In August, facing very volatile markets, we reduced exposure to emerging markets, notably in China. The collision of two high speed trains in China was the catalyst to reduce exposure to high speed rail related sectors in China. The train collision killed at least 36 people and injured 210, prompting the Railway Ministry to call for a two-month inspection of rail safety and to postpone the tenders for new railway equipment. We sold off the holdings in China Automation, CSR Corp and ZhuZhou CSR Times Electric. Additionally in August we reduced exposure to Europe both in terms of fixed interest denominated in euro and European listed equities. However, we initiated a position in Philips Electronics (Netherlands).
Positive on Philips
Phillips is a leading global manufacturer with a focus on lighting, medical devices and consumer electronics and domestic appliances. The company, led by a new management, has recentlyembarked on a landmark corporate change programme to improve business processes, cost structures and returns. Philips is a global leader across most segments of the lighting market and stands to benefit from the shift from inefficient incandescent lighting, where a very high proportion of energy is lost, to compact fluorescent or LEDs (light emitting diodes). Notably, lighting accounts for 16% of electricity consumption in the UK and 19% globally, therefore efficient lighting is key to reducing both energy consumption and carbon emissions.
What about wind and Vestas?
It is true that at current levels (around DKK70-80), Vestas is well below credit crunch levels (around DKK250) but still falling. Without a clear catalyst, it feels nothing more than a value trap.
After the last profit warning, management revised guidance down significantly: Financial year revenue guidance cut from €7bn to €6.4bn and margin guidance lowered from 7% to 4%. As a capital goods stock Vestas trades on the progress of the order book. Vestas’ order intake has been very week and deteriorating. They also face rising raw material prices (steel and carbon fibre), intense competition and unfavourable currency movements. In addition, credit availability has affected customers and suppliers equally. All of these issues make the new targets more challenging to meet in our view. We still see risks to further downgrades by analysts. Net debt has more than doubled lately and cash burn remains high with assets underutilised. While the company is reducing personnel, there is no clear target for cost savings.
Longer term, it is concerning that Chinese manufacturers are beginning to gain traction outside China through disruptive pricing. It is a similar scenario to the solar sector. The risk of buying now is being too early as the share price continues to deteriorate. In addition, management has been slow in communicating the issues to the market. Management does not seem proactive enough in these very tough market conditions. In summary, at Cheviot we feel that it is too early to be positive on Vestas in particular and the Wind sector in general.
Top Ten Holdings
Our top ten holdings are quite defensive currently with positions in water, health care and energy (hydro power and energy efficiency). Also as discussed before we do not have exposure to Japan. Regarding company size, we invest mainly in mid to large cap and we would not have a small cap company within our top ten holdings.
We have reduced our exposure to Europe and in particularly we have no exposure to the PIIGS countries, or companies like Abengoa which are based in Spain.
One of our defensive holdings is Pennon (UK). This is a “defensive growth” stock involved in water and waste in the UK. Its subsidiary, Southwest Water Ltd, is involved with water and sewage management in Devon, Cornwall, Somerset and Dorset. Its subsidiary, Viridor Waste Ltd, operates a resource recovery business with major activities in recycling and renewable energy generation. Pennon is well positioned on the water side to sustain growth and on the waste recovery side to benefit from increasing landfill scarcity and landfill tax as well as demand to generate energy from waste. Decent dividend yield at around 3.5%.