Cube Midcap Report (6 Feb 2020) – Royal Mail losing to text messages #RMG #ASHM #FUTR

Cube Midcap Report (6 Feb 2020) – Royal Mail losing to text messages #RMG #ASHM #FUTR

Good morning!

Today in the world of mid-caps, we have:

  • Royal Mail (RMG)
  • Ashmore (ASHM)
  • Beazley (BEZ)
  • Future (FUTR)
  • Compass Group (CPG)

Finished at 1pm.


Royal Mail (RMG)

  • Share price: 173.5p (-8%)
  • Market cap: £1.7 billion

Trading update

Do you remember the 2013 IPO of Royal Mail?

It was criticised (see here and here) for being a “botched fire sale”. The 330p issue price was seen in some quarters as a bargain.

Fast forward seven years and the market profoundly disagrees with those views.

While the company has paid large and regular dividends, they are mere consolation prizes for investors nursing a capital loss of nearly 50%.

What’s gone wrong?

In October 2018, RMG issued a major profit warning. It warned that UK productivity was “significantly below plan”, that costs would be higher than expected, and that letter volumes were falling at 7% (versus medium-term guidance of -4% to -6%). The decline in letter volumes was attributed to “ongoing structural decline, business uncertainty and GDPR”.

Today’s update

Recent performance is “broadly” in line with expectations (i.e. a little below expectations).

Adjusted operating profit for FY March 2020 should be within a range of £300 to £340 million, before IFRS 16. This is the same as the range given in the half-year report.

Communication Workers Union is balloting for industrial action. This was already known:

UK revenue generation (adjusted for the number of working days) is not doing too badly: +2.1%.

The scary number is probably the change in letter volumes: down 8%. Again, this is worse than the company’s historic medium-term guidance.

Revenue from letters is down by only 0.4%, despite the 8% decline in volumes. I guess this is due to price inflation?

And can you blame people for sending fewer letters, if the price is going up so much? Price changes in 2019 for stamps were very significant.

Parcel volumes were lower than expected, except around Black Friday. RMG takes a swing at the unions for driving away business, though I’m not sure how they would be able to measure this so precisely:

Due to the risk of industrial action, some customers switched volumes to other carriers. This reduced parcel revenue growth by approximately 0.5 percentage points.

Outlook for FY March 2019 – productivity improvement is running at 1.3%. RMG hopes this will improve to 1.5% for the full year, which is still below the 2% target.

Outlook for FY March 2021 – outlook is “challenging”.

  • Letter volumes not recovering as expected. Now expected to be -7% to -9%.
  • UK operations might be loss-making due to industrial relations environment and economic uncertainty.
  • RMG’s ability to hit 2024 targets will be “compromised” unless transformation plan moves forward.

My view

This looks to me like a potential value trap.

Investment software will say it’s at a P/E multiple of 12x and a dividend yield of 8%. I would worry that neither of these metrics are reliable.

Outstanding borrowings aren’t too heavy (£440 million as of September), but the pension schemes require payments of £400 million this year alone.

The two largest defined benefit schemes add up to nearly £11 billion in assets and a similar value of liabilities, according to actuarial calculations.

In summary, I can agree that RMG shares are “cheap”, but I think they are cheap for excellent reasons. It’s hard to generate a competitive advantage in the logistics business. And far from having a competitive advantage, Royal Mail seems to have competitive disadvantages due to its labour relations and legacy commitments.

In its own words, the company describes why I wouldn’t bother investing in it:

…in today’s postal market, our customers have choices. Consumers can send a text or email when they would once have written a letter; and shippers can choose from a wide range of delivery companies, not just Royal Mail.


Ashmore (ASHM)

  • Share price: 576p (+4%)
  • Market cap: £4.1 billion

Half-year Report

I covered this emerging market asset manager’s recent trading update here.

Today’s report confirms and expands on the good news in that update. AuM is up 28% year-on-year, to $98.4 billion.

Fund performance is still excellent over 5 years, but weak over 1 year (due to “adding risk at attractive price levels”).

Financial result

This company is wonderfully profitable. Today’s result demonstrates more operational leverage as higher revenues convert to profits:

  • net revenue up 20%
  • adjusted EBITDA up 24%
  • PBT up 42% (including gains made from seeding its own funds)

The adjusted EBITDA margin is an astonishing 69%.

Market review – returns across EM asset classes were positive, “continuing the broad-based rally that began in early 2016”.

Market outlook – is good (as usual!)

The outlook for Emerging Markets remains positive, and while economic and market cycles are inevitable, there continue to be strong incentives for global investors to increase allocations to Emerging Markets in pursuit of higher risk-adjusted returns than are available today in the developed world capital markets.

I agree with this and it’s one of the reasons I’m bullish on Ashmore’s long-term outlook. Institutional investors will increasingly want to access emerging markets, but they need specialist expertise to help them do it – that’s where Ashmore comes in!

Ashmore cites IMF forecasts (I’m not sure how valuable these are) which predict that EM should deliver GDP growth of +4.6% in 2020 (versus 1.7% in the developed world).

As someone who takes a keen interest in China, I think that EM economies are certain to continue narrowing the gap versus the developed world. This explosion in wealth means that EM investment opportunities will continue to multiply:

This favourable picture for Emerging Markets contrasts with the structural growth impediments, such as high indebtedness, and late-cycle valuations in many Developed Markets and their ongoing political risks, particularly in the US given the presidential election later this year.

My view

I haven’t got the time to go through this statement today with a fine-tooth comb, but I do aspire to add Ashmore to my portfolio at some point in the next 12-24 months, depending on valuation.

It currently trades at a P/E multiple of c. 18x. Its rich cash position (£427 million as of December 2019) needs to be taken into account.


Beazley (BEZ)

  • Share price: 581.5p (+9%)
  • Market cap: £3.1 billion

Results for the year ended 31 December 2019

A quick word on results from this specialist insurer.

What’s noteworthy about this result is that total profitability has spiked, despite a failure to generate any profits from the insurance business.

The combined ratio (losses and expenses as a proportion of earned premiums) increases to 100%, from 98%.

This means that losses and expenses wiped out all of the company’s insurance earnings for the year! There were “intensifying claims across several lines of business“. US jury awards get particular blame for this, especially for cases to do with US hospitals.

There is evidence of a “change in sentiment against organisations that are perceived to have failed to protect customers or investors (or patients in the case of hospitals)“.

But insurance rates do seem to be rising, in response to the higher claims environment. Beazley reports rate increases on renewals of 6%.

Investments – where the company succeeded this year was its investment returns. It now has a $5.9 billion portfolio after generating 4.8% in 2019 (versus only 0.8% in 2018).

I would caution that these returns are probably not sustainable.

82% of Beazley’s portfolio is in debt instruments, and these instruments returned 4.3% in the year, “well above the level of yields at the beginning of the period”.

What happened was that bonds went up in value, as “declining yields and narrowing credit spreads generated capital gains on our portfolio“.

I don’t think I’m going out on a limb when I say that future expected investment returns are now lower, as a consequence of bonds becoming more expensive.


Beazley expects “an improved underwriting performance in 2020, with further improvement expected in 2021”. Rates are rising, and where rates are not rising sufficiently it will say no to the business:

We are now part way through a broad-based turn in the market, with rates rising steeply across many lines of business. Over the past two years, we have seen premium rates on renewal business rise cumulatively by more than 10% for half of our book. We expect rates to continue to rise through 2020…. However, we continue to believe that some business remains underpriced, notably in the property and treaty reinsurance markets, and our underwriters will continue to walk away from business that does not meet our requirements.

The CEO says:

“…we expect to be able to achieve a combined ratio in the low 90s in the medium term (barring, of course, exceptional catastrophe losses). However, a combined ratio in the mid-90s is a more realistic expectation for 2020 subject to a more normalised claims environment.”

My view

I take an interest in this sector and would back Beazley to return to healthy profitability.

Unfortunately, this appears to be the consensus view as the shares are priced at 2.7x tangible book value.


Future (FUTR)

  • Share price: £11.68 (-2%)
  • Market cap: £1.1 billion

Capital Markets Day

Future shareholders are furiously refreshing the investor relations section of the company’s website, as they wait for the presentation and video recording of Future’s Capital Markets Day to be uploaded.

I maintain the view that Future is probably not a very high-quality business, and it’s probably overvalued.

And I’m happy to recommend the podcast that Tom Winnifrith recorded with Matt Earl recently (here’s the link). Matt is the managing partner of the fund which recently launched a short attack on the company.

Future’s response has been excellent so far, in two very important respects: it hasn’t named the shorter and it hasn’t struck an angry or offended tone. Instead, it is quickly providing the market with more detail about its strategy. As I said on Twitter this morning, this is much more professional.

When you see companies starting the corporate equivalent of a flame war, it’s usually a sign that the shorters are right!


Compass (CPG)

  • Share price: £19.4o (+2%)
  • Market cap: £30.8 billion

AGM and trading udpate

The outlook at this giant support services business is unchanged.



It’s time for lunch now. Thanks for dropping by and see you tomorrow!






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