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Investors’ Chronicle: Treatt, Virgin Money, Vertu Motors

BUY: Treatt (TET)

Healthy living and trends towards higher-end products are driving the company forwards, with strong revenue growth across in most categories, writes Christopher Akers.

Treatt’s shares plunged by more than 7 per cent as it announced a fall in pre-tax profits. But the company, which manufactures and supplies natural extracts and ingredients for the beverage, flavour and fragrance industries, raised the dividend by a quarter and said that the order pipeline would help drive revenue growth of more than 15 per cent for the full year.

It looks like the market may have overreacted to the profit drop, given that the comparative period benefited from pandemic-driven retail growth. Profits at Treatt are historically weighted towards the second half, and these results represent a return to the norm. The company confirmed that it expects profit before tax and exceptional items to be about £21.7mn for the year, in line with consensus estimates, which would be a 4 per cent uplift on last year.

Treatt’s healthier living categories continue to benefit from the increasing consumer and societal focus on health issues around, for example, sugar. Fruit and vegetable sales were up by 7 per cent and health and wellness by 10 per cent. Tea was the one disappointment, collapsing by 41 per cent against a tough comparative, which included product launches.

But the standout performers in the first half came from other categories. Herbs, spices, and florals revenue was up by 23 per cent and synthetic aroma sales jumped by a fifth. Management said that it expects the healthier living categories to “deliver both revenue and margin growth” in the second half.

The company is also taking advantage of consumers’ willingness to pay more for high-end products. This is apparent in the citrus category, the company’s revenue driver which took 47 per cent of total sales in these results, with the strategy of moving “away from minimally processed citrus towards more value-added ingredients” driving 15 per cent revenue growth. Treatt has also invested in premium coffee extracts, and has secured contracts and orders of about £2mn.

Peel Hunt analysts said the profit posting, up by 30 per cent from 2020, “demonstrates the strong progress being delivered in sales and margins”. The house broker has the shares trading at 35 times forward 2022 earnings, which it expects to fall to 32 times by 2024. This may look high, but with material opportunities in China and the US and the order book up by more than a quarter, we don’t think it looks too demanding. We stick with our recommendation despite results day volatility.

HOLD: Virgin Money (VMUK)

Rising interest rates and credit card spending boosted Virgin’s results, with a faltering economy sowing the seeds of doubt, writes Julian Hofmann.

Virgin Money has made a great deal of progress over the past few years in building its regulatory capital and returning sustainable cash flows to the business. Against the backdrop of rising interest rates rebuilding margins for the banking sector, along with a notable rise in unsecured lending, Virgin has fared better than many had forecast. However, the share price attrition over the past 12 months suggests that there are doubts over the resilience of the bank’s profits at a point when the economic picture is darkening.

Under normal circumstances, a rise in lending would not draw much attention — Virgin Money is a bank, after all — but the fact that unsecured lending was the only category to see significant growth says something about the finances of ordinary consumers. Anecdotal evidence suggests that consumers, having now spent their lockdown savings, are starting to use unsecured lending to bridge the gap on massive price rises for everyday essentials.

In these results, borrowing on cards and short-term loans rose by 7 per to £5.8bn, while business lending declined, and mortgage lending was essentially flat at £57.8bn. It still looks like it will book lower levels of impairment this year; the impairment charge fell by £25mn to £479mn in these results.

The essentially uncertain economic outlook was the reason for the bank’s cautious outlook for net interest margin this year of between 180-185 basis points, though this is a small upgrade, and management could not offer any further rallying cry beyond being “prudently provisioned.” Core tier one capital, a measure of its capital ratio, was 14.7 per cent, though Virgin aims to operate within the range 13 to 13.5 per cent. The excess capital will be determined at an annual stress test and will probably be used to guarantee its 30 per cent of dividend pay out ratio.

Trying to work out Virgin Money’s place in a unloved banking sector is not difficult. Under the circumstances, management has done well to reposition the balance sheet and restore shareholder income, but the lowly forward price/earnings ratio of four times consensus forecasts for 2022 tells its own story. With dividends back in play, the shares will receive support, but there is no compelling reason to change our view considering serious headwinds ahead for the whole sector.

BUY: Vertu Motors’ (VTU)

Revenue jumped as supply shortages bumped up prices, but the cost of living crisis could potentially hit demand, writes Christopher Akers.

Vertu Motors’ revenue soared as the car dealer benefited from higher prices due to the global supply chain issues hitting vehicle production. Investors will also be pleased with the reinstatement of the final dividend and a gross margin of 12 per cent, up 110 basis points from the pre-pandemic posting.

The average selling price for used retail vehicles (the company’s main revenue driver with 44 per cent of total sales) rose by 19 per cent to £17,376 in the year as semiconductor shortages continued. The Society of Motor Manufacturers and Traders’ latest car registration data underlines supply chain travails well. April year-to-date diesel registrations were down by 51 per cent and petrol by 17 per cent. Electric vehicles (EVs) and plug-in registrations “are the one positive among the gloom”, as LeaseLoco’s chief executive John Wilmot recently noted, with battery EV registrations up by 88 per cent.

Vertu is taking advantage of the wider EV trend. Electric and hybrid like-for-like sales were up by more than 170 per cent. The company gained the MG franchise in the year, with three outlets operating and two more planned (management is very keen on MG’s EV offering).

But the impact of the cost of living crisis on the outlook remains to be seen. Chief executive Robert Forrester said that used car prices have fallen over the past three months by around 2 per cent a month — this should provide some relief to consumers and help maintain demand.

House broker Zeus Capital has the shares trading at only six times their 2023 earnings forecast and argues that Vertu is undervalued — with the share buyback programme continuing and a robust net tangible assets position, we don’t think this is too wild a suggestion.

Chris Dillow: Snake oil salesmen and fund managers

So far 2022 has been a bad year for active fund managers. Only 42 of 243 funds in Trustnet’s database of all companies unit trusts have outperformed L&G’s UK index tracker fund (which tracks the All-Share index) and 18 of these are other trackers, mostly of the FTSE 100.

There’s a simple reason for this. The All-Share index has been pushed up by big rises in a few huge stocks such as Shell, BP and AstraZeneca. Most shares have underperformed the market, which means that so too have most funds.

This continues a long-term pattern. When big stocks beat the market most active managers underperform, as happened in 2016 and 2018. And when big stocks underperform but most shares outperform, active managers do well; this happened in 2017 and 2019. The average active manager doesn’t beat the market except when conditions are in his favour.

We have lots of evidence that active management doesn’t work — hence Warren Buffett’s claim that he would trust monkeys to pick shares rather than financial advisers.

So why is it still big business?

A precedent can help. Active funds aren’t the only products that have remained big business despite being of dubious utility for customers. In the US in the 19th century, the market for patent medicines grew for decades even though most were useless. Some of the reasons for that growth might help explain why there is still demand for active funds.

One is that people don’t adequately distinguish between skill and luck. Some people who took patent remedies would have got better anyway but they ascribed their recovery to the medicine.

Investors often buy funds that have done well in recent months even though such short-term performance doesn’t predict future outperformance. They don’t see that some funds will outperform simply by chance.

Another reason why patent medicines thrived was that people didn’t know, or didn’t trust, the advice of medical science — just as investors today don’t know or don’t trust economists’ advice to avoid active managers.

It’s true in part that economists, like 19th century doctors, don’t know much. But it’s also based on wishful thinking. The advice of 19th century doctors was often that the patient’s ailment was incurable. Faced with such a diagnosis, why not try a quack remedy? Similarly, faced with economists’ advice that we are destined for low returns, why not take a punt on beating the market?

Yet another trick snake oil salesmen used was product differentiation. While some remedies stayed on the market for decades, there was also a steady stream of new ones. This meant that customers who were dissatisfied with the failure of one remedy had many others to choose from. In the same way, not only are there hundreds of funds to buy, but also waves of new ones trying to exploit new fashions such as small-cap funds in the 1980s, TMT ones in the 1990s or ESG ones today.

Patent medicines also benefited from a growing market. Patients who weren’t cured by one remedy switched to others, while people were getting ill with new ailments every day. Similarly, with savers no longer annuitising their wealth they are staying invested in funds late in life, while people needing to save for their retirement create new demand.

Of course, there are differences between snake oil sellers and fund managers. One is that whereas patent medicines were often cheaper than the remedies offered by respectable science, actively managed funds are more expensive than the tracker funds favoured by experts. Offsetting this, however, is the fact that active managers have an advantage over quacks. Whereas customers could tell quickly that snake oil didn’t work, the failure of active management is harder to spot unless you go to the trouble of comparing the funds you bought to the trackers you did not over long periods.

The story here, however, is not just about active managers but markets generally. We instinctively believe that competition drives out bad products. And often it does. The history of patent medicines, however, tells us it does not always do so. Instead, we must ask: what are the mechanisms where some products are selected for, and some against? Sometimes, the mechanisms select in favour of inferior products. Whether this is true in areas other than quack remedies or fund management is, however, another story.

Chris Dillow is an economics commentator for Investors’ Chronicle

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