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Monthly Report: International Fund July 2018

31/07/2018
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International Fund July Monthly Report

It’s not often a company’s share price gets hammered on announcing a 64% increase in sales, but that’s what happened to Just Group (LSE:JUST). The UK annuities provider is operating in a buoyant market for its products.

Total annuity sales in the first half of 2018 were 64% higher than the previous corresponding period. Margins were healthy and management is saying the buoyant market is allowing it to be “even more selective on pricing”.

The share price, though, is down 28% since the middle of May. That’s because of a discussion paper released by the UK insurance regulator, the PRA. Just invests roughly 30% of its annuities proceeds in equity release mortgages, loans to older people against the value of their homes. A key feature is that the borrower doesn’t ever have to pay interest — it is added to the loan balance for the remainder of their lives. And they never have to pay back more than the value of their houses. While typical loan to value ratios start at around 20%, if a borrower lives for a long time and house prices fall, Just could conceivably lose some of its principal.

Just holds excess capital to protect against this risk but the PRA thinks it and its peers should be holding a lot more. Under the worst case scenario considered in the PRA discussion paper, Just could need to raise a quarter more capital than it has today (on which it will earn very low returns).

Responses are due by 30 September and the PRA will make a final decision by 31 December. We are hoping the proposal gets watered down and are expecting some transitional relief but this is not good news. The shares are still a bargain, but such a large increase in capital would seriously crimp the upside.

Petroleum Geo-Services (OB:PGS) has seen its share price more than double since Christmas. Its second quarter result justified optimism. The company owns vessels that tow streamers around the ocean collecting data for oil and gas exploration. Thanks to an improving oil market, demand is slowly increasing for its vessels and increasingly robust for its historical data. Prices are up 25% in the past few months. With the current global seismic fleet half its peak of a few years ago, there is a high likelihood of further increases.

Even in an improving market, PGS only expects to break even this year and should be “cash flow positive after debt servicing”. It needs to do a lot more than that to justify today’s significantly higher valuation. While 2019 is shaping up as a much better year, we have reduced the portfolio exposure over recent months.

On to Alphabet Inc. (Nasdaq:GOOG). This month the owner of the Google search engine copped the largest ever antitrust fine handed out to a company by Europe’s competition watchdog. It’s not all bad news though. Alphabet reported its second quarter earnings in late July and the market was pleasantly surprised. Revenue was 26% higher than last year and while the cost of acquiring search traffic has increased over the period, the increase was below expectations.

Meanwhile the “Google of China”, Baidu (Nasdaq:BIDU), continues to grow rapidly. Second quarter revenue from Baidu Core was up 28% from the same quarter last year. Core operating income increased 30% to RMB6.7bn, an operating profit margin of 34%. Baidu Core excludes the company’s stakes in separately listed internet video business iQiyi (Nasdaq:IQ) and online travel seller Ctrip.com (Nasdaq:CTRP), but still incorporates significant loss-making investments in areas like driverless cars and artificial intelligence initiatives. Baidu’s real core, search, generates even more impressive margins.

The good news was offset by credible reports that Google — absent from China since 2010 — has been working on a censored version of its search engine that might be palatable to China’s heavy-handed regulators. We’re not terribly concerned, Baidu will prove a formidable incumbent. But given the choice between competing with Google and not competing with Google, we’d take the latter.

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