SGEM.L Regulatory News (SGEM)

ScotGems Plc - Half-year Report

PR Newswire

London, August 4

From: ScotGems plc

LEI: 549300GQHCPU9P1NYM13

Date: 4 August 2021

Results for the six months ended 30 June 2021

The Directors of ScotGems plc (“the Company”) are pleased to announce the Company's interim results for the six months ended 30 June 2021.

Top Ten Investments as at 30 June 2021

Chairman’s Statement

During the six months to 30 June 2021, the net asset value (“NAV”) of your Company rose by 9.4% to 93.9p per share while the share price rose by 6.2% to 77.0p. This compares to rises in the Company’s comparator indices: the MSCI Emerging Markets Small Cap Index, the MSCI Emerging Markets ex Asia Index and the MSCI Emerging Markets Index of 14.0%, 10.1% and 5.4% respectively. These indices are only for comparison purposes and our portfolio is not managed by reference to any particular Index, but according to principles which the Investment Manager has set out in the past and which you will be able to read more about in the report which follows.

I intend to review our performance since inception in the Annual Report at the end of this year, but the positive absolute return achieved over the last year is encouraging. Your Investment Manager’s style and principles mean that in periods when companies without earnings, and whose current valuation is based on the promise of very significant future growth, our portfolio will underperform the comparator indices. Our Investment Manager has provided a comprehensive report with these accounts including a detailed look at the portfolio which I hope Shareholders will find interesting and useful. They include a contribution analysis, detail on companies bought and sold, as well as their own perspective on the events influencing valuations in the Small Cap sector in Emerging Markets.

During the period under review the Company’s discount widened from 15.6% to 18.0%. Shareholders will be aware that it is not the Board’s policy to buy back shares, for reasons that I’ve set out previously. The Board and Investment Manager continue to be aligned with the body of shareholders through their own investment in the Company. In the first six months of the year the Investment Management Team have increased their shareholding by 489,201 shares, and now own 2,176,982 Ordinary shares. This brings the total holding by employees of Stewart Investors to 8,463,092 Ordinary shares (this includes the shareholding by the Stewart Investors Employee Benefit Trust which remains unchanged at 5,000,000 Ordinary shares). The Directors shareholding of 4,790,096 Ordinary shares (including persons closely associated with them) remained unchanged during the period. The combined holdings of the Board and Investment Manager now represent 24.8% of the issued Ordinary share capital of the Company.

At the AGM held on 6 May 2021, over 90% of votes were cast in favour of all the resolutions. Your Company relies both on our Investment Manager and our Company Secretary and Administrator. We are grateful to the people of both organisations for the way that they adapted their operations to work in a virtual way and have been able to maintain their usual high standards of service. During the period, PATAC Limited changed its name to Juniper Partners Limited and I’m pleased to say there has been a continuity of personnel as well as the high level of service we’ve been accustomed to receiving.

Investment Manager’s Report

In last year’s Interim Report we discussed the gulf in valuation between Global Emerging Markets (“GEM”) companies wearing the label “value” and those wearing the label “growth”. One year later, there has been a modest narrowing in the large disconnect between the “real world” (often analogous we feel to the “jam today” of stocks labelled value) and the “world of finance” (analogous with the “jam tomorrow” of often more speculative stocks labelled or even rewarded by financial types with the label of growth). One possible reason for the modest change are concerns around inflation, interest rates, and so forth - discussed below. But, more for governance-obsessed types such as ourselves, what has been more interesting are signs of increasing corporate misconduct and decreasing predictability of government behaviour in GEM. In order for profits in 2040 or 2050 to be worth anything today, you have to believe that company management is on your side, and that the relevant government does not become your enemy. Plucking discount rates out of the air is the easy bit in GEM.

On the topic of corporate misconduct, 51 Hong Kong listed companies failed to meet the exchange’s deadline at the end of March for publishing audited 2020 financials. At the time of writing, a number of these companies remain suspended. The first of these to discuss is GCL Poly - notable because it was the largest constituent of the MSCI Emerging Market Small Cap Index for most of the reporting period. It is a supplier of polysilicon to the solar power industry in China. This description ticks a number of popular boxes amongst investors including interest in technology, renewables and ‘China’. The company’s auditor has resigned over a dispute related to the commercial rationale for a payment to a contractor. The company is also going through a restructure following a default on its debt. Those who study financial history make the observation that the frequency of fraud increases in boom times, so the company’s place at the heart of three popular themes appears to us as more than just a coincidence. At the point of its suspension, the market capitalisation of the company was approximately $6bn – size and scrutiny do not always correlate.

A second interesting example comes from state owned Huarong Asset Management and Chinese tech behemoth, Alibaba. Huarong was set up by the Chinese government in 1999, following the Asian Financial Crisis, in order to help manage bad debt, however recent events suggest that it may now have bad debt of its own. For an example of the complex pressures on the business and the government’s innovative ways of bailing it out, Huarong was recently “gifted” a part of Ant Group (a financial business incubated by Alibaba which in turn had by some interpretations seized it from other shareholders). This was part of a “rectification” deal between Ant Group and regulators, designed to tackle systemic financial risks. Huarong is another company which has been unable to file financial statements and whose shares remain suspended. The company insists that it can make the payments on its debt and says that the delayed accounts will allow it to complete a mysterious “transaction”. Its former chair Lai Xiaomin was executed for corruption in January. Huarong and its issues aside, we have strong views on the governance arrangements at Alibaba and the risks its monopoly characteristics present. Suffice to say that government interest in the business and the “retirement” of its founder ought not to have surprised any investor. Shareholders may wonder what connects behemoths such as Alibaba with our universe of smaller companies. Firstly – the scraps from the table of the huge companies feed a huge ecosystem of smaller businesses – fewer scraps, lower growth. Secondly, the behemoths are keen investors in the smaller companies – this equity investment has been a lifeline for often loss-making capital-hungry smaller companies. If this tap turns off, some small and medium sized companies will find life very tricky; others whose share prices have been bid up by the general expectation of equity investment sloshing around, may disappoint their shareholders.

As for inflation and its possible effects – we have little to add to our view that after twenty years of encouraging asset inflation, the likelihood that central banks voluntarily change their ways seems remote. Even inflation in the world of prices and wages has been termed “transitory” – a decision by the powers that be that erring on the side of yet more cheap money is preferable to conscientiously deflating bubbles. As such, valuations remain extremely stretched.

As a final not especially cheerful point, we also note how weak many GEM sovereign balance sheets are. Two decades of easy money followed by a pandemic is a potent combination. Ultimately this has a cost, often involving weaker GEM currencies. We have always enjoyed owning hard currency businesses including exporters and feel that they have an important part to play in preserving capital over the coming years.

Portfolio

The portfolio consists of shares in 39 companies. The ten largest names represent 41.2% of the portfolio at the end of June. This is a small reduction from 42.7% at the end of 2020 and 46.4% at the end of 2019 when a shareholder resolution was passed to allow a slightly longer list of companies. Cash started the period at 3.3% and ended at 2.6%.

The average market cap (weighted by position size) is $1.33 billion. Our process of looking back at the choices made by people behind each business can make very small listed companies hard to analyse when this track record may be too short, but we were pleased to add the Indonesian healthcare company Prodia Widyahusada to the portfolio. It is discussed in detail later but is an example of a high quality small cap at the smaller end of the portfolio’s market cap range. It could only be owned responsibly in a closed ended company – a strength of the investment trust structure we are keen to harness.

Additions

During the period we bought shares in four new companies. Below is a list shown in descending order of size in the portfolio at the end of the period.

Anadolu Efes is a Turkish listed brewer. It is controlled by the founding Özilhan and Yaz?c? families, and the global brewer ABI has a stake inherited from its merger with SAB Miller. We like the combination of committed family and multinational oversight. In 2018, ABI and Efes pooled their Russian beer businesses into a 50/50 JV which is the most valuable part of Efes today – it is the joint market leader with approximately 30% market share. Efes also owns a stake in a Coke bottler operating across several CIS states and in Pakistan where it is growing rapidly. Although Turkish listed, sales of beer and Coke in Turkey are barely a quarter of the overall value of the business. Over the last five years, the company has rapidly repaid debt meaning it offers a high single digit dividend yield earned from a steadily growing business.

Bladex (full name Banco Latinoamericano de Exportaciones) is a bank which facilitates the transactions of international trade. It is listed on the New York Stock Exchange, is headquartered in Panama and operates across Latin America and the Caribbean. The central banks of the countries in these regions own shares and have the opportunity to elect board members. It plays an important role in the economic development and integration of the region through its reputation as a supportive lender. This reputation comes from its historic lending in periods when other international banks avoid the region, normally in periods of crisis. Its loan book is in US Dollars, it is very affordably valued and is well positioned to enjoy an economic recovery.

Jumbo is a Greek listed retailer operating in Greece, Cyprus, Bulgaria and Romania. It is controlled and managed by the Vakakis family. It sells small baskets of everyday cheap items in a model which is comparable to Dollar General in the USA. This has so far made it less vulnerable to online retail than other formats such as the department store model. We are impressed by the company’s ability to grow through past periods of economic stress in Greece and by its growth in new markets. It is conservatively financed and has pre-paid for much of its inventory historically in order to improve pricing.

Prodia Widyahusada is an Indonesian listed medical diagnostics business with a $230m market cap at time of purchase and a free float which represents 25% of shares outstanding. It is controlled by the founding family and is conservatively financed after its IPO in 2016. It is the largest private sector diagnostics business in Indonesia and comes with an excellent record for quality. One piece of evidence of this is the fact that they are the only Indonesian diagnostics chain with a College of American Pathologist accreditation. Its track record demonstrates that the model benefits from large economies of scale – it can drive down costs as it grows allowing it to reduce pricing which in turn allows it to continue to gain market share. The business model has proved successful many times across GEM including Integrated Diagnostics Holdings operating primarily in Egypt, and whose shares are also held in the portfolio. The model deserves a strong social license given that early diagnosis allows early treatment and should therefore lead to higher survival rates.

Disposals

During the period we sold all of the shares held in two companies.

Voltronic Power is a Taiwanese business manufacturing and selling uninterruptable power supplies. We first discussed reducing this in the 2020 Annual Report but have now sold all of our shares. It is an excellent company but we are uncomfortable with the current valuation.

Dis-Chem Pharmacies is a pharmacy chain in South Africa. It is a strong franchise but following recent engagements with the company we have concerns that stewardship might not be as strong as we had previously thought. This was demonstrated in part by recent poor disclosure of a related party transaction.

Reduced

The three most significant reductions were in businesses listed in India.

Cyient is an engineering outsourcing business with global clients in industries such as aerospace and transportation. We made a small reduction on valuation.

Sundaram Finance is a finance company with a focus on commercial vehicles. We made a small reduction on valuation.

Tata Consumer Products is a food and beverages company with a focus on tea and coffee. We reported reductions in the last two Annual Reports and the last two Interim Reports. As discussed previously we believe that the original investment case remains intact, namely the importance of a recent management transition and a renewed focus on India under Tata Group stewardship, but that the company’s transformation will take a long time. Valuations currently provide limited room for error.

* Country of listing.

Contribution Analysis

The Trust has made a decent start to 2021, with NAV rising by just over 9%. The strong gains of the second half of 2020, partly a result of the hoped for vaccine miracles, means gains over twelve months are a little over 24% in Sterling. NAV has lagged the tech-dominated Emerging Markets Smaller Cap index but performed better compared to the slightly less tech-dominated broader Emerging Markets index. This is especially in the past six months as enthusiasm of other investors appears to fade for Chinese companies given the governance and government issues they face.

The Indian holdings have, collectively, contributed very significantly to fund performance. The Chilean conglomerate Quiñenco, and the South African mini-conglomerate Reunert have also been good to us. The strong rise in markets over the past twelve months means only a handful of companies have detracted significantly from performance – our retailer in the Philippines continues to find Covid-19 tough, and our Chilean water utility has suffered from concerns that future regulation may be less generous.

The top and bottom contributors are discussed below. In discussing the 12 months to 30 June it is worth pointing out that this period is unusual in that it follows the market’s initial reaction to the Covid-19 pandemic.

Positive

Top Ten Contributors – 12 months ended 30 June 2021

Cyient is an Indian research and development provider with global clients in industries such as aerospace and transportation. We discussed it in the last Interim Report as a detractor after a period in which its aerospace customers had struggled. Twelve months later, its share price has recovered and the company appears as a top contributor. Nonetheless throughout this period our investment case has not changed - we continue to back it on account of its high quality franchise, continued founder involvement, hard currency earnings and strong net cash balance sheet. We made a small reduction, as discussed earlier in the report.

Tata Consumer Products is an Indian incorporated food and beverages company with a focus on tea and coffee. A recent management transition and a renewed focus on India sets the company on a strong trajectory to improve its profitability. We believe that the company has an exceptional opportunity to leverage the Tata brand, known for excellence, to become a diversified world-class consumer products company. We have made a modest reduction, as discussed earlier.

Reunert is a South African conglomerate made up of three businesses, a cables business, an office equipment leasing business and an electrical engineering business. It reported strong results and a useful dividend despite still being adversely affected by reduced economic activity associated with the pandemic.

Indiamart is India’s largest business-to-business classified website business. It has been a strong contributor despite only being added relatively recently. As discussed previously it has benefitted from the overall popularity of all things online and tech, but has also reported strong results, is profitable on an accounting basis, and is cashflow positive.

Quinenco is a Chilean holding company with its largest asset being a stake in Banco de Chile. It is 82% owned by the Luksic family which has been both a conservative and growth oriented steward over a long period of time. The conglomerate also owns businesses in brewing, global shipping and a Latin American ports business.

Negative

Top Ten Detractors – 12 months ended 30 June 2021

* Not held at end of period

** Not held at start of period

Philippine Seven is a 7-Eleven convenience franchise in the Philippines. The company has been a detractor in this period in contrast to its longer term track record, both since launch of the Trust and before. Convenience retail has been particularly affected versus other retail models by the prolonged lockdown in the country given that many outlets are located close to places of work. We do not have longer term concerns with the business.

IAM Chile is a holding company with a 50% stake in Aguas Andinas, Chile's largest water utility. Over the long term the company has attractive defensive qualities, providing an inflation protected dividend yield. The company also exhibits a strong social purpose given that it delivers potable water to one of Latin America’s largest metropolitan areas. In the shorter term it is likely that it has been affected by investor concerns following a vote to rewrite the country’s constitution, possibly due partly to a low turnout and as a rejection of the established political parties. Whilst uncertainty in this constitutional process remains, we are more sanguine than the market consensus given that most citizens own assets in some form or another so have something to lose from any proposed undermining of property rights.

Unilever Nigeria is a local subsidiary of Unilever Plc. We discussed this detractor in the Annual Report but despite what we would have hoped was a high level of oversight from the parent, local management underperformed last year and results have been poor. Fortunately, Unilever Plc does not lack experienced country heads and we believe the management problem has been rectified and that financial improvement should follow. On a sales per capita metric, this company has more potential than possibly any other held in the Trust – though we recognise that Nigeria is about as tough an operational jurisdiction as GEM has to offer.

Hochschild Mining is a gold and silver mining company with mines in Peru and Argentina, listed on the London Stock Exchange and controlled by the Hochschild family. It enjoys a strong cost position and a long term owner.

Vinda International manufactures tissue paper products and personal care products in China and Asia Pacific. It enjoyed a significant increase in demand during the height of the Covid-19 pandemic, showing as a contributor last year, but has been less profitable lately as it continues to invest in its personal hygiene business. Longer term this investment ‘today’ for a deferred reward ‘tomorrow’ is part of our original investment case. We are backing the company to move away from tissue paper to become a dominant player in China’s feminine hygiene and incontinence markets. Success here would allow Vinda to earn more attractive returns and provide structural long-term growth from exposure to sectors that are significantly underpenetrated relative to developed markets.

Stewart Investors

Investment Manager

Tel: 0131 473 2900

Juniper Partners Limited

Company Secretary

Tel: 0131 378 0500

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

Statement of Comprehensive Income

for the six months ended 30 June 2021

Unaudited

The Total column of this statement represents the Statement of Comprehensive Income of the Company. The Revenue return and Capital return columns are supplementary to this and are prepared under guidance issued by the Association of Investment Companies.

All revenue and capital items in the above statement derive from continuing operations.

Statement of Comprehensive Income

for the year ended 31 December 2020

Audited 

The Total column of this statement represents the Statement of Comprehensive Income of the Company. The Revenue return and Capital return columns are supplementary to this and are prepared under guidance issued by the Association of Investment Companies.

All revenue and capital items in the above statement derive from continuing operations.

Statement of Financial Position

As at 30 June 2021

The notes form an integral part of these Interim financial statements.

Statement of Changes in Equity

for the six months ended 30 June 2021

The notes form an integral part of these Interim financial statements.

Cash Flow Statement

for the six months ended 30 June 2021

*Cash and cash equivalents represent cash at bank.

The levels are determined by the lowest (that is, the least reliable or least independently observable) level of input that is signi?cant 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.

At 30 June 2021 £46,180,000 of the Company’s investments were listed as Level 1, the remaining £2,369,000 were listed as Level 2 (30 June 2020: £34,158,000 listed as Level 1, £2,897,000 listed as Level 2; 31 December 2020: £42,307,000 listed as Level 1, £2,413,000 listed as Level 2). Level 2 investments represent the Company’s investments in Nigeria. These have been categorised as Level 2 owing to uncertainty relating to the Nigerian Naira exchange rate.

Statement of Principal Risks and Uncertainties

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, and the way in which they are managed, are described in more detail under the heading Principal Risks and Risk Management within the Strategic Report in the Company’s Annual Report for the year ended 31 December 2020.

The Company’s principal risks and uncertainties have not changed since the date of the Annual Report and are not expected to change for the remaining six months of the Company’s financial year.

Going Concern

The Directors believe, in the light of the controls and review processes noted above and bearing in mind the nature of the Company’s business and assets, which are considered readily realisable if required, that the Company has adequate resources to continue operating for the foreseeable future. For this reason, they continue to adopt the going concern basis in preparing the accounts.

Related Party Transactions

Details of related party transactions are contained in the Annual Report for the year ended 31 December 2020. There have been no material changes in the nature and type of the related party transactions as stated within the Annual Report.

Directors’ Responsibility Statement in Respect of the Interim Report

We confirm that to the best of our knowledge:

On behalf of the Board,

William Salomon, Chairman

4 August 2021