HL SELECT UK INCOME SHARES

Provident Financial Update

Managers' thoughts

Important information - The value of this fund can still fall so you could get back less than you invested, especially over the short term. The information shown is not personal advice and the information about individual companies represents our view as managers of the fund. It is not a personal recommendation to invest in a particular company. If you are at all unsure of the suitability of an investment for your circumstances please contact us for personal advice. The HL Select Funds are managed by our sister company HL Fund Managers Ltd.

Steve Clayton - Fund Manager

23 August 2017

A second profit warning from Provident Financial has caused sharp falls in the stock, in which we had a 2.9% position. Because of conservatism in the way we set our original targets, we still expect to declare dividends of 3.9p per unit in the fund’s first twelve months (variable and not guaranteed).

What did Provident Financial say?

The group had previously revealed (on 20 June) that it was experiencing problems with the transformation of its Home Collected Credit business, and at that time said profits for this division were likely to be reduced to around £60m. Yesterday it announced that the collections performance has deteriorated further, meaning the group now expects this division to make a loss of between £80m and £120m.

The group also disclosed, for the first time, that the Financial Conduct Authority (FCA) has concerns over its Vanquis Repayment Option Plans. While the FCA investigates this issue, Vanquis Bank has agreed not to pay dividends to the parent company. As a result the group no longer expects to pay a dividend this year. Provident Financial yesterday revealed that the FCA’s concerns were first raised with the Group in April of last year.

What is our view?

This announcement is deeply disappointing. Our reasons for initially buying into the company were predicated on its tremendous track record of cash generation and dividend payments to shareholders and the group’s ability to generate high returns on equity, in both good times and bad.

As we discussed in previous blogs, after speaking to the company we had expected the problems in the Home Collection division to be manageable and that after a period of time bedding in the new business model, the company would be back on an even keel. This assumption proved to be wrong.

Clearly the company faces a substantially greater challenge, following their latest revelations. Cash generation in the near to medium term will be severely constrained, and the company will need to prioritise securing additional funding in order to shore up its balance sheet.

At the time of writing our weighting in the company stands at around 1%. Our aim for the fund is to invest in companies that can sustainably grow their cash flows and dividends and Provident Financial no longer fits with that objective. At the same time it is our duty to try and achieve the best possible exit price for our investors, so we will not engage in a knee jerk reaction. We will update investors once a decision has been taken.

What does it mean for the fund’s dividend?

Despite this setback we remain confident of meeting our income and long term capital growth targets. When we set the income target for the fund we were conservative in our projections. As a result of this, we expect to declare a dividend for August of 0.3p, followed by a significantly larger final dividend payment for September to mark the end of the financial year.

Our dividend projection at launch was for a total dividend in the first twelve months (i.e. all dividends declared up until the end of February 2018) of 3.9p per unit. We still remain confident of meeting this projection, though of course it is not guaranteed.

While the news from Provident Financial is very disappointing, it must be seen in the context of the overall portfolio. Our fund is relatively concentrated, which allows each holding to make a difference to returns but can increase risk.

Of our remaining 27 holdings, 2 (AstraZeneca and GlaxoSmithKline) have maintained their pay-outs, while the rest have all grown their dividends. Nine have announced double-digit increases. These dividend performances will more than make up for the loss of income from Provident Financial, which shows the benefit of running a diversified portfolio. Remember, past performance is not a guide to the future.

In next week’s blog we will provide a full breakdown of the portfolio, highlighting the fund’s total dividend progression from each of our holdings since launch.

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