Note on CIL & Why We Sold

Copied here below is an excert from a note I sent out to AWSM Fund investors this morning. You can download the full note over here.

“Consolidated Infrastructure Group Ltd (‘CIL’) had been an investment in AlphaWealth Prime Small & Mid Cap (AWSM) Fund for a number of years. It no longer is.

Allow me to explain our change in opinion on this investment.

 

Why did we hold CIL?

Originally, we saw CIL’s core value residing in its Conco subsidiary. Conco is involved in pan-African power infrastructure and has a high-growth order book with large parts of this in USD’s. The Group was relatively geographically diverse and, with its other business units, offered a unique investment proposition on an undemanding multiple.

Unfortunately, over the last almost two years, CIL had a large chunk of its domestic order book exposed to the Eskom renewable sector. For various—most likely political—reasons, Eskom has still not executed on these orders. Coupled with holding the expensive overheads ready for these orders, CIL also found itself exposed to a strong ZAR (hurting the profitability of its USD-revenues with mostly ZAR-costs) and its Angolan oil services business felt the brunt of a lower oil price.

All these things combined to see a softer H1:17 financial result and, thus, it did not surprise us much when CIL reported its FY 17E full-year trading update and things remained bad. At this point, CIL reported that it expected HEPS to be down by between -25% and -35%. This was a bit worse than expected but remain within a reasonable range given the above headwinds.

At this point in time, it is worth reminding you that even the best businesses can go through bad times. Macro-headwinds are not always reason enough to sell an investment that has proven itself over time and offers unique exposure unreplicable elsewhere.

Rather, what we did at this time was risk-management: We stopped materially adding to our CIL position at this point and, in some instance, sold small chunks of it in the market. This was to manage our exposures, weightings and the portfolio’s ultimate risk.

 

Why did we sell CIL?

But then CIL released an unexpected “Further Trading Update” on the 8th of November 2017. This new announcement indicated that management now believed that their FY 17 HEPS would be between -50% to -55% down. Given that the previous trading statement was issued at year-end, this dramatically worse revision to it indicated a range of things, of which none of these was good.

More importantly, this revised trading update was not driven by macro cause nor any of the reasons counting against CIL that we could forgive the Group for. This further revision began to drive holes in our argument for the quality of CIL as an investment.

Hence, at this junction, we sold a good portion of our CIL investment. We decided to wait until we had the full results to make a complete decision, but that it was also prudent to take a large amount of risk off the table while we waited.

And that brings us up to yesterday where CIL announced yet another revision to its trading update. The problem was now that management saw HEPS as at least -55% lower for FY 17. Furthermore, they listed a number of reasons (some accounting-base, but many were also operational!) why this update was worse and how they could no longer quantify how much worse it was.

On this news, we sold our final stake in CIL.

Why, when it had already fallen so far?

Firstly, a stock that has halved, can always halve again. At least at these levels, we had the confidence in getting capital back while not carrying the increasingly risky investment.

Secondly, we have repeatedly stated how our investment methodology revolves around selecting high-quality businesses (our so-called ‘quality-bias’). As I have said above, while good businesses can go through bad times due to macro-headwinds, CIL’s two further trading updates indicated much more company-specific problems and, ultimately, made us unable to justify it as a quality business anymore.

Therefore, it did not fit our methodology anymore. And, hence, we sold it.”

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