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I've added Howden Joinery to the Share Sleuth portfolio*. Little has changed since I put the company on my buy list following the publication of its annual report in April except I have scraped together the cash to purchase a meaningful stake.
To recap: Howdens supplies fitted kitchens. The units are good quality and middle of the range, but not special enough for the average Josephine, or Joe, to insist on. I don't believe the kitchens are the main reason Howdens earns extraordinary returns on capital.
Howdens is special because of the unique service it provides to one particular type of customer: local tradesmen, which I described in April**. It is the way Howdens organises itself to supply small builders, that makes it so attractive.
In deciding to add Howden's shares I've thought most about two risks. The first is the febrile UK economy and the always looming prospect of a house price crash, which would no doubt substantially reduce demand for kitchens, albeit temporarily. I'm sanguine about that, not because I don't think it will happen, but because I don't know when it will happen.
Say I retain the shares in the portfolio for at least 10 years and Howdens share price falls substantially, but temporarily, in that period due to a sudden loss of confidence. Mathematically, it doesn't make any difference to my returns over the holding period when that happens, as long as Howdens and I weather the storm. Since it has strong finances and a profitable business model, I'm confident Howdens would prevail, and so I'm confident I will keep faith in the shares.
I'm not going to waste time in a potentially futile attempt to dodge bullets fired by a scattergun like the economy, so if there's a house price crash or deep recession later this year, or in 10 years' time, c'est la vie.
The other risk is Howdens might fill the UK with depots within my 10-year scenario, in which case it would need to find some other way to grow. Due to its entrepreneurial culture and decade long experimentation with European stores, I think it probably will be able to adapt its business model and establish profitable stores abroad.
When making a new investment I want it to be 'meaningful', which I define as at least one-thirtieth of the Share Sleuth portfolio's current value. The portfolio started with a notional £30,000 in September 2009, but is valued at over £97,000 today and my minimum investment size on Thursday 15 June, when I added Howdens, was £3,223.
Selling one share to buy another is not easy. The purpose of the portfolio is to profit as good companies prosper over the long-term. If I'm constantly trading one company for another because today I think company X might do better than company Y, I won't be executing my strategy, I'll be spending all my time watching prices and I'll be racking up trading costs. I prefer not to trade unless one share is obviously better than another, a judgement, thankfully I can quantify.
The Decision Engine, an enormous spreadsheet that automates some of my investment process, but still leaves most of it up to me, gives Howdens a rating of eight of ten. That means, broadly speaking, I believe the accounting and business model is comprehensible, the business has been profitable for a long time, it's resilient and adaptable, executives act in the long-term interests of shareholders, and the valuation isn't outrageous.
I won't trade unless there are shares in the portfolio rated at least two, or preferably three points lower than the new addition. In other words, there is clear daylight between them.
Ejecting ITE**, rated 5, was the easiest decision. ITE which runs trade shows in Russia, Central Asia and other mostly less developed countries, could be a great recovery stock. International trade shows are not particularly risky business ventures as they are largely funded by exhibitors in advance.
If demand contracts, shows contract, but the organiser remains profitable because it employs fewer people and rents less space. This has happened in Russia and Central Asia due to the collapse in the oil price and the recession and currency weakness that followed. Geopolitical instability has been a hindrance too.
ITE's response though, to buy events in other parts of the developing World has left it with substantial borrowings and shows that are not growing as fast as it expected. The finances are weaker than when I added the shares, the strategy is more constrained (I don't believe it can borrow much more), and the chief executive and finance director have moved on. ITE no longer meets, to use a much-overused phrase, the 'strong and stable' criteria of the Decision Engine.
The portfolio has grown while its shareholding in ITE has decreased in value, so selling ITE did not raise enough to fund Howdens.
Like ITE, Renishaw is rated 5 by the Decision Engine, three points below Howdens' 8. I could have easily sold the portfolio's entire holding and raised more than enough money. However, Renishaw is ranked lowly through no fault of its own and I'm in no hurry to eliminate my interest in the shares.
Renishaw makes machine tools and robots for factories mostly (but also surgical operating theatres, for example). I added the shares at a relatively low price during a sell off. Renishaw was unable to sustain revenue and profit after a windfall the previous year from a contract to supply machine tools reportedly for the manufacture of the iPhone 6.
Renishaw, which exports almost all it produces, has been a beneficiary of the weak pound, but its share price has doubled in the last six months, partly because of sightings of Renishaw logos in newly tooled factories rumoured to be producing the iPhone 8.
Once again, Renishaw could make a bumper profit, but the rumour mill has also put this fashionable share on a staggering valuation (the enterprise is valued at about 43 times adjusted profit in 2016). I reduced the portfolio's holding to the minimum meaningful holding size of about £3,200.
The ejection of ITE and the reduction in Renishaw still left me short and looking to Air Partner, also ranked 5, for the rest of the money. Air Partner, which primarily charters planes, has acquired other businesses so it can act as an agent in sales and purchases of planes and leases, and provide broader services like safety audits and training.
The company has recently published its annual report, which I will write up soon, but I have increasingly mixed feelings about the charter business and the diversification strategy.
I didn't need to sell all the shares to fund the Howdens purchase so I kept some in the portfolio. However, that decision leaves me with mixed feelings too. As the rump of Air Partner shares is worth less than my minimum meaningful size, I'm wondering why it's there.
Maybe I should have just got rid of them all in one go!
*Share Sleuth is a virtual portfolio. See the Share Sleuth portfolio page at Money Observer: http://www.moneyobserver.com/share-sleuth-portfolio
**See: 'Why Howdens is on this buy list': http://www.iii.co.uk/articles/405701/why-howdens-buy-list
***I promised I'd eject ITE in February, see 'Bargain Share or Certain sell?': http://www.iii.co.uk/articles/389718/bargain-share-or-certain-sell
Contact Richard Beddard by email: [email protected] or on Twitter: @RichardBeddard
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