Keep holding these shares for the future

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Keep holding these shares for the future

Good companies don't always perform as well as their shareholders would like, but long-term investors will not remain long-term shareholders if they sell out whenever there's a problem. Sprue Aegis (SPRP) and Next (NXT) have problems, as their recent half-year results demonstrate. I don't think it's time to ditch them yet, though.

Sprue Aegis

The good news is Sprue Aegis is growing more profitable again after 2016's calamatous result. The bad news is, its reports raise more questions than answers. This month's half-year results are no different.

Two years of living dangerously

Sprue's difficulties started in 2015 when a fault in some of its popular FireAngel smoke alarms meant a proportion of them would have to be replaced. The problems continued in 2016 when demand from Continental Europe, where Sprue earns the bulk of its revenue, more than halved.

Provisions made by the company are covering the warranty claims so the direct cost may be contained, but the damage to Sprue's reputation is not so readily quantifiable.

The collapse in European revenue exposed Sprue's susceptibility to extreme fluctuations in demand when new legislation mandates smoke alarms. For the first time every French household had to have a smoke alarm in 2016. Once the French had bought their alarms, Sprue's over-stocked distributors could no longer shift them and orders dried up.

The company says that although Germany is currently legislating the boom-bust effect is likely to be muted as different states are passing lawsa at different rates.

Silence on SONA

Apart from being name-checked in its list of brands, there's no mention of SONA in the half-year results, the trade only brand Sprue launched in December 2015. That year it devoted the cover of its annual report to SONA but I've hunted hopefully for news of it in subsequent reports and announcements. It's absence makes me nervous. Sprue was much more voluble about SONA before it's launch than it has been since, and I wonder whether the brand is flopping and what that might mean for the capitalised development costs on Sprue's balance sheet.

Connected homes

Sprue's keener to talk about the next big thing, which is connected products, gizmos that work together and can be controlled and monitored by smartphones whether you're at home or not. It's bought the software, source code and development rights from its software supplier, and plans to roll out connected safety products across Europe. The market is in its infancy, though, and burgeoning new entrants as startups and established technology companies join the fray. There's no guarantee Sprue will be a market leader.

Sticking with Sprue

So why Stick with Sprue? The Decision Engine sets my concerns against the facts that attracted me to the company in the first place. It's an inventive cash-rich business with market leading products protected by over a hundred patents that were, for ten years before 2016, highly profitable.

The expectation is those qualities will prevail, particularly because a number of executives who grew Sprue from a startup in 1998 into Europe's leading smoke alarm supplier are still with the company. As major shareholders they remain doubly concerned with its prosperity.

Good companies don't always perform well, and long-term investors need some way of accommodating their doubts when companies fall short. Mine is to hold unless I no longer believe the original qualities I identified are true.

While the problems relating to reliability and vacillating demand are dramatic and serious, I think they're unlikely to repeated to the same extent in future.

Recent events have put Sprue on the brink, in fact just over it. The Decision Engine gives it a mediocre score of 5/10. It's in the red-zone by fraction of a fraction, but I'm clinging on.

Next

I'm conflicted about Next too, which also scores 5 out of 10. On the face of it the business has an outstanding record of profitability, the shares are cheap, management experienced and committed, and I like the product: Bright, tidy, efficient, everyman/woman clothes shops where you're not expected to select items in the dark, or wear noise-cancelling headphones to block out the aural bombardment from the store's soundtrack.

On the other hand, it's two connected businesses. A High Street chain that is still very profitable, but less so. And a growing online business that already earns more profit than the stores. The likely net effect this year, though, is for profit to fall, as it did in 2016.

The half year results, in which Next revealed profit probably won't shrink by as much as it previously thought has emboldened traders, but the long-term outlook isn't any clearer.

I have two big worries to set against the many good things about Next. The first is competition. Next is being run for profit. The profit margins in its online business are much higher than celebrated, listed, online fashion retailers like ASOS (ASC) and Boohoo (BOO). They're maximising revenue, a bit like Amazon (AMZN), in the expectation of grabbing a big share of the market, and the custom, particularly, of young people. I don't know how long they're prepared to sacrifice profit for growth, or Next can sacrifice growth for profit.

The second thing is what happens when young ASOSers and BooHooers grow up? Do they discover Next? Or do they stay with the brands they loved as teenagers and twenty somethings?

There are experienced people grappling with problems like these at Next. I'm holding not just because of what they've achieved in the past, but because of what they might still achieve in the future.

Coming soon

Alumasc (ALU), Finsbury Food (FIF), and FW Thorpe (TFW) have recently published full-year results. These are usually incomplete accounts of a firm's performance and financial condition, so I will wait until the annual reports are published, probably in October before I update the Decision Engine.

Recently I've reviewed the annual reports and investment cases of Cohort (CHRT) (a good investment), Renishaw (RSW) (trying to hold forever), Goodwin (GDWN) (not a straightforward rebound story) and Dart (DTG) (unruffled by decline in return on capital). 

As always, I've fed the data and information into the Decision Engine which ranks them according to five factors. The most highly rated businesses are easy to understand; resilient and adaptable; profitable through thick and thin; and managed in the long-term interests of all shareholders. A good long-term investment should also be reasonably priced.

There are five criteria in total, so each share can score up to 10. Here are the current scores for the companies I'm following most closely:

If I hold the shares in the Share Sleuth model portfolio, the extent of the holding is indicated too.

Contact Richard Beddard by email: [email protected] or on Twitter: @RichardBeddard

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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