SGEM.L Regulatory News (SGEM)

ScotGems Plc - Half-year Report

PR Newswire

London, July 29

From: ScotGems plc

LEI: 549300GQHCPU9P1NYM13

Date: 30 July 2020

Results for the six months ended 30 June 2020

The Directors of ScotGems plc (“the Company”) are pleased to announce the Company's interim results for the six months ended 30 June 2020.

Highlights

Top Ten Investments as at 30 June 2020

Chairman’s Statement

During the period our net asset value (“NAV”) fell by 13.0% to 75.7p per share while our share price fell by 17.6% to 58.5p. This compares to falls in the Company’s comparator indices, the MSCI AC World Index, the MSCI Emerging Markets Small Cap Index and the MSCI Emerging Markets Index of 0.4%, 8.1% and 4.3% respectively. As shareholders will be aware, these Indices are for comparison purposes only and the portfolio is not managed by reference to any Index. It should also be noted that all comparators are significantly differentiated by country and sector to the Company’s portfolio. This makes it highly likely that they will perform differently. At 28 July 2020, the latest practicable date prior to publication of this document, the share price was 59.5p and the discount to NAV was 18.3%. The NAV has fallen by 16.3% since 31 December 2019.

While the performance has been disappointing, the Board and Investment Manager continue to support the Company’s long-term strategy. Since the year end the Board and Investment Manager have increased their holdings in the Company. The Directors (including persons closely associated with them) now own 4,790,096 Ordinary shares, an increase of 650,000 shares from the year end, and the employees of the Investment Manager have increased their shareholdings by 754,543 shares and now own 3,503,698 Ordinary shares. The shareholding by the Stewart Investors Employee Benefit Trust remains unchanged at 5,000,000 Ordinary shares. The combined holdings of the Board and Investment Manager now represent 24.8% of the issued Ordinary share capital of the Company.

The Company’s Investment Manager has largely completed the transition of the portfolio following the changes to the investment policy which were approved at a General Meeting on 9 December 2019. The proportion of the Company’s portfolio invested in equities is currently 91.5%.

During the period the Company’s discount widened from 18.4% to 22.7%. It is not currently the Board’s policy to buy back shares.

The development of the Covid-19 pandemic has resulted in a difficult period for organisations and businesses large and small. Both our Investment Manager and our Company Secretary and Administrator each rely on a handful of key individuals. Each organisation was quick to move to offsite working even before imposition of the lockdown and have functioned smoothly throughout the last few months.

Shareholders should recognise that their investment is best thought of as a long-term commitment, mirroring the commitment the Investment Manager has made to the underlying companies in the portfolio. The Investment Manager has set out below a detailed description of the existing portfolio and their assessment of the impact on the portfolio as a result of the Covid-19 pandemic.

Investment Manager’s Report

The printing presses of central banks have gone into overdrive this year in an attempt to ward off the greatest economic and social uncertainties most of us have ever encountered. One of the very early consequences of this unprecedented action has been the widening of various distortions in stock markets. One such distortion is the large difference between stocks wearing the label ‘value’ and those preferring to don ‘growth’. The discrepancy in performance between growth and value has rarely, if ever, been wider than it is currently. This is the case globally and emerging markets are no exception.

At the end of June the price to earnings ratio (or “PE Ratio”) of the MSCI Emerging Markets Index was 16x; the MSCI Emerging Markets Value Index was 11x; and the MSCI Emerging Markets Growth Index was 30x.(Source: Factset. The MSCI Emerging Markets Value and MSCI Emerging Markets Growth indices are two subdivisions of the MSCI Emerging Markets Index categorised by MSCI according to the characteristics of the companies they hold.)

The graph on page 3 of the Interim Report shows the difference between the MSCI Emerging Markets Growth and Value Indices’ PE ratios divided by the Value Index’s PE ratio, over the last 20 years. For example if the Value Index’s PE ratio was 10x and the Growth Index’s was 20x, the premium would be 100%.

Unsurprisingly, therefore, we have increasingly been asked to self-identify as either ‘growth’ or ‘value’ investors. We have to reply, ‘neither’. The question is akin to asking whether we own t-shirts or jackets – we feel it prudent for your wardrobe to include a few well-made versions of both. Rather, the common thread that runs through all of the Trust’s investments is that of ‘stewardship’. The companies in which your Trust invests are presided over by prudent and capable individuals with high levels of integrity and long-termism. Some have higher growth rates than others, some have higher dividend yields than others, but we believe that all are well stewarded, and that minority shareholders will be able to benefit from their future successes as a result.

As an aside, it is true that no fund manager would claim to be uninterested in stewardship, but it is clear that, for many, other factors are far more important. Consider the two largest constituents of the emerging market indices. Both companies are active and willing participants in, and beneficiaries of, China’s surveillance state. This entails the general curtailment of human rights of the populace, with especially alarming treatment of certain groups – none more so than that of Xinjiang province’s Uighur population. The behaviour in question is well documented by the independent press; its links to large components of a typical ISA less so. It does not really seem important whether these two companies are labelled as growth or value.

The Trust’s portfolio

Let us consider how the above relates to some specific investments held by the Trust.

Two ‘Growth’ Investments

Two examples of companies that might be categorised as ‘growth’ investments are Philippine Seven and IndiaMart.

Philippine Seven operates 7-11 convenience stores across the Philippines, a format in which it has a 70% market share and four times as many stores as its closest competitor. It is a highly cash-generative model. The company has grown its revenues ten-fold since 2007 and still has a large opportunity ahead of it – convenience retail has just a 3% market share in total, so it is hoped that growth can continue for many years to come.

IndiaMart is India’s largest (and the world’s second largest) business-to-business classifieds website, with a market share in excess of 60% and rising. About six million suppliers are listed on the website, having grown at over 30% per annum over the last three years, and there are nearly 100 million registered buyers. It is a highly cash-generative company.

For us, more important than the growth prospects of either company is the identification of their stewards. These must be individuals that possess high levels of integrity and who are well aligned with their shareholders for the long term, with the competency to grasp the opportunities ahead of them and to grapple with the inevitable challenges too. Philippine Seven is controlled by Taiwan’s President Chain Stores, one of Asia’s finest retailers, itself owned by a group of families. The local founding family of the Filipino subsidiary remains involved with a significant shareholding themselves. Despite its growth, the company’s balance sheet is conservative. IndiaMart is run and controlled by its founder, Dinesh Agarwal, who has an aversion to debt and a fondness for cashflows. These are two companies with conservative, long-term stewards who certainly do not lack ambition. We believe both are reasonably valued.

Two ‘Value’ Investments

Two examples of companies that would more readily be labelled as value investments are Consorcio ARA in Mexico, and Yue Yuen, a Hong Kong listed company.

Consorcio ARA is a Mexican housebuilder that can be bought for less than a quarter of its net asset value (‘NAV’) currently. NAV may be understated too, given that the land it owns is held at cost. The dividend yield is 9% and the company is net cash. It is unlikely that the company will grow significantly. It is the Trust’s purest value investment if such a label is required.

Yue Yuen is the world’s largest shoe manufacturer, producing over 300 million pairs per year. Nike and Adidas are its largest customers. This is a cash generative business that currently has a dividend yield of over 9%. It is probably most easily categorised as a value investment, but it also owns 62% of rapidly-growing Pou Sheng, China’s second largest sports retailer.

Value investments, perhaps, but crucially these two companies are stewarded by families that we trust will act in the best interests of minority shareholders. Consorcio ARA has been run by German Ahumada Russek and his brother for over 40 years. He may be trying to slowly wind the company up now, and we are confident that minority shareholders will benefit as a result – he has a strong governance track record and is competent enough to do so in the most beneficial manner possible, if indeed that is his plan. If, in fact, it is ‘business as usual’, we have no doubt he will continue to share the company’s significant cash flows with its minority shareholders.

Yue Yuen is ultimately controlled by the Tsai family who have looked after shareholders well over the years and who have in recent years improved the company’s treatment of all stakeholders. Nike and Adidas are highly dependent on the company (nearly 10% of Nike’s total purchases are from Yue Yuen) and will be motivated to see it succeed in the years ahead.

Performance

The year has been a difficult one so far for small cap companies in emerging markets. The Trust’s NAV has fallen by 13.0% and the MSCI Emerging Small Cap Index by 6.3% in GBP total return terms over the six months to the end of June. Indices have never been our starting point for portfolio construction but when comparing performance with this small cap index, it may be useful to point out that it has a significant concentration by country and sector. Over half of its combined country exposure is to Taiwan, China and South Korea, and it has a significant exposure to Information Technology. Most emerging markets have experienced large falls in 2020, although China and Taiwan are notable exceptions. There has been little differentiation between quality companies and less-good ones since the outbreak of the Covid-19 pandemic and the related sell-off. It is not unreasonable to expect that companies blessed with long-term stewardship, strong balance sheets and resilient cash flow generation are relatively well-placed to deal with the stresses and uncertainties ahead. The Trust holds many such companies.

Two of the Trust’s detracting investments have been particularly adversely impacted by the pandemic. City Lodge Hotels in South Africa has had a few months of zero revenue as its modest hotels have sat empty during lockdown. Cyient, an Indian research and development provider, has been unpopular as its aerospace customers struggle. These investments have been especially disappointing. Others have been more positive. Vinda International, China’s largest tissue manufacturer, has enjoyed a large increase in demand for its products during the pandemic. Tata Consumer Products has been a positive contributor, having recently become the home of Tata Chemical’s branded consumer products, appointing a new CEO, and improving the performance of some of its core brands.

‘Growth’ investments may have been relatively very popular so far this year, but it is unlikely that their divergence from sound but less glamorous investments will continue unabated forever. We feel it prudent to keep your wardrobe furnished with both well-made t-shirts and well-made jackets.

Portfolio Construction

At the end of June the portfolio consisted of 37 companies. This has risen from 28 at the end of 2019. Whilst there are a greater number of companies in the portfolio, the top ten made up 42.0% of the portfolio at the end of June which is down from 46.4% at the end of 2019. We believe that this still offers an acceptable level of concentration and note that this is far from the maximum of 50 companies envisaged in the Company’s shareholder resolution, passed last December. Cash was 8.0% at the end of the period and remains split between USD and GBP.

Valuation

We are often asked to explain how we attempt to value companies and it makes sense to explain this here given our comments above about the term ‘value’. We follow some broad principles. Use of the word ‘principle’ here is deliberate because it reflects the fact that every analyst in our team will approach this differently and as a process it serves more as a source of debate than it does as a standalone exercise. The most important point is that for those companies which do not meet our strict quality criteria, there is no price we are prepared to pay, given that the downside risk is always 100%. Next, for those which do meet our quality criteria there is a sliding scale of risk associated with relative quality.

Our investment time horizon is long, we attempt therefore to think about valuation on a ten year basis. Valuation for us is an art rather than a science and is most valuable when identifying extremes of over or under-valuation. We don’t believe in decimal points and believe that the fewer assumptions made the better.

We don’t have any crystal balls used to predict the future but our ten year fair market values are largely based around examining corporate histories as far back as we can. We try to use multiple valuation methods to build up an overall picture – the value of different methods varies by country, industry, company, accounting standard and time. There are times when earnings yields are helpful while at other times book value or replacement cost can help.

Portfolio Transactions:

Additions

Reunert is a small South African conglomerate made up of three businesses, a cables business, an office equipment leasing business and an electrical engineering business. It is managed by a committed long-term team and has a strong balance sheet.

Quinenco is the Chilean holding company of the Luksic family with high quality assets in banking, beverages and shipping. The Luksic family have been a conservative and growth orientated steward over a long period.

Indus Motor Company is Pakistan’s largest car manufacturer. It is a 30 year partnership between Toyota and the Habib group. It has remained profitable through various cycles, has historically returned much of this profit through dividends and is financially very conservative.

IndiaMart is India’s largest business-to-business classified website business with a dominant market share and strong cash generation. It has strong growth prospects given current low internet use by small businesses.

Guaranty Trust Bank is a Nigerian bank which has proven itself in two crises in ten years (2009 and 2016) without making a loss and without needing to raise equity.

Square Pharmaceuticals is Bangladesh’s leading manufacturer of pharmaceuticals with a market share double that of its closest competitor. The founding family remain as shareholders and are directly involved in the business.

Mahindra & Mahindra Financial Services is an Indian non-banking financial company. It is owned by Mahindra & Mahindra whose promotor Anand Mahindra has a long track record of good governance and effective capital allocation.

Yue Yuen is the world’s largest shoe manufacturer headquartered in Hong Kong. It is family owned and has Nike and Adidas as its largest customers. It is a cash generative business.

Reductions

Tata Consumer Products is a food and beverages company with a focus on tea and coffee in India.

We mentioned a reduction in the 2019 Annual Report and have continued to reduce in the last six months following strong performance.

Disposals

Coca-Cola Icecek is a Coca-Cola bottler in Turkey. We sold this company on increasing concerns about

a currency mismatch between earnings and borrowings.

Thermax is an Indian engineering company involved in power generation, water and waste management, waste heat recovery and air pollution control. We sold it on valuation concerns.

* Country of listing.

Contribution Analysis

Positive

Vinda International manufactures paper products and personal care products in China and Asia Pacific. It has enjoyed a significant increase in demand during the Covid-19 pandemic. Longer term, we are backing the company to make progress in higher-margin product categories.

Tata Consumer Products is an Indian incorporated food and beverages company with a focus on tea

and coffee. It has continued to deliver on its plans to move into new consumer categories such as food.

Voltronic Power is a Taiwanese business which manufactures and sells uninterruptible power supplies. It has grown market share successfully over the course of the last decade, delivering robust growth in the process.

Coca-Cola Icecek is a Coca-Cola bottler in Turkey, Pakistan and Central Asia. It has experienced a period of strong sales. We sold the position during the period, as discussed above.

Quinenco is the Chilean holding company of the Luksic family. This company has contributed positively to performance but has only been held for a short period.

Top Ten Contributors – 12 months to 30 June 2020

* Company not held at start of period

** Company not held at end of period

Negative

Unilever Nigeria is a local subsidiary of multinational and consumer goods company Unilever. Previous management let receivables get out of control in the last financial year which has affected recent results. The CEO has now been replaced by the parent who have increased their stake in a rights issue. This has left it with a net cash balance sheet. The company is very small in comparison to Unilever’s operations in India and Indonesia – both are countries with similar demographics to Nigeria.

City Lodge Hotels is a hotel chain owner and operator in South Africa and Botswana. Occupancy rates have been directly affected by lockdowns (as discussed above) but we remain confident that the business is resilient based on high profitability prior to the crisis, the long tenure of the management team and the fact that they own the majority of their hotels so are well collateralised.

Cyient is an Indian research and development provider with global clients in industries such as aerospace and transportation. It has been unpopular as its aerospace customers struggle. Despite this we continue to back this company on account of its high quality franchise, continued founder involvement, hard currency earnings and strong net cash balance sheet.

RCL Foods is a South African business generating the majority of its earnings from commodity foods, namely chicken and sugar which are under pressure from imports and which have been oversupplied in the country. Longer term we are backing the company to develop consumer brands in grocery categories. The company is controlled by the Rupert family’s South African investment holding company, Remgro. The family is long term, competent and honest and has a history of incubating good businesses – we invest in Remgro in many client funds.

Delfi is an Indonesian chocolate company. The company has suffered recently due to aggressive competition from local competitors and multinational chocolate brands. It has adjusted its product range and hired external management but progress has been gradual so far.

Top Ten Detractors – 12 months to 30 June 2020

* Company not held at start of period

Glossary

Distortion - A change from an original form.

Price to Earnings Ratio - Used frequently as an indicator of a company’s value. It is used to make comparisons with other companies, or the company’s own historic ratio.

Dividend Yield - A company’s dividend expressed as a percentage of current share price.

Net Asset Value - Net asset value or NAV. The value of total assets less current liabilities.

Net Cash - A company with a net cash balance sheet has a positive cash balance when all its liabilities are set against its cash position.

Stewart Investors

Investment Manager

Tel: 0131 473 2900

PATAC Limited

Company Secretary

Tel: 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

for the six months ended 30 June 2020

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 2019

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 2020

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

Statement of Changes in Equity

for the six months ended 30 June 2020

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

Cash Flow Statement

for the six months ended 30 June 2020

*Cash and cash equivalents represent cash at bank.

The condensed Financial Statements for the six months to 30 June 2020 comprise the Statement of Total Comprehensive Income, Statement of Financial Position, Statement of Changes in Equity and Cash Flow Statement, together with the notes set out below. They have been prepared in accordance with FRS 104 ‘Interim Financial Reporting’ and the AIC’s Statement of Recommended Practice issued in October 2019.

The position as at 31 December 2019 on page 12 of the Interim Report is the same as that contained in the Annual Report and Accounts, which received an unquali?ed audit report and which have been ?led with the Registrar of Companies. This Interim Report has been prepared under the same accounting policies adopted for the year to 31 December 2019.

Expenses include the fee paid to the Company’s investment manager – Stewart Investors who received a management fee equal to 1% of the net asset value of the Company less any reduction owing to the cap on expenses set at 1.5% of net assets. In the six month period to 30 June 2020 the management fee was £193,000 but was reduced to £59,000 owing to the cap (six month period to 30 June 2019 – management fee was £255,000, but was reduced to £157,000 owing to the cap; year to 31 December 2019 – management fee was £499,000 but reduced to £301,000 owing to the cap).

The return per Ordinary share figure is based on the net loss for the six months ended 30 June 2020 of £6,065,000 (six months ended 30 June 2019: net profit of £1,926,000; year ended 31 December 2019: net loss of £3,253,000) and on 53,533,770 (six months ended 30 June 2019: 53,533,770; year ended 31 December 2019: 53,533,770) Ordinary shares, being the weighted average number of Ordinary shares in issue during the periods.

At 30 June 2020 there were 53,533,770 Ordinary shares in issue (30 June 2019: 53,533,770; 31 December 2019: 53,533,770).

Investments in securities are ?nancial assets designated at fair value through pro?t or loss on initial recognition. In accordance with FRS 102 and FRS 104, these investments are analysed using the fair value hierarchy described below. Short term balances are excluded as their carrying value at the reporting date approximates to their fair value. 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 2020 £34,158,000 of the Company’s investments were listed as Level 1, the remaining £2,897,000 were listed as Level 2 (30 June 2019: £45,087,000 listed as Level 1, £nil listed as Level 2; 31 December 2019: £42,395,000 listed as Level 1, £nil 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.

Cash Flow Statement

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 2019.

The Company’s principal risks and uncertainties have not changed since the date of the Annual Report with the exception of the current unprecedented situation surrounding the Covid-19 pandemic. The Board notes that there are a number of contingent risks stemming from the pandemic that may impact the Company. These include investment risks surrounding the companies in the portfolio such as reduced demand, reduced turnover and supply chain breakdowns. The Investment Manager will continue to review carefully the composition of the Company’s portfolio. Operationally, Covid-19 is also affecting the suppliers of services to the Company including the Investment Manager and other key third parties. To date these services have continued to be supplied as normal and the Board will continue to monitor the arrangements.

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 2019. 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:

the condensed set of financial statements has been prepared in accordance with FRS 104 ‘Interim Financial Reporting’ as adopted by the EU;

the Chairman’s Statement and Investment Manager’s Report include a fair review of the information required by the Disclosure Guidance and Transparency Rules (“DTR”) 4.2.7R, being an indication of important events that have occurred during the first six months of the financial year and their impact on the condensed set of financial statements;

the Statement of Principal Risks and Uncertainties shown above is a fair review of the information required by DTR 4.2.7R; and

the condensed financial statements include a fair review of the information required by DTR 4.2.8R, being related party transactions that have taken place in the first six months of the current financial year and that have materially affected the financial position or performance of the Company during the period, and any changes in the related party transactions described in the last Annual Report that could do so.

On behalf of the Board,

William Salomon, Chairman

29 July 2020