OVERVIEW TOP NEWS FEED - Hinde Capital · Sainsbury (J) has traded between 210 to 340p and Vodafone...

OVERVIEW TOP NEWS FEED

OVERVIEW

OUR MAIN INVESTMENT IDEA 1. Vodafone Group PLC 2. Sainsbury (J) PLC INVESTMENT INSIGHTS

WHAT HAPPENED? Market & Sector Analysis

HINDESIGHT DIVIDEND UK Portfolio # 1 (March 2019)

APPENDIX I: THE WAY WE THINK

APPENDIX II: HOW WE THINK

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Looking forward to relaxed hemp regulations, a new analysis estimates that the CBD market could

explode - and outpace marijuana

Everyone seems to be talking about the new craze, the cannabidiol (CBD) market. In a few short months, it has become the fastest selling ‘food supplement’ across health shops and online websites. It promises everything from anti-anxiety, lower blood pressure and anti-inflammation to treating chronic pain relief and cancer! Too good to be true, surely? But what is it, for starters?

CBD is one of a hundred or more cannabinoids identified in cannabis plants, which could account for up to 30%

MARKET WILL HIT $22 BILLION BY 2022

NEW REPORT PREDICTS

WWW.HINDESIGHTLETTERS.COMISSUE 52 - MARCH 2019

2 HINDESIGHT Dividend UK Letter

of the plant’s extract. The other main extract is tetrahydrocannabinol (THC). This has far more history as it is the plant’s principal psychoactive constituent, the stuff that gets you high. The plant’s other extracts – CBN, CBG, CBC, and so on – are largely untested and unknown at the moment. This fantastic infographic comes courtesy of the excellent MedReleaf and VisualCapitalist. https://www.visualcapitalist.com/history-medical-cannabis-shown-one-giant-map/

Cannabis belongs to a family of flowering plants called Cannabaceae. Three main species are generally recognised – Cannabis Sativa, Cannabis Indica and Cannabis Ruderalis. There is an excellent twenty-minute documentary on Netflix called ‘Weed Explained’ that is very educational.

Hemp is also, in effect, the cannabis plant, but the hemp strain refers to those varieties of cannabis that have been cultivated for non-drug use, with low THC.

As the infographic above tells us, cannabis and hemp are arguably the oldest plants cultivated by humans, and also have the most uses. While cannabis or marijuana,

which have higher THC strains, possess medicinal benefits that have been recorded for most of human history, hemp has played its role in human society. The world’s oldest bible, the 600-year-old Gutenberg Bible, was written on hemp, and the sails of the English Fleet that defeated the Spanish Armada under the command of Sir Francis Drake were made of it. In fact, it was once illegal NOT to grow hemp in England.

Human history is full of twists and turns. George Washington grew hemp on Mount Vernon in the late 18th century, by 1937, hemp and cannabis were outlawed in the US and the growing world. We must remember that alcohol was completely banned in the US during the ‘Prohibition period’ of 1920 to 1933, which seems insane to the modern world. While conspiracies on marijuana’s ban abound, that the big Pharma, tobacco firms and timber companies sought to protect their industries, the fact remains that everything stopped. Despite hemp’s long list of uses, from construction materials, clothes and fuel to foodstuffs, it was not grown at all. And there were no medical studies into cannabis to speak of, despite its long beneficial history. If it is eventually discovered that cannabis can help to cure cancer, this period of prohibition in the late

THE COMPANY

Mark Mahaffey

Ben Davies

Aalok Sathe

HindeSight Publishing which runs HindeSight Letters is a unique blend of financial market professionals – investment managers, analysts and a financial editorial team of notable pedigree. The co-founders of Hinde Capital, Ben Davies and Mark Mahaffey, a successful alternative investment management company joined forces with the financial journalist David Stevenson best known for his regular columns in the FT Weekend, Money Week and numerous other global media titles to deliver something different in the financial newsletters segment – simply put it’s a reliable newsletter version of a managed fund.

Our writers actually run money, not just write about it, so they are the right mix of book smarts and street smarts. Truly a team of individuals that make up a formidable pool of knowledge, wherever the investing landscape shifts to.

CONTRIBUTORS

CO-FOUNDER & CFO OF HINDE CAPITAL

CO-FOUNDER & CEO OF HINDE CAPITAL

FUND MANAGER

ISSUE 52 - MARCH 2019 3

20th century will be seen as a true travesty. Of course, we all know that the big Pharmaceutical companies have no interest in actually curing diseases, as their profits, made by the sale of expensive medicines, would suffer if someone found the cure for diabetes.

In 1998, the endocannabinoid system was discovered to exist in humans, animals and plants, with the receptors CB1 and CB2 being particularly significant in maintaining the stability and health of organisms. These studies are still in their infancy but the early work suggests that absorbing cannabinoids into our system is key to well-being.

It has taken a long time coming but the walls are slowly crumbling. Uruguay legalised cannabis in 2013, and since then, several US states have done the same. Last year, Canada followed suit and the US farm bill signed by President Trump in December 2018 has, in effect, legalised cannabis at the Federal level. But, not quite. It has legalised hemp or cannabis cultivation where the THC content is lower than 0.3%. This means it is not psychoactive, but the path has been laid out. State by state, full legalisation is being put forward. Whether it is down to a desire for tax revenues, better monitoring and regulation, or concern about the 300,000 deaths last year from opiate abuse, the drums are beating louder.

As you would expect, with a high-yielding cash crop that shows all the signs of being a wonder drug, interest, money and investment are all now moving into the arena. With uncertain and ongoing changing regulation, it is, in many aspects, a typical wild-west bandwagon. The fact that most of the cannabis stocks are listed on the Canadian stock exchanges should be of concern to the whole industry, as dubious practices are being used that have long been outlawed in modern market places. But, for the first time in my career, the gold rush – which is aptly being called ‘the green rush’ – may well offer true opportunities for high reward investment, if it can indeed provide mankind with even a fraction of the anecdotal benefits that are currently being promised.


Twelve months ago, Sainsbury’s share price was riding high after the grocer had announced a mega-deal

with Walmart’s Asda. Unfortunately, the deal has since been called off for the time being as the Competition and Markets Authority (CMA) believes it could be bad for consumers, which has caused its share price to fall over (30%) in absolute terms.

Vodafone Group plc is now trading at its lowest level since 2009 with many believing that the company is now on shaky ground. Many analysts are worried that the group will face a cash crunch in the near term as it tries to fund its €19bn buyout of Liberty Global’s European assets. With its debt rising, Vodafone Group has become a worry from an income perspective for the broader market, especially those who have invested in the telecom giant. Since January 2014 and January 2018, Vodafone Group has fallen by over (56%) and (45%) respectively.

Our thesis for both was originally based on:

• Sainsbury (J) suffering a loss in value in December 2014, as it was subject to two major competition enquiries after the Office of Fair Trade had received several complaints.

• Sainsbury (J) deviating from its long-term mean in August 2016 and trading closer to its trough as the firm’s margins came under pressure, despite it having solid revenues and an unchanged market share.

• Vodafone Group coming under pressure when its share price suffered in January 2015, as a result of the European communications industry going through a transitionary period. With technological advancements rapidly increasing throughout the industry, there was significant consolidation within the market. The biggest problem for the industry was keeping up with consumers’ insatiable appetite for connectivity and speed.

Since we last recommended these two large cap names, Sainsbury (J) has traded between 210 to 340p and Vodafone plc traded sideways for several years until its largest down trade, which occurred throughout 2018.

Both Sainsbury (J) and Vodafone are now at extreme lows for the reasons described above. The exhaustion that we are seeing has been flagged by our proprietary trend indicator (shown below). Coinciding with the exhaustion patterns that we have been observing, Vodafone is trading at the lowest levels on a long-term RSI basis that we have seen since the financial crisis, which demonstrates how extreme the current lows really are. With Sainsbury and Vodafone offering a forward P/E of 11.5x and 22x, which is low in their own individual cycles, it is evident that all the negativity is priced into

By Aalok Sathe

Vodafone Group plc and Sainsbury (J) plc have both been in the HindeSight Portfolio before. We previously wrote about Sainsbury’s in both December 2014 and August 2016, which resulted in the company returning over 30% and 23% respectively. Similarly, we recommended Vodafone Group in January 2015. Our investment in Vodafone resulted in its stock triggering our stop-loss level despite it picking up a significant dividend cushion.

FUND MANAGER AT HINDE CAPITAL

INVESTMENT IDEA #1VODAFONE GROUP PLC & SAINSBURY (J) PLC

Due to their poor performance, we recommended both Vodafone Group and Sainsbury (J) on the 18th of March 2019 (at a price of 143p and 226p respectively) as both are placed within the top 20 members of our equity factor model, along with the cheapest members on our path barometer.


both firms’ valuations. Both are highly undervalued, offering a dividend yield of 4.3% and 9.5% respectively.

Just to summarise, Vodafone and Sainsbury (J) have come under attack this time around due to:

• The investor community being worried about Vodafone’s rising debt, as well as its ability to pay dividends going forward.

• Sainsbury’s potential merger with Asda coming under threat as the CMA is investigating the impact that it could have on consumers.

Sainsbury’s and Asda Merger Not Over Yet

In February 2019, the CMA said that it could block the merger between Sainsbury’s (the UK’s second largest supermarket chain) and Asda (the third largest in the UK) as they believe this move could result in higher prices and less choice for the consumer. This caused Sainsbury’s share price to fall by over (28%) since the 30th of April 2018, when the deal was announced. We believe the deal will go through as both groups have suggested that the merger will allow them to pass on £1bn in price cuts to

savers, while Sainsbury’s will cap the amount of profit it makes on petrol. They have also invited an independent body to check this promise in public. In a joint statement, both parties have promised the following:

1. To deliver £1bn of lower prices annually by the third year following completion of the merger. To invest £300m in the first year of the merger and a further £700m over the following two years, as the cost savings flow through. This would reduce prices by around 10% on everyday items.

2. Sainsbury's will cap its fuel gross profit margin to no more than 3.5p per litre for five years; Asda will guarantee its existing fuel pricing strategy.

3. The price commitments will be independently reviewed by a third party and the parties will publish the performance each year, holding them to public account

4. Sainsbury's will move to pay small suppliers (turnover with the business of less than £250,000) within 14 days; Asda will continue to pay its small suppliers within 14 days, in line with existing commitments

Tickers Model Score Trend Index SignalWMH LN EQUITY 60.36 2.79BATS LN EQUITY 59.58 4.07HFD LN EQUITY 58.16 1.69CEY LN EQUITY 57.95 2.86

VOD LN EQUITY 57.82 2.88PTEC LN EQUITY 57.61 1.96WPP LN EQUITY 57.35 1.72888 LN EQUITY 56.6 1.26 Trend Ready/RSI OversoldPFC LN EQUITY 56.31 4.09BAB LN EQUITY 55.71 2.25INCH LN EQUITY 55.66 1.56ELM LN EQUITY 55.46 2.84CNA LN EQUITY 55.23 3.14

SMDS LN EQUITY 54.97 1.27TED LN EQUITY 54.86 2.05

GFRD LN EQUITY 54.51 1.8KGF LN EQUITY 54.45 2.34

SBRY LN EQUITY 54.37 3.71BA/ LN EQUITY 54.27 2.8PZC LN EQUITY 54.22 2.71

STAN LN EQUITY 54.11 0.98 Trend Ready/RSI OversoldGFS LN EQUITY 53.88 2.33WG/ LN EQUITY 53.87 2.51RTN LN EQUITY 53.86 3.47AV/ LN EQUITY 53.84 1.55HTG LN EQUITY 53.78 1.48PPB LN EQUITY 53.46 2.83GVC LN EQUITY 53.31 2.96SXX LN EQUITY 53.13 1.19

MGAM LN EQUITY 52.99 0.59


With the CMA’s final decision set to go through on the 30th of April 2019, we believe a deal will be agreed that will help to form a supermarket giant that would leapfrog Tesco into first place in terms of market share. Their main selling point is that joining forces would enable the combined group to negotiate better prices with their biggest suppliers, which would then be passed on to the consumers. This would see them pledging to cut the price of everyday products by 10%. With the deal currently in doubt, we believe this is a good time to develop a position in this supermarket giant.

Vodafone Not Beaten Yet

When a company looks to fund its acquisitions, they usually look to debt. However, if they already have too much debt then they can look to raise cash by issuing new shares.

For Vodafone, they will need to come up with €10.8bn in cash to finance last year’s €18.4bn deal to buy the European cable operator Liberty Global. Unfortunately, the group’s net debt of €32bn is already too high. The problem with issuing new shares is that it dilutes shareholders and

would increase the annual cost of paying dividends. This would make a dividend cut more likely and it’s something that Vodafone needs to avoid. Mr Read, the Vodafone CEO, has come up with an astute plan to issue £3.4bn of mandatory convertible bonds that are repaid with new shares, as opposed to cash.

The company hopes that because no cash is due to be repaid, these bonds won’t affect its credit rating. When these bonds mature in 2021 and 2022, he plans to buy back the new shares he’ll have to issue. To fund this buyback, Vodafone plans to issue more debt.

We believe going down this route will provide breathing space and enable the firm to maintain its dividend, which is a significant driver for investment into Vodafone. Furthermore, the firm is currently reviewing its businesses as it plans to sell non-essential assets in order to help ease its situation and change its structure on a long-term view. The structural changes that Vodafone’s new CEO is putting into place will help to stabilise the firm’s share price and eventually rerate higher.


Analysts’ Corner

Sainsbury’s is a grocery giant. It has a global presence and is widely followed by the research community. The company is attributed with an average target price (TP) of 298p, representing an upside of over 25%.

Vodafone is one of the biggest communications providers in the world. Similar to Sainsbury’s, it is widely followed by the research community. The company is attributed with an average target price (TP) of 190p, representing an upside of over 30%.

Summary

Both Sainsbury’s and Vodafone are two of the longest serving members within the UK universe and highly regarded brands that have been built up over time. Both have seen their fair share of highs and lows. With the duo trading at significantly depressed levels in their cycles, we believe it is a good time to start building positions in both. Sainsbury’s future will be more certain on the 30th of April 2019 while Vodafone’s CEO is helping to restructure the firm’s balance sheet to a healthier standing. Ultimately, we believe both provide the opportunity to add value to any UK-focused portfolio.


By Mark Mahaffey CO-FOUNDER & CFO OF HINDE CAPITAL

INVESTMENT IDEAVODAFONE GROUP PLC

Vodafone is a UK based telecommunications firms, headquartered in Newbury. It was founded in 1991 and is now the second largest telecommunications company in the world behind China Mobile. The firm operates networks in over 20 countries through local partnerships. Its heritage tracks back to 1982, and Rascal Electronics plc, which was the UK’s largest producer of military radio technology. Through various mergers and acquisitions, including at one time agreeing to buy Cable and Wireless, it is now the company that it is. This giant has now gone on to become a household name.

Today, Vodafone has 92,812 employees, a market capitalisation of £60bln generating £38bn in

revenues. The company has a large global presence, significantly covering the likes of India, South Africa and Turkey. These emerging markets are continuously growing at a rapid rate helping Vodafone to make up for the decline in European revenues.

Despite last year’s yield of a huge 28% including the return of capital (resulting from the sale of its 45% stake in US operator Verizon in early 2014), Vodafone’s share price and the company itself have lost its way to an extent.

The European telecommunications industry has been going through a transition over the past decade and this looks set to continue over the next few years. The industry has been changing with new technological trends forming. This has resulted in a major consolidation within the market, creating various partnerships, enabling the providers to stay competitive.

The biggest challenge within the industry has been for providers to keep up with consumer’s insatiable appetite for connectivity and speed. The demand for high-bandwidth to be used from business to gaming

Previous CallsPrevious write-up on VOD from 2015 trade recommendation


VODAFONE GROUP PLC

is creating pressure on the industry to increase the availability and quality of broadband connectivity. This means that providers are continuously having to innovate in order to meet this demand. A key trend that keeps developing is the growing adoption of mobile devices and from this, machine-to-machine communication is developing quickly. Mobile technology is being extended into new areas such as wearable technology, which include smart watches and fitness/health devices for example.

The landscape continues to change, however deploying and servicing this industry is a very expensive task. Telecommunications providers are having to increase their capital expenditure and invest in order to expand their footprint and improve the technology and infrastructure that they currently possess.

Those entities that are unable to do this or fund their research and development are falling short or being taken over by others for their intellectual property and existing networks. 2015 looks like it will be the year of convergence as those looking to dominate the “Quad-Play” market (providing broadband, mobile, pay-tv and fixed line packages) make their strongest push, helping consumers to create their “smart” homes and lives. The challenge for operators is that subscribers typically expect to pay less for multiple products sold within a packaged bundle as opposed to being sold separately.

The race to develop the ability to provide this packaged service is underway. Many mainstream telecommunication providers are vying with each other to buy out mobile operators. In the UK, BT Group are in talks with EE while Vodafone is rumoured to be considering moves for everyone! Either way the race to provide convergence technology is well and truly on.

Vodafone has a HDVM® score of 56.75. The large 2015 expected dividend yield of 5.3%, an underperformance to the index over the last 12 months of -21.3% and generating a £38bln revenue are the key factors in the score.

What has gone wrong?

• The perception is that Vodafone’s size will force it into a poor partnership/acquisition and it has been stalling on that and the analysts don’t like uncertainty.

• Project Spring, its multi billion pound European and Asia upgrade is too capital extensive and profits will fall.

• Competition for instant and voice messages will significantly reduce the business that Vodafone has traditionally provided

• Allegations that Vodafone underpaid for Germany’s telecom operator Kabel Deutschland and ONO in Spain, another acquisition being accused of committing tax fraud.

We believe that these factors have been viewed too negatively and short term, the usual reason for an attractive entry point in the stock price. If the market has priced in a poor acquisition and falling profits, surely any sound strategic partnership like Liberty Global would be very attractive.

Creating a solid network throughout Europe and expanding within Asia through regions such as India is very important given the rapid adoption of “Machine to Machine” communication. “Project Spring” is in fact a significant point in the company’s history especially as it is predicted that more than 50% of Vodafone’s revenues over the next three decades will come from the Indian subcontinent. As India develops from an emerging economy to a world superpower Vodafone is finding itself having to defend its market share against competitors such as Reliance Jio who have significant local knowledge. Luckily for Vodafone, Reliance Jio is thought to be more interested in the local data market rather than pure play telecommunications.


Analysts’ Corner

Vodafone is a well-covered stock, by a wide range of analysts. Over the past month, analysts have started to become more bullish on this business (with 32 out of 38 analysts giving it a buy or hold rating). Our scoring system suggests that the stock has an average 12 month target price (TP) of 223.69p, representing a 0.43% upside from recent prices. However, in January 2015 alone, three analysts have given an average target price (TP) of 250.33p which actually represents an upside of 12.43% relative to recent prices. The general recent consensus is that the stock will outperform the benchmark over the next year.

Our external analyst scoring system* places Vodafone at 47.97 (range 30-70), which is a very weak score, being in the lower half of our external analyst system.

Summary

We believe that with the Verizon transaction behind them, Vodafone can now fully shift their focus back onto its core businesses and future innovations with a focus on international expansion. With “Project Spring” creating a distortion in the group’s revenue’s, this will ease as the infrastructure is implemented and rolled out.

This temporary disruption has created an opportunity for investors to buy into a fundamentally sound firm that has built up a reputation for providing a solid dividend to its investors. This growing dividend along with the changing environment within the telecommunications industry makes a compelling argument for owning Vodafone over the long term. It is thought that “Project Spring” will result in over a £1bn in free cash flow being generated over the next few years. This will help secure Vodafone’s long term dividend growth provided it successfully rolls out its “Quad-Play” service throughout Europe and further into Asia.


Readers of the HindeSight Letter will have received a buy alert from Sainsbury’s on 4th August at 224.50p.

Sainsbury’s has featured in the dividend portfolio previously from December 2014 (with a similar purchase price of 226.40p as this recommendation) until March 2016 making a total return of 30.1% including 5.3% of dividends.

As we mentioned last month with the re-introduction of TalkTalk to the portfolio, over time we will invest in many stocks several times over the years as we believe not just in the cyclicality of stocks and industry groups but also that stock prices tend to move far more than the fundamentals might suggest in the short term. If we look at the chart of Sainsbury’s we can see that over the last 8 years, the price has ranged between 200-400p and more recently 220-300p. The previous trade analysis suggested that Sainsbury’s was cheap on purchase in 2014 at 226p and fair on exit at 280p and there are similarities to today’s market. We continue to understand the general poor performance of the big supermarkets as they compete with the discounters like Aldi and adjust to the changing shopping habits of consumers. Current margins are under pressure despite solid revenue and relatively unchanged market share for many years.

Sainsbury’s recently approved takeover of Argos/Home Retail group has had mixed reviews within the investor community after it had only just closed the doors on its joint venture with Danish discount supermarket Netto with costs of £20mil closing the 16 joint stores. However, Argos might prove to be the turnaround in fortunes that Sainsbury’s are looking for as Argos actually enjoy rising total sales both from new stores and online sales.

Looking at the Price/Earnings ratio on the chart below, we feel that we are hardly overpaying for earnings especially

when many large cap stocks have P/E ratios closer to 20 times as low interest rates force valuations higher. Food suppliers have generally been seen as defensive investments by nature and margins have proved to be cyclical in the past as they may well be again.

With a dividend yield of 5% and an entry price of 224.50p, we believe that Sainsbury’s offers us a reasonable margin of safety at these levels on an outright and relative basis. Our path analysis that measures each individual stock against every other component of the FTSE 100 index suggests that Sainsbury’s is in the top ten of cheapest stocks collectively.

We have attached the full write of Sainsbury’s from last year at the back for the letter for further reading.

Previous write-up on SBRY from 2015 trade recommendationSainsbury (J) Recommendation (Again)


Price (£)Turnover (£mm)Net Income (£mm)Market Cap (£mm)Fwd P/E RatioDividend Yield (%)Payout Ratio (%)Total Debt to Total Equity (%)FCF to Market Cap (%)ROIC (%)

241.023,949.0716.016,874.6129.78.2%45.9%54.2%-4.9%1.5%

SAINSBURY (J) PLC

By Aalok Sathe FUND MANAGER AT HINDE CAPITAL

ORIGINAL INVESTMENT IDEA (DECEMBER 2014)

SAINSBURY (J) PLC

Sainsbury’s (SBRY) needs no introduction. A staple part of most shoppers’ diets over the decades, it has navigated the stagflation of the 70s, the 90s price wars and has embraced internet shopping online. Shopping habits have changed in recent years as efficiencies in distribution technology have enabled more competition and more consumer choice. We all know about the price sensitivity of the 99% – as the Occupy movement refers to the majority who experience income inequality – and this has seen an emergence of the discount stores’ winning market share. However, you may be surprised to know that Sainsbury’s has lost no market share on a revenue per share basis! Although Tesco may be down 44% year to date, at its lows Sainsbury’s was down nearly 40%. So what gives with Sainsbury’s?

The UK grocery market has been the subject of two major competition inquiries in recent years.

In October 2000, the Competition Commission completed the first of these and it led to the creation of a Code of Practice to regulate the relationship between the largest supermarkets and their suppliers.

However, the OFT received many complaints that the Code was not preventing supermarkets exploiting some of their suppliers, and putting many small shops out of business. In May 2006, the OFT referred the market to the Commission for a second time. In April 2008, the Commission completed its inquiry, concluding that in many respects UK grocery retailers were “delivering a good deal for consumers”, but that action was “needed to improve competition in

local markets and to address relationships between retailers and their suppliers”, including a strengthened and revised Code of Practice to be enforced by an independent ombudsman.

The outcome of this inquiry has benefited supplies by preventing supermarkets from passing on unexpected costs to suppliers, which means in the latest price wars they cannot price gouge their suppliers anywhere to the extent that they used to be able to. Of course, this means they cannot maintain their margins so easily in these new price wars. This has a structural impact on the sector, but we believe SBRY is more immune and can survive and thrive in this environment.

The last albatross in the Antarctic is most probably aware now of the dismal state of affairs of the UK supermarket sector and the price wars with the dreaded discounters Lidl and Aldi. Whilst Tesco has seemingly borne the brunt of the problems, Morrisons and SBRY have had their fair share of misery.

They have all managed to take the standard non-cyclical defensive business model – selling the basic essentials of foodstuffs (yes we know, there is more to them than selling food) – and turned their businesses into troubled going concerns.


Current Market Share vs 2007 Market Share for the Supermarkets

SBRY currently is our highest ranked stock from the FTSE 100 on the Hinde Dividend Value Matrix ® with an outstanding score of 62.40. Despite the high-rating ‘accolade’ HDVM ® has given it, this is partly a reflection of the dire share price performance over various time frames, down over 32% year to date.

A backgrounder on Sainsbury’s

Established in 1869 at 173 Drury Lane in Holborn, London, as a partnership by John James Sainsbury and his wife, the trading motto was “Quality perfect, prices lower”. At the time of his death in 1928, there were 128 shops and when the now limited company went public in 1973, it was at the time the largest flotation on the London Stock Exchange.

Today, SBRY has 161,000 employees referred to as ‘colleagues’, almost £25bn in revenue and £800 mm in net income with 16.1 % of the UK supermarket share. Its store sizes’ vary from 10,000 to a colossal 100,000 square feet. While much has been written about the huge, out-of-town hypermarkets and how most of them are not suited to the needs of today’s shoppers, almost half of their stores are Sainsbury’s ‘Local’ convenience stores.

SBRY isn’t just a food store. Its diversification seems unending from Sainsbury’s fuel, pharmacy to bank

and mobile services – it truly caters to a broad spectrum of our daily necessities.

In 2007, the share price was close to 600p, close to a 20-year high, but today it is back to the 2003 lows. Talk about a reversal of fortunes – what happened? Many businesses outlive their sell-by date through the natural passage of time due to new technology or changing consumer preferences, but it really shouldn’t be the case with a 150-year-old retailer of a basic necessity like food. No, for this reversal in fortunes, you need a bad business plan and a tried and tested recipe for failure like ‘believing in your own b***shit’.

There is no quicker way to lose sight of the core fundamentals than to employ a policy of rapid expansion and acquisition. Just ask Fred ‘the Shred’ Goodwin of RBS infamy. Sainsbury’s and Tesco opened new stores at breakneck speed from 2005 to 2009. This turned out to far exceed the customers they pulled in – making a mockery of their research forecasts.

Anyway, if you build more shops than customers, guess what, no profits! Likewise, following a similar

ORIGINAL INVESTMENT IDEA (DECEMBER 2014)

SAINSBURY (J) PLC


line of thought on expansion, a large store at Sainsbury’s store has a 30,000 product line – only 20% are their own label. Too much.

These are known as SKU’s or Stock Keeping Units. A SKU is a store’s catalogue product and service identification code – think machine readable bar codes – that get swiped at checkout. They refer to any billable products which the suppliers can also track within their data management systems, enabling just-in-time inventory. So while SBRY are clearly catering to its wide customers’ needs, the shop clearly has too much overcapacity. There is a cost issue trying to manage so many SKUs. On the other hand, the two main discounters Lidl and Aldi have an average of only 1000-3000 lines.

Walk into Sainsbury’s today and try to buy tomato ketchup for instance. You will have not only the choice of brands, but also a ridiculous array of sizes and packaging to choose from – up to 20 lines. Go into a Lidl and you will only have one or two choices. It should come as no surprise that economies of scale and margins have been squeezed.

The food retailer spectrum ranges from the cheap-no-frills discounters of Aldi and Lidl, through the mid-range of Asda, Tesco and Sainsbury’s, to the most expensive ‘posh’ food retailer of Waitrose. Sainsbury’s are generally considered to be the best of the mid-range providers; however, the middle is being squeezed.

The Great Middle

• The Trussell Trust, a food bank charity, recently reported that it handed out 913,000 food parcels in the last year, up from 347,000 the year before.

• In the weekend’s ‘Financial Times’, an article discussed how the demand for first-class air travel is taking off with the aviation data company OAG showing a 34 per cent rise in the number of first-class seats on planes departing in 2014, compared with 2009.

• According to the ‘Evening Standard’ last week, Britons are suffering the most severe decline in real earnings since Victorian times, with workers in the UK facing the seventh consecutive year of falling real earnings.

Human nature as it is, unfortunately makes poor decisions when everything is going well and much better decisions when the proverbial has hit the fan. Today, let’s just say the fan is fairly messy to say the least. According to 'Healey’s Law', named after British politician Denis Healey, the best way to dig oneself out of a hole is to stop digging.

In the latest interim report, Sainsbury’s CEO Mike Coupe announced it would be undertaking a complete strategic review covering dividends, business strategy and capital expenditure. The group has stated that they are confident in their accounting process – it's a very ‘rigorous process’ – and will:

• Deliver cost savings of £500mm over the next 3 years • Reduce capital expenditure to two per cent of sales• Fix dividend cover at 2.0 times underlying earnings• Continue to diversify into growing non-food areas• New pricing policy will Brand Match to Asda and no

longer Tesco• SBRY are on average 50% cheaper on brand match

comparison

It appears the digging may have stopped and better decisions will prevail, as a result of the low share price.

The recent joint venture with Danish discount chain Netto is SBRY's move to capture more of the £10 bn a year UK discount sector. With Netto initially based in the north of England where SBRY is weak, this looks a reasonable venture.

Although Tesco’s dividend cut came to a resounding fanfare, Sainsbury’s have made sure all the analysts have revised down their final dividend payment to 8p from 12.3p, despite the interim being unchanged recently. This will still make the dividend yield around 5.5%.

SBRY might not have lost market share like Tesco, but again analysts are concerned that margins can’t regain the +5% level of a few years ago for the industry as a whole. However, despite the low EBIT margin we believe the differentiation we mentioned means SBRY doesn’t have to enter into price wars as

It would appear that QE programmes employed by the world’s central banks are really making the rich richer and the poor poorer while wiping out the middle classes.


much as the other players of the Big Four – Tesco, Asda and Morrison’s.

Analysts’ Corner

In our External Analyst scoring system, Sainsbury’s lies at 44.55, which is in the bottom third of the index. The general analyst consensus has been very bearish (with 17 out of 24 analysts giving a hold or sell recommendation). However, the score has been turning more positive over the past month. The average 12-month target price (TP) is 262.35p, a 12.4% upside from current levels. The firm’s current valuation metrics look severely beaten up due to structural changes that the grocery industry is going through.

Our external analyst scoring system* places Sainsbury’s at 44.55 (range 30-70), which is a negative position. This score has become more positive relative to a month ago with analysts seeing improved conditions.

*(Please see the Portfolio section for a description).

HOT OFF THE PRESS

At the time of publishing this letter we saw rumours of activist’s buying stakes in SBRY:

• UK activist investment fund Crystal Amber (CRSL.L) is in talks with several overseas investors about buying shares in Sainsbury's (SBRY.L), as part of a plan to shake up the food retailer that could cause a takeover bid to be made, The Sunday Telegraph newspaper said

• Some 26 per cent of Sainsbury’s equity is owned by the Qatar Investment Authority, which walked away from a possible takeover in 2007, while the different parts of the Sainsbury family own around 11 per cent

• We think the activist talk is just that, mainly ‘talk’, but it does highlight the vulnerability of SBRY’s too aggressive external interest seeking corporate restructuring and break-up value

Summary

Is Sainsbury too contrarian an investment play? Is it a value trap? In short, has the price fallen to bargain basement levels?

It may well be seen as a contrarian play but some of the best investments often are. Sainsbury’s is paying a dividend of over 5% for the time being. It is not at the mercy of the price wars. It is cutting costs, it is taking note of what the growing competitors are doing and continues to diversify. The current price provides excellent protection – a margin of safety with a tremendous amount of bad news priced in. We believe SBRY is a very cheap defensive high yielder and so is a good addition to the HindeSight portfolio this month.


INVESTMENT INSIGHTS

The analytical research that we have developed at Hinde Capital over the years has had many sources

of origin; hopefully, some more original than others. Certainly, some of the stock picks and timing has proved out much of the work in the real world of profit and loss.

One such analysis, which we refer to in-house as the ‘Path analysis’, has been derived from a problem that was first recorded in the 19th century as the ‘Travelling salesman problem’.

Mathematicians W.R. Hamilton and Thomas Kirkman formulated the problem in the 1800s but it has been

increasingly of interest since, with institutions like the Rand Corporation offering prizes for any progress on the puzzle.

The simple observation that one first goes from a starting point to the closest point, then to the next closest point, and so on, does not generally yield the shortest route. Hence, the need for a suitable solution.

For decades, algorithms have been sought that look for exact solutions rather than just brute force trial and error. Despite the rather dated thought of a travelling salesman plying his wares across the country, this problem is all around us in the modern world. Whether it is the connection of electrical cabling, Amazon delivery drivers’ routes or the flow through in-chip circuitry, there is continued interest in making improvements.

Prim’s algorithm is a mere footnote in the history of the problem, but the concept of minimum spanning trees have ignited some ‘Eureka’ moments in the Hinde Capital office when we were looking for alternative mean reversion measurements across the UK FTSE equity components. While many analysts look at specific individual companies and make evaluations about their value, our research has focussed on looking at every single stock in the index, as we believe the performance across the whole spectrum will tell us much about both the UK economy as a whole and the cycle it is following.

We are constantly looking for ‘cheap’ large stocks, with a margin of safety, that are temporarily out of favour and have either cyclical poor margins or built-in bad news. While our analysis does focus on the potential for growth, this pales in comparison with our focus on value.


The Hinde Capital Path analysis starts with the assumption that every stock in the index has a relationship with every other stock as a series of pairs, e.g. SHELL-VODAFONE. We can measure the ‘distance’ between the pairs in many similar ways to Prim’s minimum spanning tree. Readers may prefer to think of the SHELL-VODAFONE as an orbiting pair of planets in the galaxy.

If we just use the FTSE 100, we have (100*100)/2 = 5000 paths or orbits to consider, SHELL-VOD being the same as VOD-SHELL. However, if we use the FTSE 350, we have 61,250 paths to consider. As you can imagine, the computing/coding power needed is quite different.

In selecting the ‘top 20’ cheapest stocks by the Path analysis, we make various measurements and observations. Unfortunately, we can’t give away the exact details of our proprietary process but the crux of the analysis is:

• The path analysis does not focus on whether a certain stock is distant/cheap in orbit from the index. It focuses on how the stock’s orbit or path is relative to every single other stock in the index independently, either with 5000 paths to consider or 61,250.

N.B. In all aspects of finding ‘value’ through mean reversion, whether it is comparative market capitalisation or orbiting paths, the assumption that ‘gravity’ will prevail does not always happen, i.e. when stocks go to much lower values (out of their regular orbit) or even zero, like Carillion. It is extremely important to have rigid stock losses in place to reduce this risk. We always exit losing positions at 25% losses without hesitation, and that applies to both HindeSight letter recommendations and Hinde Capital’s models. No stock that is deemed to be ‘cheap’ by our models should lose that much without a need to exit and re-evaluate.

Current Path Analysis for FTSE100


UK MARKET VALUATIONS

PORTFOLIO UPDATE - WHAT HAPPENED?MARKET & SECTOR ANALYSIS

UK INDICES PRICE/EARNINGS RATIO PRICE/BOOK RATIO DIVIDEND YIELD(%)

FTSE 100 INDEXFTSE 250 INDEX

16.7422.77

1.671.68

4.86%3.54%


HINDESIGHT DIVIDEND UK PORTFOLIO # 1 (MARCH 2019)PORTFOLIO UPDATE AND CONSTRUCTION

No Dividents for this month

PORT

FOLI

O

UPD

ATE


Highest ranked (‘cheapest’) stocks selected from the FTSE350 universe (as 31ST of March 2019).

Tickers Model Score Trend Index SignalWMH LN EQUITY 60.36 2.79BATS LN EQUITY 59.58 4.07HFD LN EQUITY 58.16 1.69CEY LN EQUITY 57.95 2.86

VOD LN EQUITY 57.82 2.88PTEC LN EQUITY 57.61 1.96WPP LN EQUITY 57.35 1.72888 LN EQUITY 56.6 1.26 Trend Ready/RSI OversoldPFC LN EQUITY 56.31 4.09BAB LN EQUITY 55.71 2.25INCH LN EQUITY 55.66 1.56ELM LN EQUITY 55.46 2.84CNA LN EQUITY 55.23 3.14

SMDS LN EQUITY 54.97 1.27TED LN EQUITY 54.86 2.05

GFRD LN EQUITY 54.51 1.8KGF LN EQUITY 54.45 2.34

SBRY LN EQUITY 54.37 3.71BA/ LN EQUITY 54.27 2.8PZC LN EQUITY 54.22 2.71

STAN LN EQUITY 54.11 0.98 Trend Ready/RSI OversoldGFS LN EQUITY 53.88 2.33WG/ LN EQUITY 53.87 2.51RTN LN EQUITY 53.86 3.47AV/ LN EQUITY 53.84 1.55HTG LN EQUITY 53.78 1.48PPB LN EQUITY 53.46 2.83GVC LN EQUITY 53.31 2.96SXX LN EQUITY 53.13 1.19

MGAM LN EQUITY 52.99 0.59

CURRENT EQUITY FACTOR MODEL


We passionately believe that dividends really,really matter. William Thorndike in his fascinating book

'The Outsiders- Eight Unconventional CEOs and Their Radically RationalBlueprint for Success' examined one of the most impor tant aspects of running a business a CEO must undertake: Capital Allocation. He summarised how a CEO deploys capitalin 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 let ter

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 untilwe create a portfolio of 25 UK dividend stocks. This will be the HindeSight UK Dividend Portfolio #1

• You wiII bealerted 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

• Theentry points willthen be recorded in the next month ly in the HindeSight UK Dividend Portfolio section and the stock(s) wr itten 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, (HDVMdl), a proprietary stock-rating system

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

APPENDIX I

THE WAY 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.

APPENDIX II

HOW WE THINK


The basic premise of the strategy is to accelerate returns by selecting relatively high yielding stocks that 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 cash flow 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, Cash flow 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.


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

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 30-702. 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.

EXTERNAL ANALYST SCORE (EAS)

OVERVIEW TOP NEWS FEED - Hinde Capital · Sainsbury (J) has traded between 210 to 340p and Vodafone...

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