the Company have entered into the Investment Management Agreement. Pursuant to the terms of the Investment Management Agreement, the AIFM has delegated to Stewart Investors the management of the Company’s portfolio subject to its and the Directors’ overall supervision. Details of transactions during the year and the balance outstanding at the year end are disclosed in note 3 of the Annual Report.

There were no other related-party transactions.

Notes:

1. ScotGems plc is a public company limited by shares, incorporated and domiciled in England and Wales, and carries on business as an investment trust. Details of the Company’s registered office can be found in the Annual Report.

The accounts are prepared in accordance with the Companies Act 2006, United Kingdom Generally Accepted Accounting Practice (Accounting Standards “UK GAAP”) including Financial Reporting Standard (FRS) 102 “The Financial Reporting Standard applicable in the UK and Republic of Ireland” and the Statement of Recommended Practice “Financial Statements of Investment Trust Companies and Venture Capital Trusts” (“the SORP”) issued by the Association of Investment Companies in November 2014 and updated in January 2017.

All of the Company’s operations are of a continuing nature.

The accounts have been prepared on a going concern basis under the historical cost convention, as modified by the revaluation of investments held at fair value through profit or loss.

Estimates and judgements are continually evaluated and are based on historical experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances.

There are no critical accounting estimates or judgements.

The accounts have also been prepared on the assumption that approval as an investment trust will continue to be granted.

The functional and reporting currency of the Company is pounds sterling as most investors in the Company are based in the United Kingdom.

2. The Company held the following categories of financial instruments as at 31 December 2018:

The Company held the following categories of financial instruments as at 31 December 2017

The above table provides an analysis of financial assets and financial liabilities based on the fair value hierarchy described below. Short term balances are excluded from the table as their carrying value at the reporting date approximates to their fair value.

Fair Value Hierarchy

The fair value hierarchy used to analyse the fair values of financial assets and liabilities are described below.

The levels are determined by the lowest (that is, the least reliable or least independently observable) level of input that is significant to the fair value measurement for the individual investment in its entirety as follows:

Level 1 - investments with prices quoted in an active market;

Level 2 - investments whose fair value is based directly on observable current market prices or is indirectly being derived from market prices; and

Level 3 - investments whose fair value is determined using a valuation technique based on assumptions that are not supported by observable current market prices or are not based on observable market data.

3.

4. These are not statutory accounts in terms of Section 434 of the Companies Act 2006.Full audited accounts for the year to 31 December 2018 will be sent to shareholders in March 2019 and will be available for inspection at Broadgate Tower, 20 Primrose Street, London EC2A 2EW, the registered office of the Company. The full annual report and accounts will be available on the Company’s website www.scotgems.com.

5. The audited accounts for the year ended 31 December 2018 will be lodged with the Registrar of Companies.