Artemis UK Select Fund update

Source for all information: Artemis as at 30 June 2024, unless otherwise stated.

• The fund continued to build on its long-term record of outperforming both its peer group and the wider UK market.
  
• Holdings in NatWest and Mitchells & Butlers were among this quarter’s strongest performers.
• We added new holdings in Plus500 and the National Grid; we sold Crest Nicholson.
  
   

Performance 

The UK market edged higher over the quarter, aided by M&A activity and by positive news on the economy. With a return of 4.3%, the Artemis UK Select Fund performed slightly better than both the index (up 3.7%) and its peer group (up 3.9%).

That capped off a strong start to the year for the fund in both absolute and relative terms: over the first half of 2024, it returned 14.4% versus 7.4% for the FTSE All-Share index and 6.9% for its peer group.

Contributors

NatWest (up 17%)

Like Barclays (which the fund also owns), NatWest continued to perform strongly as its first-quarter results came in ahead of expectations. Those results highlighted an increase in net interest margins (NIMs) and showed that impairments in its loan book remain benign.

Mitchells & Butlers (up 26%)

Modestly better like-for-like sales and easing in inflationary pressures underpinned a strong set of results for Mitchells & Butlers. Its operating margins increased to 11.7% while its operating profits came in at £164 million versus expectations of £130 million. Cashflows were materially better than expected, with the result that its balance sheet is stronger today than at any point since the global financial crisis. We expect further strong momentum through the summer as our original investment thesis – that the strongest operators in the hospitality sector will grow even stronger as weaker players exit – continues to play out.

Oxford Instruments (up 16%)

Earlier this year, there were fears (which we didn’t share) that Oxford Instruments would warn that weaker spending by its customers in the semiconductor and life science industries was having a detrimental impact on sales. So, when its trading statement dispelled those worries, its shares rallied, more than recovering the ground they had lost in the first quarter.

3i (up 10%)

A statement accompanying 3i’s AGM confirmed that Action, the European discount retail chain which is its largest investment, continues to trade strongly. There was also news that Action would increase the size of its refinancing from the debt markets as it re-gears the business to reflect its higher profits. This re-gearing should result in a significant dividend being paid to 3i.

GSK (not held; down 10%)

We run a focused portfolio of around 45 names. As a result, companies we don’t own sometimes have a significant impact on the fund’s relative returns. This quarter, we benefited from not owning underperforming market heavyweight GSK. It was hit by news that a court in Delaware would allow expert witnesses to present scientific evidence in the ongoing litigation around Zantac; some 70,000 lawsuits allege that the heartburn drug may increase the risk of cancer. In a further blow to sentiment, the US United Food and Drug Administration (FDA) narrowed the patient recommendation for GSK’s blockbuster RSV vaccine Arexvy.

Detractors

Melrose (down 18%)

Shares in aerospace group Melrose fell sharply after Airbus, one of its major customers, cut its production targets due to issues elsewhere in its supply chain. We spoke to Melrose after the news and, although it is certainly unhelpful, it is far from terminal. The delay in delivering new planes will result in older aircraft remaining in the skies for longer. In the short term, that will lead to an increase in Melrose’s sales of spare parts, a business where margins are attractive. The demand for civil aircraft has not diminished and we still see many years of sales growth ahead.

Ryanair (down 21%)

Ryanair’s share price fell sharply in response to some cautious comments on summer trading. That caution appeared to stem from weaker-than-expected demand for mid-week leisure travel and ‘shoulder season’ sun routes; the company is not certain whether this is a trend or blip. Our guess is that we are seeing a normalisation in consumer travel patterns after the post-Covid ‘revenge spending’ seen in recent years. Meanwhile, the capacity constraints across the European short-haul routes that Ryanair had anticipated have not been as severe as expected for two reasons.

1. Airlines are keeping their planes flying for longer (as an aside, this is good news for two of our holdings: Rolls-Royce and Melrose, both of whom make good money selling spares needed to keep older aircraft flying safely).
2. Aircraft leasing companies have been shifting global capacity to the European market, where returns are high.

The fall in Ryanair’s shares highlights how short-term the horizons of many investors have become, with a narrow focus on short-term earnings and share-price momentum. At current levels, we see significant long-term value in Ryanair and have added to our holding.

WH Smith (down 15%)

Interim results at WH Smith were in line with expectations, its earnings guidance was unchanged and its UK travel business showed better-than-expected progress. The problem was that its profits in the US were flat. The market regards the US as the company’s medium-term growth driver so its weaker performance there weighed heavily on the shares. Our expectation is that sales momentum in the US will recover and, in the meantime, it continues to de-lever its balance sheet. We believe the company can return to its old model of progressive dividends and share buybacks. We therefore used to the proceeds from the sale of Crest Nicolson (discussed below) to add to our holding.

Activity

We initiated a new holding in Plus 500

Plus 500 is a business we have followed for a long time and one that our colleagues who manage the Artemis Alpha Trust know well. We believe the global expansion of its cash-generative CFD business represents a significant growth opportunity. This part of its business makes circa $200-250 million per annum in years when volatility is low; that has the potential to double in years when volatility is high (typically at times of market stress). This makes Plus 500 a useful portfolio hedge against volatility in financial markets. It has around $1 billion of net cash on its balance sheet and a strong record of growing dividends and returning cash to its shareholders through share buybacks. Its US futures business appears to be making strong progress and, given the popularity of self-trading in the US, this would appear to be a huge market for it to tap.

We started a new position in National Grid

We used a period of weakness in National Grid’s share price around a rights issue as an opportunity to establish a holding. The money raised by the placing will enable it to double the pace of investment in its electricity transmission networks in the UK and US. Both countries are looking to upgrade their grids to enable the increased use of renewables and to support the electrification of their economies. At present, the focus in the UK and the US has moved away from keeping customer bills down to enabling investment needed to support the energy transition. In our experience, the best time to own a regulated businesses is when the regulator is looking favourably on investment.

We added to Flutter on technical weakness

Earlier this year, Flutter’s shareholders voted in favour of a proposal to move its primary share listing from London to New York. One result was that index funds mirroring the composition of UK market became forced sellers, sending its share price lower. Trading at Flutter’s underlying businesses such as FanDuel remains strong and, in time, the shares should receive support from US tracker funds as they are included in US market indices.

We funded our purchase of Plus 500 by reducing M&G

M&G’s latest results gave us no cause for concern and it continues to generate a useful dividend yield. It is, however, having to run hard to stand still. Its high exposure to managing credit funds for pension schemes could become a drag as a growing number of defined-benefit pension funds transfer risks to insurers through buyouts.

We reduced our holding in Ashtead

Ashtead, an equipment hire company, has been a beneficiary of the recent boom in government spending in the US. Investors are increasingly questioning whether the current pace of deficit spending in the US is sustainable; those questions will only get louder as we get closer to the election.

We sold a small holding in housebuilder Crest Nicholson

The union between Barratt and Redrow and the rumoured sale of Cala by Legal & General has re-focused attention on the potential for consolidation among UK housebuilders. Crest has a large land bank and trades at a significant discount to book value. But it is also accident-prone… Historic issues surrounding build quality, cladding and problematic sites have repeatedly come back to bite it over recent years. Fixing these issues is absorbing the majority of its cashflow, leaving little room to invest in and grow the business or to pay a meaningful dividend. We now prefer other companies in the sector: Redrow, Vistry and Morgan Sindall.

Outlook

The outcome of the UK general election was largely as the polls had predicted. Thoughts now turn to the question of whether the new government can, as promised, deliver stability, end the political drama that has characterised much of the last decade and improve UK economic growth in the medium to long-term.

If it is to avoid getting trapped in a doom loop (no growth leading to spending cuts and higher taxes) the new government needs to get the economy moving. To do this it will need to pull the lever on low-cost policies that can boost both consumer and corporate confidence. Planning reform has been highlighted as one early focus.

In terms of kickstarting growth, the new chancellor may find she is pushing against an open door. With real wage growth strong and consumer confidence improving sharply, we continue to see the UK economy accelerating through the second half of 2024.

After the political turmoil of recent years, a period of calm is likely to be welcomed by UK plc. It also has the potential to capture the attention of international investors: the UK economy appears to be putting its brief flirtation with populist policies behind it just as some other Western economies are heading the other way. Given political instability elsewhere in the world, the UK might suddenly go from being viewed as a basket case to a relative safe haven.

At a fund level, we remain encouraged by the trading performance of the companies we invest in. We believe there is a significantly greater-than-normal number of mispriced stocks in the UK market. This is reflected in the modest earnings multiple on which the fund trades: our portfolio trades on a price-to-earnings multiple of just 9.3x versus 11.3x for the broader UK market. Meanwhile, over half of the companies in the fund by value are buying back shares, with IAG the latest company to join the list.

Having been in the relative wilderness for the best part of a decade, we are hopeful that the changing narrative on the UK economy – particularly at a time of increased uncertainty elsewhere – will provide the catalyst for the UK market to finally start to close the valuation discount to its global peers.