here we go marching again… · here we go marching again… welcome to the first few weeks of...

HINDESIGHT DIVIDEND UK LETTER / FEB 17

Mark Mahaffey Ben Davies

1

Aalok Sathe

HERE WE GO MARCHING AGAIN…

Welcome to the first few weeks of Donald Trump’s presidency. There are so many headlines, tweets and images, the media networks are having a field day. We will not be short of news for the foreseeable future, it would appear. In the UK, we are well used to campaigning politicians promising the earth on their election trails, only to conveniently forget about them upon taking office. There was an assumption that many of Donald Trump’s outrageous campaign promises would face the same fate, but we should remember that he is not a life-long politician and has never held a government job. The old rules don’t apply to him. Who knows, maybe he says and does what he actually believes; pretty unique for a politician, no matter how sensational it might appear.

Last week’s adjustment to the Doomsday Clock to 2.5 minutes to midnight, the closest since 1953, was not welcome sensational news. The Clock represents how close we are, in the Bulletin of the Atomic Scientists’ opinion, to a global catastrophe. Since its inception in 1947, it has focussed primarily on the risk of nuclear Armageddon, but climate change has been taken into account since 2007, as well as the potential political climate. It is no surprise that the end of the Cold War in 1991 signalled the furthest point (17 minutes) from midnight. Unfortunately, the outcome of the twice-yearly meeting has had to take President Trump’s policies on nuclear weapons, climate change and the rise of the popular vote into account, which led to the first ½ minute adjustment to the clock, taking it back to a level that was last seen in the early days of the nuclear age where war seemed imminent.

FEB 17

“Democracy is a charming form of government, full of variety and disorder, and dispensing a sort of equality to equals and unequal alike.”

― Plato

HINDESIGHT DIVIDEND UK LETTER / FEB 17 2

As I write, the media is reporting on the chaotic scenes seen at US airports, sparked by the executive order to prevent incoming passengers from seven predominantly Muslim countries. Last week, the headlines were about the President’s announcement of plans to start building the long-discussed border wall with Mexico.

‘America first’ was one of Trump’s campaign slogans. With that slogan, the potential age of globalisation, which may be traced to the collapse of the Berlin wall in 1989, appears to be coming to an end, not just with regards to the US.

Borders and fences are being erected everywhere; soon Europe will have more physical barriers on its national borders than it did during the Cold War. According to a recent report, there were 16 border fences around the world in 1989. Today, there are 65 that have been either completed or are under construction.


They include:

• India’s 2,500-mile fence around Bangladesh • Morocco’s huge sand ‘berm’ minefield • Israel’s ‘apartheid wall’ between Israel and the West Bank • Saudi Arabia’s wall with Yemen • Kenya’s wall with Somalia

These are only the lesser-known border fences, as there are also European walls in Macedonia, Hungary, Serbia, Norway and Greece. The list goes on. Apparently, factories that provide barbed wire and fence materials in Europe are being inundated with purchase orders and working 24/7 to fill demand. Whether we are building walls to keep out ‘drug-dealers, rapists and criminals’, as the Donald tells us, or this is a desperate attempt to stem the flow of migrants, it is a thriving business to be in right now.

This may come as a surprise to many people, but what is going on is a revolution – a populist revolution. It is still early but it has all the hallmarks of revolution:

Think 1792 France, 1917 Russian, 1933 Germany, 1979 Iran and so on. As dramatic as that sounds, only a time-traveller can say for sure how this will play out, but the same tinderbox from history has re-emerged. The people, the masses, the majority – however you label them – have been pushed too far and are revolting by voting for Brexit, Trump and Le Pen. Who knows where it will end.

In the last few decades, most especially post-Cold War, we have embraced globalisation as a generally positive force. New cheap labour has benefitted developed nations, as well as emerging nations. With that globalisation, we have seen more immigration and the opening of trade barriers. The well-known wars fought in the Middle East and Afghanistan, as well as numerous terrorist instances, have largely been accepted and overcome. Unfortunately, there has been a shift in power during this time, according to John Sullivan, a former editor of National Review:

‘… away from elected and accountable bodies such as Parliament, to semi-independent bureaucratic agencies that make their own laws (called regulations), to the courts, and in more recent years to European and other transnational bodies. Liberal progressive elites at the top of mainstream political parties went along with this shift in power. It helped them to ignore the apparent wishes of the voters. (Does anyone really think that UK MPs represent the views of their constituents? No wonder most were blindsided by Brexit). They did so by the simple expedient of not discussing these wishes by keeping them out of politics. Immigration and ‘Europe’ are examples. Over time, majorities ceased to be the dominant decision-makers and became merely one player in the system. Majoritarian democracy mutated into a system that the Hudson Institute’s John Fonte calls post-democracy, in which elites and the institutions they control increasingly exercise more power than the voters and their elected representatives.

The Gini Coefficient was developed in 1912 by Corrado Gini as a method of measuring inequality of income. 0=when all people earn the same, 1=one person earns all the money. The steadily rising ratio in the US and many other developed nations underscores the growing inequality.

And there you have it, the people have said ‘ENOUGH’. They want less immigration, especially if it comes as a direct threat to their way of life, and they don’t want a self-serving bunch of liberal elites exercising power to enrich the few at the masses’ expense. Most people will think revolution is far too strong a term for this upsurge in the populist vote, but history tells us that we should never ignore the whipped up fever of the suppressed masses by a new leader. One of the concerns I have is of the tendencies of cycles to overshoot.


‘25 hedge fund managers make more money than all of the kindergarten teachers in America combined... half of American adults have been completely shut off from economic growth since the 1970s. Approximately 117 million people earn, on average, the same income that they did in 1980, while the typical income for the top 1% has nearly tripled.’ – New Yorker magazine

Your typical cycle, whether it is a business cycle, a cycle of regulation or an asset class cycle, tends to boom, bust and overshoot either way, rather than remain at fair value. The current manic wave of regulation that is being employed by the unelected agencies above is a clear overshoot of the lunacy we have written about before. We know that the current regime of increased policing in the name of regulation is increasing costs and suppressing business growth, while its merits are harder to observe. In time, this 180-degree overshoot will reverse and we will no doubt revert at some time to an ultra-lite period, similar to 2007, and the age-old problems will surface again. Logic, rationality and common sense, which should keep any cycle muted by oscillating around fair value, invariably go absent for long periods.

The cycle of society rule has theoretically alternated from the style of the single ruler, monarch or dictator holding power over the masses by force, and the middle – a more open ‘democratic’ society where the majority believe they decide what’s in society’s best interest. Unfortunately, as John Sullivan believes, the end of the cycle is what he terms as post-democracy. Last year, it would appear we had arrived at that peak, where the majority believed they were no longer a heard voice in the arena. In an age when we can have a black man as a US President, women in charge of Germany and the UK, and the rights of minorities are prime on everyone’s agenda, we have forgotten about the majority. The majority, for the most part, are the white working class, the blue-collar workers, the rapidly shrinking middle class and the struggling unemployed. Historically, the left has represented them; but in post-democracy, the new left seems to have deserted them too. Global economic forces have not been kind in the last two decades to the majority. Whether it is the people of the ‘Rust Belt’ in the US or the forgotten workers in the north of the UK, having to compete with the low labour rates of the global world has destroyed their jobs, their income level, but most of all their pride. They are angry.

In 1930s Germany, a messiah came, a brilliant orator who spoke in defence of the masses. His hatred of foreigners focussed on the Jews, aided by an excellent propaganda machine that promised a new economy and jobs for the people.

Fast forward to the US in 2017. We have a new leader who speaks to the forgotten masses, demonising Muslims and Mexicans, promising both new jobs and ‘America first’ patriotism. The similarities are striking, a clear move towards nationalism. His supporters are intensely loyal and they will only expand their new power. The people have spoken in voting for Trump, they have spoken in voting for Brexit. As much as the ‘educated’ classes of the right or the left want to deny it, march against it or try to institutionally reverse it, this is the true democracy that we are meant to desire so strongly. Sure, it’s a close call around the 50% marker, but the ballot box has to be respected, however influenced people were by ‘outside’ forces. The media coverage of the uproar over the Muslim travel restriction to the US or Trump’s potential UK State visit would seem to suggest overwhelming dissent, but I very much doubt it. If there was a ballot of all the US population for or against the Muslim ban in its current form, I strongly believe, just like in the UK, the majority would be in favour. It doesn’t make it right or wrong. Push the people too far and you will see a reaction. Unfortunately, that reaction doesn’t stop at the middle ground after an extreme peak; it often goes to the other peak.


Like most people, I hope any comparison with previous revolutions or Adolf Hitler’s Germany is just fearmongering, something to write in a newsletter perhaps. We do have to remember Godwin’s law after all. We can’t really be that foolish again surely. History books are excellent sources of knowledge but are mostly written after events have taken place and so are not subject to change or speculation. You only have to look at how many ‘experts’ wrote books after the 2008 Financial Crisis, telling you how it happened, but their daily comments in the years before were noticeably absent of all concerns. I have found the diaries and newspapers written at the time were far more useful in understanding what was really happening and the likelihood of events changing. One of my favourites is ‘Berlin Diary’ by William Shirer, an American correspondent who reported daily from Germany from 1934 until 1941. Those unedited daily reports, from a man on the ground at the time, make far more interesting reading than history books detailing those times. We would do well to remember that there is far more concern about Trump and negative views about his policies than there was of Hitler in his early days. Not just the German masses, but most of our MPs and some of the Royal family believed the Führer was a great example and force for good.

As Donald Trump’s presidency evolves, we will have to monitor the subtle, slow changes. Will current uproar be followed by the masses slowly gaining power, emboldened by their new strong leader? The real test will be to see how many of the current anti-Trump ‘educated elites’ start positioning themselves behind him as they see the winds are changing in the coming months as the protests fizzle out and reality settles in. Once the industrialists in 1930s Germany were on board, the seeds were sown.

P.S. I hope this is a dream or I’m dead wrong.


CONTENTS Inside this edition of the UK Dividend Letter you’ll find:

OVERVIEW 1

INVESTMENT IDEA #1 INMARSAT PLC 7

INVESTMENT INSIGHTS 16

PORTFOLIO UPDATE - WHAT HAPPENED? MARKET & SECTOR ANALYSIS 20

HINDESIGHT DIVIDEND UK PORTFOLIO # 1 (FEBRUARY 2017) 22

APPENDIX I THE WAY WE THINK 24

APPENDIX II HOW WE THINK 25

Our main investment ideas this month are:

1. Inmarsat PLC


INVESTMENT IDEA #1 INMARSAT PLC by Mark Mahaffey

IMARSAT PLC

Price (£) 610.0 Turnover (£mm) 833.9 Net Income (£mm) 184.2 Market Cap (£mm) 2,878.0 Fwd P/E Ratio 14 Dividend Yield (%) 6.00% Payout Ratio (%) - Total Debt to Total Equity (%) 171.7% FCF to Market Cap (%) 8.8% ROIC (%) 10.0%

Inmarsat plc (ISAT: LSE) is an industry leader and pioneer in mobile satellite communications, helping to power connectivity for more than 30 years. It provides a broad range of services to keep its clients connected at all times, whether they are travelling by land, sea or air. Inmarsat plc was listed on the London Stock Exchange in 2005 and currently trades with a market capitalisation of over £2.8bn. Rupert Pearce was named as CEO in July 2011, taking over from Andrew Sukawaty. In 2016, the company generated over £1.3bn in revenue and is a constituent of the FTSE 250 index.

The 17th Century German astronomer and mathematician, Johannes Kepler, is first credited with using the phrase ‘satellite’ to describe orbiting bodies around planets and stars in his work on planetary motion.

Satellite Industry The satellite communications industry originated through a global need for communication and was initially an international research effort. In 1945, Arthur C. Clark described for the first time how satellites could be arranged in a geosynchronous orbit to provide seamless, worldwide coverage. Clark went on to produce two more documents that detailed how one could achieve such a feat, but from a technical perspective. He produced these submissions while working as a radar technician for the Royal (British) Air Force.


While many had written about the concept that Clark had initiated, he was the first individual to detail the technical requirements required and conducted research through the British Interplanetary Society. These findings were the result of over 25 years of research into the topic of missile launches and the technology required. The continued advancement in the use of radio waves led to a growing interest in planetary communication networks.

After the Second World War, most nations were on the verge of bankruptcy, so the industrial drive was led by the USA and USSR, which eventually led to ‘The Space Race’. In 1957, the USSR moved ahead by launching Sputnik I, the first satellite to orbit the Earth, which was an amazing achievement. While the Americans claimed the ultimate prize of moon landings over a decade later, this rivalry led to more than 1,500 research-focused satellites being launched over the next 20 years. By 2013, over 5,890 satellites had been introduced into orbit, which accounted for over 80% of the world’s involvement.

The satellite industry saw most of its investment come from the USA, as it focused on creating a legal framework for using satellites for commercial gain. Eventually, the industry saw the formation of the Satellite Communications Act, which helped to guide the strategy that allowed the US government to supervise the fair access and operation of satellites for commercial communication. The new regulations coincided with the year when AT&T and Bell Labs successfully launched the world’s first communication-based satellite called Telstar-1.

Industry advancement led to the formation of COMSAT (Communications Satellite Corporation), which was based in the U.S. The corporation went on to have branches across South America in Brazil, Argentina, Colombia, Mexico, Peru and Venezuela. Eventually, COMSAT helped to create, and was the majority owner in, the International Telecommunications Satellite Consortium (INTELSAT), an international body with the goal of creating global satellite coverage. Each country that was part of INTELSAT at the time had an appointed signatory who was charged with responsibility for access to the system over all other companies and subscribers within its sovereignty. These signatories were local, government-based organisations or privately funded operators known as Public Telecommunications Operators (PTO). The PTOs held a natural monopoly over local access; however, if any difficulties they had were reported to their International Services Operators (ISO), such as INTELSAT, SputnikSat or EUROSAT.

Eventually, all the ISOs were aggregated under the International Telecommunications Union, which served as a branch of the United Nations. This stringent structure gave the satellite industry the reputation of promoting ‘closed skies’. The level of access to the shared satellite system controlled by the ISOs was decided by the amount invested by each PTO. Ultimately, as more countries participated, especially as television began to take centre stage around the 1980s, satellites became cheaper to manufacture, launch and manage. This consortium has continued to grow and today has 143 members.

Over the years, satellite technology has become cheaper as many organisations became worried about the level of control of the PTOs and started lobbying to create a flatter structure that was not so centralised. After a number of ‘World Radio Communication Conferences’, which featured discussions about the ‘open sky’ policy, we eventually had the Open-market Reorganisation for the Betterment of International Telecommunications (ORBIT) act.

Inmarsat, which once operated as a cross between an ISO and a PTO, became the first ever satellite company to privatise in 1999.


The satellites that orbit the Earth today provide us with a connectivity that we mostly take for granted. Whether it is the Sat-Navs in our cars, Satellite TV, worldwide broadband connections or the ability to locate our lost phones by GPS, we are all reliant on the satellites that A.C. Clarke envisaged in 1945. But the original roots of this technology can be traced back to the need for ships at sea to be in constant contact and the ability to pinpoint their locations, most importantly in times of distress.

The CEO of Inmarsat, Rupert Pearce, is often quoted as saying the Titanic would not have been the disaster it was if the ship had been carrying an Inmarsat beacon. Before this tragedy, a loosely operated wireless system that monitored the closest vessels was the best method of connecting ships. In 1912, the operator of the closest vessel to the Titanic turned off the system just ten minutes prior to the iceberg collision, as there was no requirement for 24-hour coverage at that time.

The unfortunate events led to an international outcry for a reform in safety. After years of discussions, there was a global agreement to form the International Convention for Safety of Life at Sea (SOLAS). Ultimately, as regulations changed, the International Maritime Organisation (IMO) was formed by the UN and merged its interests with SOLAS, creating a partnership that governed safety at sea. As the space race gathered pace, the group started looking into the possibility of using satellite communication for advanced maritime safety, which eventually led to the creation of the International Maritime Satellite Organisation (INMARSAT) in 1979, a non-profit intergovernmental organisation.

In 1988, SOLAS established the Global Maritime Distress Safety System (GMDSS), which required the convergence of ship-to-shore with ship-to-ship communications through a dedicated network of satellites and ground technology that was to be completed by 1992. Inmarsat was selected to carry out the satellite duties for the new safety system. The amount of investment in satellite voice communications vastly increased in the 1990s, and as the cellphone industry continued to develop, there was an enormous untapped market for mobile phones, which many thought low earth orbit satellites could capture.

The industry’s needs were changing fast and Inmarsat, in effect, split in 1999 with the operational unit becoming a private company and the inter-government organisation becoming the regulatory body for satellite communications), the International Mobile Satellite Organisation (IMSO).

Inmarsat’s client base includes merchant ships, governments, airlines, broadcasting media and oil & gas firms at the very least. The company maintains a fleet of orbiting satellites that their clients connect to in order to communicate and broadcast data. Connected to all the satellites is an array of equipment, including global handheld phones and notebook-sized broadband Internet devices. The company can also provide specialist terminals that are installed on ships, aircraft and land vehicles.

The company has a presence in over 60 locations across every continent and produces its revenues through five market-facing business units:

• Inmarsat Maritime • Inmarsat U.S Government • Inmarsat Global Government • Inmarsat Enterprise • Inmarsat Aviation

The firm’s Maritime group accounts for just over 50% of revenue. Europe (ex-UK) and North America account for over 70% of the revenues generated from a geographical perspective, with the US government being the largest customer.


In early 2016, ISAT’s share price was trading over 1100p. Since then, it has lurched lower periodically to the recent low of nearly 600p, a fall of over 45%. The latest drop in early 2017 saw a 25% decline from 800p. What on earth is going wrong?

The bad news includes:

• An ongoing decline in global trade volumes • Commodity cycle collapse, especially oil • Brexit • Delayed Satellite launch • Peer group profit warning • Trump protectionism that is adding to the woes of trade volume

Maritime Exposure The shipping industry has clearly suffered since the financial crisis of a decade ago. The Baltic Dry Index (shown below) provides an assessment of the cost of moving major raw materials by sea. It accounts for 23 different shipping routes that are measured on a time charter basis. Currently, it is evident that these long-term rates are trading at depressed levels.

INMARSAT PLC vs. FTSE 100 INDEX vs. FTSE 350 TELECOM IX

65.0

75.0

85.0

95.0

105.0

115.0

125.0

135.0

Jan-

16

Feb-

16

Feb-

16

Mar

-16

Mar

-16

Apr

-16

Apr

-16

May

-16

May

-16

Jun-

16

Jun-

16

Jun-

16

Jul-1

6

Jul-1

6

Aug

-16

Aug

-16

Sep

-16

Sep

-16

Oct

-16

Oct

-16

Nov

-16

Nov

-16

Dec

-16

Dec

-16

Dec

-16

Jan-

17

INMARSAT PLC FTSE 100 INDEX FTSE 350 TELECOM IX


Global trade volumes are hardly growing and the collapse in the oil price, from over $100 a barrel over a year ago, has only exacerbated the crisis. Most recently, the shipping industry has not reacted well to the US election results, as many believe that Donald Trump’s protectionist policies will have a negative impact on much of global trade. The analyst community fear that President Trump is just the latest threat to the shipping industry, which has already suffered over the past five years.

The maritime industry is obviously closely linked to global trade and ISAT’s revenues are heavily reliant on this industry.


Delayed Satellite Launch (SpaceX) & Peer Group Profit Warning

Last year, Inmarsat was severely affected by two events that were beyond their control – the market took the news that Eutelsat (its closest peer group rival) had issued a profit warning and SpaceX announced a delayed shuttle launch very poorly.

Eutelsat’s announcement saw its own share price drop over 30%, while Inmarsat’s market capitalisation was down sharply. The news had a systemic impact across the whole peer group. One of the main reasons for this profit warning was due to the fact that Eutelsat had either lost certain military contracts or had to offer these contracts at a lower price due to the competitive nature within this space. The market believed that Eutelsat was not keeping pace technologically with their peer group and doubted many of its competitors, causing the whole industry group to fall. On the contrary, Inmarsat had announced good results with rising revenues and investing heavily into their research and development, particularly within the communication and high-speed Internet sectors, keeping them at the forefront of the satellite industry.

Similarly, SpaceX was due to take an Inmarsat satellite into space in September 2016 but unfortunately delayed the launch of its rocket after an earlier explosion. Investors raised their eyebrows as the satellite was due to provide Inmarsat’s new aeronautical broadband service and believed that this delay would have an impact on Inmarsat’s near-term revenues. As the London-based satellite operator grew frustrated with SpaceX and its progress, they announced that their contract (for that particular launch) had been cancelled and arranged for the satellite to be taken up into space by Arianespace in mid-2017.


While the two damaging announcements were not directly the fault of Inmarsat, they both saw the firm’s share price fall dramatically. Fortunately, Inmarsat was able to issue statements about its health or their solutions to the problems at hand in both cases, confirming the management team’s ability to guide the firm through difficult situations. With the firm’s satellite due to be launched later this year, Inmarsat will be in a position to offer its new services and generate further revenues going forward.

Inmarsat plc enters the HindeSight Dividend portfolio this month as a typical value investment. The company has been a long-term industry leader, offering services that have high barriers to entry with a business that generates substantial free cash flow throughout the business cycle. The company currently trades with a forward P/E of 14x and offers a strong dividend yield of 6%%. Given how significantly Inmarsat plc has fallen in recent months, the communications group offers good value to any portfolio at current levels.

We have harped on about the cyclical nature of most industries in our letters over the years and the communications industry is no different.

Global trade may well currently be in decline but there are encouraging signs. Analysts often follow the South Korea Inventory Cycle for clues. There is a positive relationship that exists as South Korea’s economy is constructed of 50% exports and 50% imports, making it highly sensitive to global inventory circulation. It can be seen that the 12m % change in the South Korean Inventory Circulation Cycle leads the 6m % change in Inmarsat’s share price. The relationship may not be perfect, but it does give a very good indication as to where you might see Inmarsat’s share price trading 6 months forward.


Commodities (Specifically Oil) Over a year ago, the commodity market collapsed with oil ultimately trading at just above $25/barrel. Our research has shown that Inmarsat’s share price tends to lag the commodity industry and, more specifically, movements within the oil market. Inmarsat is correlated to this market, as many of its clients are oil & gas producers. As the oil market becomes negative, many of these producers review their outgoing costs and services they subscribe to (one of them being Inmarsat’s service). However, as oil recovers it can be seen (below) that Inmarsat does well, as their clients’ usage increases, helping Inmarsat’s revenues to rise rapidly and eventually see its share price recover. It is cyclical with a sizeable lag.

We believe that Inmarsat plc provides an impeccable service and a range of products that are desired by a broad range of clients. Its share price is correlated to factors, such as the oil market and the maritime industry as a whole. However, with the oil price acting as a leading indicator, the probability of a recovery in Inmarsat’s share price is rising. We have seen a recovery in the commodity markets and, therefore, believe the stock will improve from its depressed levels going forward, despite the negative political environment.

BREXIT & Currency Impact With BREXIT shocking the world, the UK stock market fell dramatically, causing all of its constituents to trade in an adverse manner. Inmarsat was no different, as investors were worried by its exposure to the UK and the revenues that it generates within this region.

What many had overlooked was the fact that the UK accounted for a relatively small proportion of Inmarsat’s revenues and the weakness in sterling would actually be of a beneficial nature to its business. With the communications provider being a UK-based company, but generating more than 92% of its revenues abroad, we consider Inmarsat to be an exporting business and this would, in fact, act as a tailwind for its financial performance going forwards. Following the treacherous market conditions, Inmarsat reported strong financial results, declaring a growth in revenues aided by a weak pound. The UK currency has remained at depressed levels and, as a result, we believe this will go on to help Inmarsat strengthen its financial position and help the firm regain its market capitalisation.


With an experienced management team, Inmarsat’s dependency on its maritime business is becoming less apparent as they look to focus on building other streams of revenue. Aviation has been a success with the firm winning new contracts, as they have seen a global surge in demand for wireless connectivity. Management has been working hard, signing up Lufthansa and Air New Zealand to their Global Xpress service, which provides them with in-flight broadband connectivity. Furthermore, IAG, who own British Airways and Iberia, have set plans in place to install Inmarsat’s forthcoming European Aviation Network (EAN), which is a high-speed, in-flight passenger broadband service. This service is set to be installed across 341 planes that IAG own.

In addition, Rupert Pearce and his team recently reported the appointments of Honeywell and Boeing to develop technologies for their next-generation high-speed, in-flight wireless Internet service. Together with Inmarsat, the three corporations will research, test and develop the avionic hardware, software and services for Inmarsat’s new satellites. Eventually, this will be valued highly by the aviation industry, as it will not only be used in-flight, but also on the ground by air traffic control.

Finally, government revenues have been rising with the strong demand for Inmarsat’s GX services, along with other new products, such as their airborne surveillance. Diversification of its revenue streams will help the company to weather the volatility it has experienced as the maritime industry has fluctuated in the past. This will help to avoid significant down trades that have been suffered over the past 12 months.

Analysts’ Corner Inmarsat plc is a leading satellite communications business that is relatively well covered by the analyst community. Over recent months, the community has been negative to neutral on Inmarsat’s situation. However, they believe long-term prospects are good, attributing the firm with an average 12-month target price (TP) of 891.74p, representing an upside of over 45%.

Summary Inmarsat trades at a significant discount relative to its past performance and that of its industry competitors. The communications provider currently sits at a four-year low having suffered unfairly due to a series of negative events that have weighed down on its share price. The firm is a market leader within the satellite communications industry and has built a strong reputation that is based on the quality and speed of its service, giving the stock a reasonable margin of safety.

The firm’s management team have a reputation for guiding Inmarsat through difficult periods. Its share price has suffered due to negative sentiment within the commodity industry, as well as adverse news reported across its peer group.

Being an exporter based within the UK, the company is due to feel the positive revenue impact fostered by a depressed sterling price. The communications provider offers investors a dividend yield of 6 %, supported by their ability to generate free cash flow throughout the business cycle. Given Inmarsat’s depressed share price, this would be a good entry point.


INVESTMENT INSIGHTS

Last month, we promised that we would update readers on our portfolio thoughts.

Whenever I read the New Year’s portfolio choices, either in The Investor Chronicle or in IFAs’ literature, I am always surprised at the typical 100% invested nature with virtually no cash holdings. They always advise the need to have enough in case of a six-month emergency, but never as an investment portfolio choice. Is it because of the way they are compensated or just their investment style?

Currently, I have 50 percent of my investable portfolio in cash – Treasury Bills to be exact – with no bank risk.

I must be an idiot. You would have thought I’d have learnt more in my 32 years as a trader and investment manager.

Why do I hold so much cash at this time? I have worked hard to build up the capital. I have never received any financial help from others in any way since my 16th birthday. I have also worked in the financial markets as a trader since 1984, seeing market events first hand with booms and collapses in all asset classes, stocks, bonds, property and commodities. As such, I might be warier than most about what future events can do to my capital.

Straightforward common sense dictates that the cheaper we pay for something, the better the returns will be.

• Buying bonds that yield 10% is better than buying them at 2% • Buying property valued at three times income multiple is better than buying it at ten times • Buying commodities at zero premium to extraction cost is better than three times premium • AND BUYING STOCKS AT PRICE/EARNINGS RATIOS of 10 is better than buying at 25

The very basic chart below demonstrates that downward sloping line of future returns relative to price paid in Price/Earnings terms. You can substitute in any of the above yields, income multiples or extraction premiums and get the same downward line relative to returns.

Currently, I am worried that many of the asset classes will produce a return worse than cash in the short to medium-term horizon and so holding 50% cash is my chosen portfolio allocation.


Trust me, if bonds were at 8-10% yield and stocks were trading with single digit p/e, I would be fully invested, and more so, and the discussion about cash would be irrelevant. That is not the case at all today.

STOCKS ARE NOT CHEAP I think it’s better to start with this introduction because it’s important to realise there will always be people, retail or professional, who are bullish on stocks – always. They were bullish at the highs in 2000 before a 50% decline in price and they were bullish in 2007 before a similar decline. I don’t know whether they are just eternal optimists in everything they do, with little respect to the facts, or it’s specific to the stock market.

But when I write ‘Stocks are not cheap’ and challenge a perma-bull, I can at least get them to agree and we can start off the discussion, rather than starting at far more extreme levels.

One of the most common ways to look at the stock market or compare single stocks is to look at the Price/Earnings ratio.

With seemingly only two moving parts, Price (of the stock) and Earnings per share, it is straightforward enough to see that if you are able to find a company making £1mil a year in profit, which was valued at only £2mil, then it is a great investment. In effect, you would own the company for free after just two years of earnings. Of course, this rarely happens.

Unfortunately, earnings are not constant in most companies and, as such, there is much up for debate using price/earnings ratios as a key yardstick.

• Trailing (historical) earnings are earnings that have actually been recorded • Forward Earnings are estimated earnings for future years and, as such, are subject to change • Cyclically adjusted earnings: most industries and the stocks in them operate in cycles – the good times and the

bad times, when earnings range from good to bad accordingly. By adjusting for the cycle, we can get ‘average’ earnings.

A recent set of charts sent to me from an ex-colleague at Pantheon Economics tells one side of the story.

Source: Morgan Stanley Research


Source: Morgan Stanley Research

These charts use trailing earnings, which suggest that current valuations across the board are clearly in nosebleed territory. The payout ratio is the amount of dividends paid out relative to earnings. Clearly, paying out 108.9% of earnings is not sustainable.

The perma-bulls will immediately challenge that outrageous claim of an imminent crash, using a 10-year CAPE ratio (Cyclically Adjusted Price Earnings), and the chart below may suggest we are much closer to fair value.

Source: Telegraph, Bloomberg

The problem, as is often the case with statistics, is that you can show a graph to prove almost any point you make. Using trailing earnings doesn’t allow for a cyclical pick-up in earnings and so might very well overexaggerate the point. Using forward earnings might well be far too optimistic, as earnings are much more often revised down than up, and using average earnings can smooth anything out far too often and make it look benign.

In addition, the problem with the FTSE is the skew, not just to the largest top 20 companies, but also the size of the largest sectors and their relative earnings. So, for argument’s sake, let’s just have a look at the trailing (actual) P/E


ratios for the FTSE ex-oil/Gas and equal weight the components, rather than use the index market capitalisation weight.

Despite his dismal performance last year, the well-known fund manager Crispin Odey is a long-term market professional and was recently quoted as saying: “I like to find stocks where the price is stable but the company’s earnings are growing, that is a value opportunity. Unfortunately, in today’s markets, it appears to be the opposite, earnings are stable or dropping and the stock price is rising making everything more expensive.”

We have written before about our general outlook for earnings and the factors that often influence them.

Common sense and history tell us that when:

• Oil is rising, earnings usually decline • When interest rates rise and the cost of capital increases, earnings decline • When the labour market is tight and wages are rising, earnings decline • Globalisation helps earnings, protectionism hurts earnings

And, unfortunately, that is the exact situation we have currently, not to mention the massive challenges in the UK for UK companies with Brexit, especially our large importing companies.

I have made a late charge to fatherhood, possibly only beaten by Rod Stewart and George Clooney, and am very fortunate to have a three-year-old son. One of his games is to take an egg out of the carton and hold it firmly while walking around the kitchen shouting, “I’m concentrating”. Obviously, the inevitable usually occurs.

This analogy is where my mind is with the current stock market valuation and any stock portfolio allocation. Even if we assume that our ‘permanent portfolio’ holds an average weighting of 25% stocks, there are arguably times to own less and there are times to own more. There are times to be rigid in value investing and there are times when a passive equity index will do a great job.

On the balance of all my charts and statistics, stocks are clearly not cheap. They might well be screaming rich, as rich as in all the other pre-crash times in history or more so. My view on earnings is negative for the reasons above, so if I thought the P/E ratios are too high now, God help us when earnings drop.

So, I have decided to hold fewer stocks than normal. I have decided to hold more cash than normal and I will be doing what my young son does and concentrate hard on making sure that the stocks I actually do invest in are very cheap with an inherent value derived from a strategy like the Hinde Dividend Value Strategy.


PORTFOLIO UPDATE - WHAT HAPPENED? MARKET & SECTOR ANALYSIS

UK Market Valuations


HINDESIGHT DIVIDEND UK PORTFOLIO # 1 (FEBRUARY 2017) Portfolio Update and Construction


PORTFOLIO UPDATE

IG Group PLC IG Group PLC had an ex-dividend date on 2nd of February 2017 for 9.42p.

PORTFOLIO MOVEMENT

Dunelm PLC On 18th of January 2017, we stopped out of on our position in Dunelm plc at 677p. The stock was down (12.86%) and (15.94%) in absolute and relative terms respectively.

Pearson PLC On 18th of January 2017, we stopped out of on our position in Pearson plc at 579p. The stock was down (29.00%) and (41.23%) in absolute and relative terms respectively.

Taylor Wimpey PLC On 18th of January 2017, we took profit on our position in Taylor Wimpey PLC at 173p. The stock was up +35.72% and +23.49% in absolute and relative terms respectively.

Lloyds Banking Group PLC On 24th of January 2017, we took profit on our position in Lloyds Banking Group PLC at 64.52p. The stock was up +26.14% and +16.75% in absolute and relative terms respectively.


APPENDIX I

THE WAY WE THINK We passionately believe that dividends really, really matter.

William Thorndike in his fascinating book ‘The Outsiders - Eight Unconventional CEOs and Their Radically Rational Blueprint for Success’ examined one of the most important aspects of running a business a CEO must undertake: Capital Allocation. He summarised how a CEO deploys capital in order to best utilise cash flow generated from his or her business operations. Essentially, CEOs have 5 ways of deploying capital:

• Investing in existing operations • Acquiring other businesses • Repaying debt • Repurchasing their own stock (buybacks) • Paying dividends

Dividend payments are a crucial operation in creating stakeholder wealth. It is this aspect of a business that we are so fixated by – the propensity for a company to produce and continue to grow dividends so that we may accrue wealth over a generation. But as readers will know we can’t just grab stocks with the highest yield for fear that this signals some cash flow or even solvency issues for the firm. So it is with this very real threat in mind we explore only well-capitalised FTSE 350 companies.

This letter’s purpose is to help inform readers on dividend investing so that they can construct a portfolio of sound UK dividend stocks based on our recommendations.

Our prerequisite is that any stocks selected for this letter must be liquid, well-capitalised with a strong free cash flow and a progressive dividend policy.

Our System

• Every month we will provide a write up of 3 to 4 stocks until we create a portfolio of 25 UK dividend stocks. This will be the HindeSight UK Dividend Portfolio #1

• You will be alerted by subscriber email intra-month when these stocks become a buy. Timing is critical to the strategy, not only buying quality stocks but buying them at the right time

• The entry points will then be recorded in the next monthly in the HindeSight UK Dividend Portfolio section and the stock(s) written up in full

• We will run our winners but tend to rotate every 6 months depending on specific criteria which would elevate cheaper companies into the portfolio relative to stocks that had performed

• The basis for stock and portfolio selection is derived from our quantitative systematic methodology which screens these companies using the Hinde Dividend Value Matrix®, (HDVM®), a proprietary stock-rating system

• In the section on ETPs we will highlight our investment philosophy and the investment process behind our stock selections. This is the basis of our dynamic risk and money management in our portfolio construction for you. You can also read the stand-alone Hinde Dividend Value Strategy document to see the methodology behind our stock selection


APPENDIX II

HOW WE THINK “We have met the enemy, and he is us.” Walt Kelly

Our key to long-term performance investing is premised on the following:

• Systematic rule-based strategy • Systematic risk and money management • Occam’s razor, aka ‘K.I.S.S.’, Keep It Simple Stupid • Consistency • Discipline

All our investment ideas are rule-based methodologies driven by systematic and quantitative models.

Hinde Dividend Value Strategy Hinde Dividend Value Strategy seeks to generate a total return from an actively managed basket of UK dividend-paying stocks. The strategy selects 20 highly liquid, mid-to-large capitalised stocks on an equally-weighted basis, which offer the highest total return potential. The 50% Hedge version of the strategy would then be subject to a strategic Beta Hedge*, which is designed to cover 50% of the value of the UK stock basket at all times.

The 50% hedge is maintained using UK equity benchmark indices to reduce exposure to overall market volatility, but without reducing overall total returns to the market over the long run. The Hinde Dividend Value Strategy (100% Hedge) would deploy a full beta hedge at all times.

Hinde Dividend Value Matrix® The strategy employs a quantitative, systematic methodology, whereby FTSE 100 and FTSE 250 constituent stocks are screened using the Hinde Dividend Value Matrix®, a proprietary stock-rating system. We use the same system to select stocks for any of our strategies, long-only, 50% Hedge or 100% Hedge. The only difference is clearly the extent of the hedge on the exposure to the overall market.

The basic premise of the strategy is to accelerate returns by selecting relatively high yielding stocks which offer the highest potential for capital revaluation. The dynamic rotation of stocks each quarter enables us to sell stocks where the capital revaluation and dividend has been captured, and use this additional capital to invest in more undervalued quality companies. If successful, this cycle of capture and re-investment offers the chance to significantly improve the total return generated by the Dynamic Portfolio.

The basis of the stock selection process is the Hinde Dividend Value Matrix®, which is a derived process that looks at 3 crucial variables:

* Beta is the stock’s sensitivity to market movements, e.g. if a share has a beta of 1.5 its price tends to move by 1.5% for each 1% move in the index

1. Dividend Screen The top ranking stocks will be those offering a relatively high dividend. A composite of the following criteria comprises the Dividend Rank:

• Relative Dividend Yield • Dividend Capture • Payout ratios

The Relative Dividend Yield assesses if a company pays a higher dividend than the Index it derives from (the FTSE 100 or FTSE 250). The Dividend Capture criteria explain how quickly and how much of the dividend is paid at any point in time. The Payout Ratio gives a snapshot of whether a company will be able to maintain and grow its dividend. It helps us to assess how much of a company’s revenue, profit or cashflow is paid out in dividends.

The lower the amount of dividends paid out as a percentage of profits, the healthier future dividend potential will be. History is for once a good guide as to whether companies will continue to pay and grow their dividends. A stock with an excessively high yield relative to its sector or the overall market is invariably showing signs of heightened risk to its dividend sustainability and often the viability of the company itself. The screen incorporates a limit on yield dispersions from the overall market.

The strategy is emphatically not a yield chaser. It is the Performance and Value screens that are used to assess the total return potential of a stock by analysis of how undervalued it is relative to its fundamentals, sector and overall market index.


2. Performance Screen The top ranking stocks have the poorest relative performance to their index over multiple time horizons.

A composite rank of the following criteria provides the Performance Rank:

• Stock relative performance ranked over multiple time periods • Average of time periods taken to select rank of stocks

3. Value Screen The top ranking stocks by key fundamental criteria show stable fundamentals and exhibit upside momentum growth potential. The following are some of the criteria that provide the Value Rank:

• Value - Price to Book (intangible book adjustment), Free Cash Flow metrics • Quality - Return on Investment and Earnings metrics • Financial Stability - Debt levels, Coverage and Payout ratios • Volatility - Stock variance, Dividend variance • Momentum - Sales Growth, Cashflow metrics • Liquidity - Minimum market capitalisation relative to index, Shares outstanding

Implementing the Hinde Dividend Value Matrix® The FTSE 100 and FTSE 250 stocks are ranked using the Dividend, Performance and Value screens. An equally-weighted composite rank is then taken of these 3 ranks, which provides a final ranking from which a selection of 20 stocks is made for the portfolio.

The stocks with the highest ranking are compiled for the FTSE 100 and the FTSE 250. The top 10 from each index are then taken, subject to diversification rules, which entail that normally only 1 stock per sector per index can be invested in. For example, if the top 10 stocks are all mining companies, the selection process would take the first of these and then move on to select the next top stock from another sector. As long as a stock has the highest score in its sector, the fact that it has appeared in the final ranking means it is already eligible for investment. In exceptional circumstances, it may be that more than one stock has to be selected from an individual sector.


External Analyst Score (EAS) This score is derived from 3 inputs that have been obtained from all the external analysts at leading institutions who are covering the stock:

1. The 12 month target price in relation to current price

2. The number of analysts covering the stock

3. The recommendation analysis, e.g. STRONG SELL, SELL, UNDERPERFORM or HOLD

This score is used to observe the other analysts’ view of the stock and is helpful when understanding the methodology that other analysts use to determine their 12-month target price. We ultimately get a blend of price targets that is based on different valuation metrics.

EAS Score Output: 1. The combined score will vary from 30-70

2. A stock with a lowest score of 30 shows the majority of analysts not only have a full sell/underweight recommendation, but also a low 12-month target price in relation to current price.

3. A stock with the highest score of 70 shows the majority of analysts not only have a full buy/overweight recommendation, but also a high 12-month target price in relation to current price.

Note:

- On a standalone basis, the EAS score must be viewed in the following context:

• Equity analysts issue far more positive recommendations than negative • If all analysts are overwhelmingly bearish or bullish, then this can signal a contrarian position be held, but this is

determinate on the where the stock is valued.

- However, in conjunction with the HDVM®, we have found the score to be useful when it is high or momentum is turning higher, as this suggests that the stock offers deep value.

Disclaimer This newsletter is intended to give general advice only on the importance of dividends within the equity space. The investments mentioned are not necessarily suitable for any individual, and you should use this information in conjunction with other advice and research to determine its suitability for your own circumstances and risk preferences. The value of all securities and investments, and the income from them, can fall as well as rise. Your investments may be subject to sudden and large falls in value and you may get back nothing at all. You should not buy any of the securities or other investments mentioned with money you cannot afford to lose. In some cases there may be significant charges which may reduce the value of your investment. You run an extra risk of losing money when you buy shares in certain securities where there is a big difference between the buying price and the selling price. If you have to sell them immediately, you may get back much less than you paid for them. The price may change quickly, particularly if the securities have an element of gearing. In the case of investment trusts and certain other funds, they may use or propose to use the borrowing of money to increase holdings of investments or invest in other securities with a similar strategy and as a result movements in the price of the securities may be more volatile than the movements in the price of underlying investments. Some investments may involve a high degree of ‘gearing’ or ‘leverage’. This means that a small movement in the price of the underlying asset may have a disproportionately dramatic effect on your investment. A relatively small adverse movement in the price of the underlying asset can result in the loss of the whole of your original investment. Changes in rates of exchange may have an adverse effect on the value or price of the investment in sterling terms, and you should be aware they may be additional dealing, transaction and custody charges for certain instruments traded in a currency other than sterling. Some investments may not be quoted on a recognised investment exchange and as a result you may find them to be ‘illiquid’. You may not be able to trade your illiquid investments, and in certain circumstances it may be difficult or impossible to sell or realise the investment. Investment in any of the assets mentioned may have tax consequences and on these you should consult your tax adviser. The opinions of the authors and/or interviewees of/in each article are their own, and are not necessarily those of the publisher. We have taken all reasonable care to ensure that all statements of fact and opinion contained in this publication are fair and accurate in all material respects. All data is from sources we consider reliable but its accuracy cannot be guaranteed. Investors should seek appropriate professional advice if any points are unclear. Ben Davies and Mark Mahaffey the editors of this newsletter, are responsible for the research ideas contained within. They or any of the contributors or other associates of the publisher may have a beneficial interest in any of the investments mentioned in this newsletter. Disclosures of holdings: None relevant to any content discussed within this issue of the newsletter

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