Artemis UK Smaller Companies Fund update

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

The Artemis UK Smaller Companies Fund made 1.4% in the third quarter of 2024, compared with 5.1% from its Deutsche Numis UK Smaller Companies (-InvTrust) benchmark and a loss of 0.4% from its IA UK Smaller Companies sector average.

UK small caps got off to a promising start during the quarter, with the strength of the market in July meaning many stocks rallied despite a lack of any meaningful news. Specialist lender Vanquis even rose on bad news – up 9% in the month – despite announcing £40m in one-off impairments.

This reflected improving sentiment towards the UK, after the general election produced the expected result and initially suggested we could look forward to a period of relative political stability against an uncertain global backdrop. More recently, investors have become circumspect. The new government’s downbeat tone as it blamed the Conservatives for leaving a ‘black hole’ in the nation’s finances appears to have dented consumer confidence and affected investor fund flows into UK markets.

We believe the Bank of England’s first interest rate cut of the cycle was significant, but it may take further reductions (easier now that inflation is back at target) and the sight of the 30 October Budget for consumers, businesses and investors to gain confidence.

Positives

We have spoken before about a potentially transformative contract win from Beeks, which provides cloud computing services to the financial sector. Following advanced progress on this contract, including SEC approval, the stock rose by 47.9% during the quarter.

Elsewhere, engineer Keller and cyber security company NCC rallied on strong earnings updates. LBG Media (owner of LADbible) saw significant gains despite only trading in line with expectations, although its first half was much stronger than the equivalent period in 2023.

We also benefited from avoiding a couple of stocks that fell by more than 40%: pharmaceutical Indivior and engineer John Wood Group.

Negatives

Consultant Next 15 (-47%) fell by more than 40% after an equivalent drop in earnings caused by the early termination of its largest customer contract. This was a known risk but not one that we were expecting to be called on so early. The valuation still stacks up and as a holding company of a dozen largely independent businesses, the loss of a contract in one (Mach49) should not affect the underlying performance of the others. We added to our position.

TT Electronics fell by more than 30% on a profit warning. While the manufacturer has booked some strong orders from US customers, these are for delivery in 2025. Low manufacturing yields at one US facility and a problem sourcing a specialist component at another resulted in a 30% hit to profits. While the shares look cheap, we are waiting to see whether these issues can be solved before we decide what to do with the position.

Ticketing technology company accesso downgraded profits by 18% following delays in a Saudi Arabian project and lower transaction volumes. We bought more stock on the fall.

Finally, marketing consultant Ebiquity announced a profit warning as some customers cut spending. 

Activity

We bought back into record-management company Restore after a series of earnings downgrades over the past couple of years caused the shares to halve in price, leading to the departure of its management team and the return of its previous chief executive.

Restore is the second-largest document storage company in the UK (it currently looks after more than 22 million boxes at £4 each per annum) with more than 20% market share. The boxes, including documents such as medical records, legal files and financial services records, are typically held for many years, providing Restore with sticky long-term recurring monthly cashflows which we value highly. Acquisitions in adjacent markets have been unsuccessful but have not damaged core cashflows. The returning chief executive is taking the group back to its box-storage roots.

Victorian Plumbing is an online category killer in bathroom and plumbing products. While we met with its management at IPO in 2021, it was difficult to quantify the extent to which the business model had benefited from lockdowns, so we decided to pass. But following a nasty profit warning in 2021 and with the share price at 60% below the IPO price, we now feel the current valuation looks attractive. Victorian Plumbing has a 70% share of the online market (which is still only 30% penetrated), while a major new distribution warehouse should solve capacity problems, resulting in additional sales, greater efficiency and operational gearing.

Following share-price weakness, we added to positions in translation services provider RWS, travel agent On the Beach, and SSP, which operates food & drink outlets at transport hubs.

Outlook

We expect a change in rhetoric after the Budget. Like new management kitchen-sinking investor expectations ahead of a new growth plan, we think the post-Budget government narrative will likely be more geared towards economic growth and improving consumer confidence. We expect this to play to our overweight positions in many lowly valued but market-leading niche consumer companies (examples include Moonpig, Dunelm, DFS, Jet2 and Hollywood Bowl).

There has been much speculation about which taxes will be raised to plug the 'financial black hole'. A concern for small-cap investors is that the current inheritance tax relief for investors in AIM shares could be cut.

We have about 27% of our fund invested in this part of the market and while there is the short-term risk of a knee-jerk reaction if the benefit is reduced or removed, we are confident that our AIM holdings could easily transfer to the main market as Alpha Group did earlier this year (Gamma Communications is currently considering this option). The tax concessions enjoyed by our AIM holdings have not led to them trading on premium valuations, so we do not expect to see any long-term loss of value. The AIM index has already underperformed materially so far this year, suggesting some of this risk is already factored into share prices (and we would see further weakness as an opportunity for investors who share our three- to five-year time horizon).

The UK remains at a discount to Europe and the US, with small caps cheaper still. We believe UK consumers are relatively well placed, having yet to spend the savings built up through Covid, and the macro outlook is better than widely perceived. Without an unforeseen shock, we see an enticing prospect of a simultaneous recovery in consumer, business and investor confidence. The impact on an out-of-favour UK small-cap market could be material.