SCOTGEMS From: ScotGems plc
LEI: 549300GQHCPU9P1NYM13
Date: 11 March 2022
Results for the year ended 31 December 2021
The Directors of ScotGems plc (“the Company”) are pleased to announce the Company's results for the year ended 31 December 2021.
- The Company’s objective is to provide long-term capital growth by investing in a diversified portfolio of small cap companies listed on global stock markets across a range of sectors.
- During 2021 the share price fell by 0.7% and the Net Asset Value (“NAV”) rose by 8.2%.
Chairman’s Statement
The disappointing performance of your Trust in both absolute and relative terms since inception is attributable to the Managers’ cautious approach to investing the initial funds raised at a time of rising markets, and its subsequent geographical allocation. In particular, their focus on corporate governance — firmly endorsed by the Board— has led them to have a minimal weighting in China. Valuations in South Korea and Taiwan also discouraged them from establishing significant positions in these very popular markets. The latter three Asian markets, which together accounted for nearly 50% of the MSCI Emerging Markets Small Cap Index and over 60% of the MSCI Emerging Index at the end of 2021, have been the primary driver of the whole emerging markets asset class over the last few years.
A substantial exposure to Africa, now significantly reduced, has also detracted from performance over all periods. Specifically, significant difficulties in convertibility of sales proceeds from Nigeria has resulted in the Trust making a provision of over 30% against remaining investments in that country. As will become clear in the following Investment Manager’s report, the content of the portfolio is driven by a bottom up, stock selection process and is not influenced by index weightings.
Quantitative easing has meant little attention being paid to sustainable cash flow generation in all markets. Many conceptually attractive but totally unproven smaller companies have, until recently, achieved astronomical valuations — hence the outperformance of the Emerging Markets Small Cap Index since inception and, most noticeably, over the last year.
The investment team at Stewart Investors running your Portfolio changed in late 2019. While performance in 2020 continued to disappoint, a positive NAV return was achieved in 2021, with the Manager’s emphasis on capital preservation and stewardship leading to much improved relative returns. The Board is pleased to see this trend being sustained in the volatile markets we have recently been experiencing. As significant shareholders in the Trust ourselves, we are aware that there is still considerable ground to recover and that better performance has yet to be reflected in the wide share price/net asset value discount now prevailing.
Your Trust currently has a portfolio of 40 companies, the market capitalisation of each being less than $2.5 billion at the time of investment. The Investment Manager has set out below a detailed description of the existing portfolio, as well as their philosophy in selecting the particular companies in which ScotGems invests.
Given the current focus on environmental, social and governance (“ESG”) investing within the asset management industry, our Investment Manager has set out on pages 14 and 15 of the Annual Report a detailed description of their approach to ESG and included a relevant case study. Stewart Investors’ investment philosophy has always been based on the principle of responsible stewardship, and they have long implemented ESG inputs as part of their investment process.
The conflict in Ukraine has quickly become an area of focus for the Board. We will continue to monitor any impact the conflict may have on the Company. However, the situation has highlighted how little the Board can do to mitigate against such geopolitical risks. We of course hope that a peaceful outcome can be found.
Until very recently, our Investment Manager had avoided direct investment in Russian companies largely on corporate governance concerns. Regrettably, on 24 February 2022, they bought a position (1.1% of Trust NAV) in a London-listed GDR of a Russian retailer called the Fix Price Group. The Board were very surprised with such a decision being made, and even more so that First Sentier Investors permitted such a trading instruction to be processed, in the prevailing circumstances. Given that stock market trading in all London listed Russian companies has subsequently been suspended, this investment is now held in the portfolio at nil value.
James Findlay has decided to stand down from the Board at the AGM in 2022. He has brought a wealth of experience to the Board of the Company, providing effective challenge and oversight of the Investment Manager since the Company’s inception.
The Board and Managers remain aligned with the body of shareholders through their own investment in the Company. The Directors (including persons closely associated with them) hold 2,290,096 Ordinary shares. In addition a further 2,500,000 shares are held by the Tam O’Shanter Trust, of which Angus Tulloch is the Chairman. The Investment Management Team have increased their shareholdings by 489,201 shares and now own 2,176,982 Ordinary shares, with a further 1,363,364 shares held by other Stewart Investors’ employees. Including shares owned by the Stewart Investors Employee Benefits Trust (unchanged at 5,000,000 Ordinary shares), this brings the total holding of Stewart Investors’ employees to 8,540,346 Ordinary shares. The combined holdings of the Board and Investment Manager now represent 24.9% of the issued Ordinary share capital of the Company.
On 9 March 2022 First Sentier Investors resigned from the management of the Company's portfolio. They will however continue to manage the Company's portfolio until alternative arrangements have been made (subject to a maximum period of six months). The Board has received interest from a number parties regarding the management of the Company’s portfolio, and the Board will communicate the outcome of these discussions in due course.
The Annual General Meeting will be held on 5 May 2022 at the London offices of First Sentier Investments. I look forward to seeing many of you there. This will be the first opportunity which we have had to hold such a meeting since the start of the Covid-19 pandemic. There will be a presentation by the investment team and an opportunity to question them in more detail about strategy and individual investments that the Company has made.
Investment Manager’s Report
Introduction
We wrote six months ago that ScotGems owns a lot of “jam today” companies – by which we meant well-stewarded businesses which we can value according to actual cash flows rather than hopes, dreams, and powerpoint presentations. It feels like owning “real” businesses could be coming back into fashion. Even modest increases in some central bank interest rates are focusing the mind on how to discount far-off predictions back to their value today. But fiddling with discount rates answers a very linear question. The more important and distinctly non-linear question is whether predictions for some of the most generously valued companies are plausible in the first place. Over?paying for growth is a “linear sin” – the sums change and clients lose maybe 20% or 30% or 50%. Paying anything at all for a concept which doesn’t come true is a “non?linear sin” – you lose nearly everything nearly every time.
Brasil always provides great examples of extremes. A high-profile example is playing out right now. At its listing in December 2021, “Nubank” was the most valuable financial company in all of Latin America. It is very “sign of the times”. Although a Brasilian business, it is incorporated in the Caymans and listed in New York. The founder has shares with 20x votes per share – an unusually high voting multiple even for fintech. It probably goes without saying that Nubank is backed by SoftBank’s deep but increasingly debt-funded pockets, and maybe also that “we have incurred losses since our inception, and we may not achieve profitability”. So if none of the above was a surprise in today’s enlightened times – what was? Well, it wasn’t that “total expenses for the 2021 contingent shares awards are expected to be approximately US$400-500m”. No, the surprise was that “None of our subsidiaries is licensed to operate as a bank”. At time of writing in late January, Nubank is merely the third most valuable financial business in Latin America – as it happens, both of the firms which have overtaken it have banking licences, make money hand over fist, and pay dividends. I can’t imagine either of them paying their hired hands half a billion dollars.
The small companies’ end of GEM doesn’t have quite such glamourous examples as Nubank but it is not short on conceptual valuations. The very nature of many smaller companies is that they make only one or two products, selling only to a handful of customers or to a single industry. The companies may be as honest as the day is long but they are risky. We don’t avoid companies with a narrow franchise but we do try to value them conservatively recognising that the famines between the feasts can last some time.
Our other area of concern is Indian valuations. India has a long list of high quality small and mid-cap companies but valuations are often excessive. The local retail investor has (re)discovered their appetite for risk, foreign investors are perhaps redeploying money from nearby communist regimes, and perhaps above all, money globally remains plentiful and cheap. ScotGems is the only portfolio we run from Edinburgh which is “underweight” what the benchmark says we should have in India. For our larger-cap portfolios we grudgingly accept the full valuations for large and diversified multi-billion dollar companies – qualitatively they are better than large-cap alternatives. In the smaller companies world of ScotGems we see Indian over-valuation as a bigger gamble – the smaller companies are typically less proven and narrower in franchise yet with no corresponding valuation discount. More importantly and more optimistically, we think we have found more attractive long term ideas elsewhere.
One idea added to the portfolio in 2021 was Prodia Widyahusada – a medical diagnostics firm. It is a family controlled Indonesian business which leads the market. We believe it has many years of growth ahead of it, not only via “classic” emerging market factors (rising wealth and growing population) but more importantly through the competence of its owner-managers. We acquired shares for the Trust at a trailing price-to-earnings multiple of just under 15x (or closer to 12x if adjusting for the net cash on balance sheet at the time) and its historic revenue growth was just shy of 10% in US Dollars for the previous three and five years. We considered this an attractive entry point. By way of comparison, the nearest Indian equivalent trades at nearer 75x trailing price-to-earnings. It has grown more rapidly – between 10-15% per annum for the last three and five years – but at 75x earnings this growth needs to carry on for a very long time indeed. One important difference between India and Indonesia is competitive intensity. Despite the attractiveness of the Indonesian market, Prodia faces only modest levels of competition. In contrast, India is to many the “last great untapped opportunity”. As a result, every man and his dog (and the dog’s private equity fund) are busy buying shares in existing companies or providing capital to competitors. This famously happened in India a decade ago in the telecoms market – licences were begged, borrowed or stolen and capital was destroyed. India today may be a little cleaner than it was then, and the sectors attracting capital are less licence dependent (anything medical, anything online/tech related, all things consumer). Nonetheless, the potential to lose money is probably quite high. We have been fortunate in 2021 to make good money in India but we have also trimmed nearly all our Indian holdings.
I hope the remainder of the report helps explain what we have done with shareholders’ money as well as offer some guidance as to how and why we have made decisions. Thank you for reading.
Portfolio
The portfolio consists of shares in 40 companies. The ten largest names represent 40.6% of the portfolio and is a small reduction from 42.7% at the end of 2020 and 46.4% at the end of 2019 when a shareholder resolution was passed to allow a slightly longer list of companies. Cash started the year at 2.6% and ended at 2.9%.
At the end of the year the average market cap (weighted by position size) was $1.65bn and the average free float (weighted by position size) at the end of November was 49.1%. This small free float reflects the frequency with which we find the qualities we require by investing alongside a controlling shareholder. 36 of the 40 companies in the portfolio have a controlling shareholder.
New Holdings
During the year we bought shares in eight new companies. Below is a list shown in descending order of size in the portfolio at the end of the period. Of the eight new companies, Prodia Widyahusada and NESR are the product of more recent work whilst the remainder have been owned before in portfolios managed by our team, but subject to ongoing research.
Anadolu Efes (or Efes) is a Turkish listed brewer. It is controlled by the founding Özilhan and Yaz?c? families, and the global brewer ABI has a stake inherited from its merger with SAB Miller. We like the combination of committed family and multinational oversight and have seen it succeed many times before in GEM. In 2018, ABI and Efes pooled their Russian beer businesses into a 50/50 JV which is the joint market leader with approximately 30% market share. Efes also owns a stake in a Coke bottler operating across several CIS states and in Pakistan where it is growing rapidly. Although Turkish listed, over three quarters of earnings are derived outside Turkey. Over the last five years, the company has rapidly repaid debt meaning it offers a substantial yield earned from a steadily growing business. The repayment of debt is partly responsible for our increased conviction here.
Post script – 4 March 2022: Efes has three breweries in Ukraine held through the 50/50 JV with ABI. These have currently ceased production. These, and the 50/50 JV with global brewer ABI in Russia represent approximately 20-25% of Efes overall. It remains to be seen what the longer term value of this business is and whether any profits can be repatriated. The largest part of Efes is a stake in a Coke bottler (with nil Russian exposure). It also sells beer in Turkey and several CIS states. Efes is Turkish incorporated and listed on the Istanbul stock exchange.
Alicorp is a consumer goods company, headquartered in Peru and a market leader in its home market but also with a presence in Bolivia, Ecuador and other parts of Latin America. It is controlled by the Romero family. They also control Credicorp, a bank, and a family member sits on the board of Hochschild Mining, another holding in ScotGems. Alicorp dominates many of the markets in which it operates (mayonnaise, pasta, sauces, cookies and crackers) despite competing against most multinationals. Recent external hires of senior staff with multinational experience indicate that the company is evolving from a family business to a more professional one. It is highly cash generative. Risks include the fact that the company has stretched its balance sheet in the past as a result of acquiring businesses, although the strong predictable cashflows of the business means the debt was swifty repaid. Alicorp has some less glamorous divisions (fish food for farmed prawns and salmon for instance) and although these do not deserve the rating of some of the branded parts of the company, they have still contributed useful cashflows. The company was attractively valued when purchased and we added to the holding during the recent election-related sell-off in Peru.
Prodia Widyahusada is an Indonesian listed medical diagnostics business with a US$230m market cap at time of purchase and a free float which represents 25% of shares outstanding. It is controlled by the founders and their families, and is conservatively financed after its IPO in 2016. It is the largest private sector diagnostics business in Indonesia and comes with an excellent record for quality. One piece of evidence of this is the fact that they are the only Indonesian diagnostics chain with a College of American Pathologist accreditation. Its track record demonstrates that the model benefits from large economies of scale – it can drive down costs as it grows allowing it to reduce pricing which in turn allows it to continue to gain market share. The business model has been successful many times in GEM including Integrated Diagnostics Holdings (IDH) operating primarily in Egypt, and whose shares are also held in the portfolio. The model deserves a strong social license given that early diagnosis allows early treatment, and should therefore lead to higher survival rates. Early diagnosis and treatment also take cost out of a healthcare system which is chronically underdeveloped. Risks include changes in regulation although this is mitigated to a degree by the essential nature of its work. In addition, the similarity to the business model of IDH , the Egyptian diagnostics business we own, will limit our position size here.
Jumbo is a Greek listed retailer operating in Greece, Cyprus, Bulgaria and Romania. It is controlled and managed by the Vakakis family. It sells small baskets of everyday cheap items in a model which is comparable to Dollar General in the USA. This has so far made it less vulnerable to online retail than other formats such as the department store model. We are impressed by the company’s ability to grow through past periods of economic stress in Greece and by its growth in new markets. It is conservatively financed and has pre-paid historically for much of its inventory in order to improve pricing. We first met with the company during the wreckage of the 2008 crisis – a period which the company positively enjoyed. We first tried to establish a position for the Trust in 2020 but were only able to buy a small number of shares before the valuation increased beyond a point where we were comfortable.
Bladex (full name Banco Latinoamericano de Exportaciones) is a bank which facilitates the transactions of international trade. It is listed on the New York Stock Exchange, is headquartered in Panama and operates across Latin America and the Caribbean. The central banks of the countries in these regions own shares and have the opportunity to elect board members. It plays an important role in the economic development and integration of the region through its reputation as a supportive lender. This reputation comes from its historic lending in periods when other international banks avoid the region, normally in periods of crisis. It is very affordably valued and is well positioned to enjoy an economic recovery. Although its loans are mostly short term US$ trade finance, the risk with every bank including Bladex is that it loses lending discipline in the future.
Vitasoy is a Hong Kong-based producer of healthy plant-based products including soya milk, tea, juice and tofu with most of its sales from mainland China. Our team first owned the company in client funds in the 1990s. The founding Lo family, now in their second generation, owns approximately 20% of the company and today it is run by professional management. The company demonstrates an impressive track record of long term decision making – we would argue that the time frame for these decisions has only been made possible under family ownership. We admire the decision taken many years ago to take profits generated in Hong Kong and to use them to invest in building a leading soy milk franchise in China and Australia. It took a very long time for the company to succeed, yet China is now its largest market. Today the company is well positioned to benefit from changing consumer trends towards health and well-being, increasing demand for protein and increasing water scarcity in China. This last point relates to the fact that growing soya beans is significantly less water intensive than dairy production. The company generates strong cash flows and is financially robust. Recently, an internal memo was leaked to the press. This memo showed that a staff member had offered condolences to the family of an employee who had committed a politically motivated crime, committed as an individual rather than within the company’s sphere of influence, then committed suicide. This led to a boycott of Vitasoy products – a sign of how unpredictable China is, but also a chance to initiate a position in the company at what we believe to be an attractive price.
NESR (full name National Energy Services Reunited) is an oilfield services provider, listed in New York and serving Middle Eastern and North African markets. NESR does not own oil producing assets but helps its customers access their reserves more efficiently. It is still in its early stages of development, but we are backing Sherif Foda the company’s founder. He spent two decades at Schlumberger (also in oilfield services) where he ultimately ran the largest of its three divisions, a US$30 billion revenue business. NESR originated as a Special Purpose Acquisition Company (SPAC) but contrary to common recent use of the SPAC merger approach, often used to acquire speculative businesses, it was launched to acquire and merge two businesses from Saudi Arabia and Oman respectively, which were both profitable at time of acquisition. The sellers of the two businesses remain shareholders of the combined entity and are well-respected locally. The company operates in the world’s lowest cost region – lowest in terms of operational cost per barrel but also in terms of environmental impact. It has a tailwind from the desire of petrostates in the Middle East to increase their sourcing from indigenous firms – the history and shareholders of this firm tick that box. Although oil services revenues are more closely linked to volume of production than the oil price directly, the risks to the investment clearly include the oil price as well as the speed of transition to alternative sources of energy. Any hint of untoward procurement practices would also be damaging – we are comforted here as the decision to turn two private companies into one US listed public company is a radical increase in transparency. In light of these potential risks, and in common with our views on any company linked to commodities, we are unlikely to own a large position.
Youngone Corporation is the operating company of Youngone Holdings which has been held in the portfolio since near inception. It operates as a clothing manufacturer listed in Korea but mostly manufacturing in Bangladesh. It has played a pivotal role in building the garment sector into the country’s most important export industry. Its customers include brands such as The North Face and Patagonia. During 2021 we invested in shares of the operating company because we believe that it benefits our company engagement to own shares in both entities – we admire the group and its ultra-conservative family owners very much but are keen for a slightly more generous dividend. In addition we want to increase our exposure to a company which earns hard currency, has a net cash balance sheet and which remains extremely favourably valued. Youngone Corporation also owns a majority stake in the bicycle brand “Scott”, a business which has prospered during the pandemic.
Additions
The two largest additions to existing investments were to Orascom Construction and IAM Chile.
We added to Orascom Construction, an engineering and construction contractor for infrastructure, industrial and commercial projects, operating in the Middle East, North Africa and the United States. It
is owned by the founding Sawiris family. Nassef Sawiris, has proven his entrepreneurial ability many times – most evidently in selling his cement business to Lafarge with excellent timing. During 2021, the company reported a healthy pipeline of new projects including Egypt’s first high-speed rail system and sizeable contracts in the student housing sector in the United States. The company is attractively valued. Some of our addition was merely reinvesting dividends received – the trailing dividend yield is almost 10%, paid in US Dollars.
IAM Chile (full name is Inversiones Aguas Metropolitanas) is a holding company with a 50% stake in Aguas Andinas, Chile’s largest water utility. Over the long term the company has attractive defensive qualities, providing an inflation protected dividend yield. The company also has a strong social purpose given that it provides potable water to one of Latin America’s largest metropolitan areas. In the shorter term and as discussed in the Interim Report, it is likely that it has been affected by investor concerns following a vote to rewrite the constitution of Chile, possibly partly due to a low turnout and as a rejection of established political parties. Uncertainty remains but we are more sanguine than the consensus given that most citizens own assets in some form or another so have something to lose from any undermining of property rights. A recent interest rate rise in Chile is also evidence that institutions retain some independence. Nonetheless this uncertainty has left the company attractively valued and we have increased our investment.
Disposals
During the year we sold all of the shares held in four companies. Below is a list in descending order of size at the start of the year.
Voltronic Power is a Taiwanese business, manufacturing and selling uninterruptable power supplies (UPS) and electrical inverters. The founder Alex Hsieh owns 20% of the shares. He started his first UPS business in 1979 before selling it to Phoenixtec. He left in 2007 with a number of colleagues in order to set up Voltronic, having noticed that there was an opportunity for a company that did not compete with its branded customers. This lack of competition has built trust, as has the high quality of Voltronic’s own products and their ability to reduce customers’ time to market with their new products. It is rare for us to find a company as focused as this but we are uncomfortable with its valuation. We first discussed reducing it in the 2020 Annual Report but have now sold all of our shares.
RCL Foods is a South African business generating the majority of its earnings from commodity foods such as chicken and sugar. The company is controlled by the Rupert family’s South African investment holding company, Remgro. Our investment case had been based on Remgro’s desire to turn it into the leading consumer goods business in South Africa, using cash flows generated by the existing business. Remgro has an impressive track record of developing new businesses including FirstRand, which we believe is perhaps the best financial services firm in South Africa and Richemont a leading global luxury goods company. RCL has announced that it will separate its commodity foods business, whilst growing its consumer goods businesses through acquisitions. This announcement was well received by investors but one which we believe introduces additional risk into a business which is already something of a turnaround. The company’s transition may well work and we have the upmost respect for Remgro but prefer other consumer staples companies such as Alicorp (discussed earlier) because it is far more cash generative, and has far larger market shares.
Dis-Chem Pharmacies is a pharmacy chain in South Africa. It is a strong franchise but we have concerns that stewardship might not be as strong as we had previously thought. This was demonstrated in part by recent poor disclosure of a related party transaction (RPT), despite us discussing other RPTs with them. Governance issues such as this are relatively frequent in family owned GEM companies in their early stages or even before they list. They can be acceptable on a case-by-case basis, but in this instance we were unable to remain confident that governance is heading in the right direction.
Indus Motors is Pakistan’s largest car manufacturer. It is a 30 year partnership between Toyota and the Habib group, generates strong cash flow and is financially very conservative. We sold our investment, banking (modest) gains as we are concerned by the economic environment. Indus Motors imports a significant proportion of its components and the Pakistani Rupee is rarely a long term winner especially if global inflation is rising and oil prices are high. We would be keen to own the business again if the price gave a suitably wide margin of error for the economic risks.
Reduced
The three most significant reductions were in businesses listed in India. Although we think India perhaps has a great number of quality businesses than any other emerging market, valuations have become increasingly stretched. Towards the end of the year a tech bubble inflated as enthusiastic local investors bet on new listings – “growth at any price” has been a popular (though incoherent) investment mantra of late and India has not been spared.
We reduced Cyient due to valuation. It is an engineering outsourcing business with global clients in industries such as aerospace and transportation. The CEO today is the son of the founder. It made some recent acquisitions which appeared to be disappointing initially although these have now started to perform better.
Tata Consumer Products is a food and beverages company with a focus on tea and coffee. We reported reductions in the last two Annual Reports and the last two Interim Reports. We have trimmed further based on valuation. As discussed previously we believe that the original investment case remains intact, namely the importance of a recent management transition and a renewed focus on India under Tata Group stewardship, but that the company’s transformation will take a long time.
Sundaram Finance is a finance company with a focus on commercial vehicles. We made a small reduction on valuation.
Demerger
Shareholders may notice a new name in the holdings list of Aclara Resources. This is not a new purchase but the result of Hochschild Mining demerging its rare-earth elements project. It is listed on the Toronto Stock Exchange but its sole asset is in Chile. It is unquestionably a risky investment by our conservative standards but we are happy staking a very small portion of the Trust’s NAV on a conceptual project. We can only do this because we have some faith in the major shareholder (Eduardo Hochschild) and because we see Chile as an acceptable mining jurisdiction – it may have some bureaucracy but it is not corrupt. Rare-earth elements have a range of industry uses in growing sectors such as rechargeable batteries and very little of the world’s supply is currently outside China – both are points which could make Aclara attractive.
Post script 4 March 2022: we note the situation in Ukraine. St Andrews Partners has never owned companies operating at the “commanding heights” of the Russian economy (oil, gas, metals, finance, telecoms, etc), nor have we owned state-owned businesses in Russia. We are following the changing situation closely. We are hoping for a swift and peaceful outcome.
Contribution
During 2021 the Trust’s NAV increased by 8.2%. The MSCI Emerging Markets Small Cap Index increased by 11.1%, the MSCI Emerging Markets ex Asia Index increased by 4.4%, and the MSCI Emerging Markets Index decreased by 3.7%. Contributors and detractors are discussed below.
Positive
Cyient is an Indian research and development provider with global clients in aerospace and transportation. We discussed it as a detractor in the 2020 Annual Report after a period in which its aerospace customers had struggled. Furthermore some of its recent acquisitions had appeared disappointing. In 2021, it enjoyed a rebound in operations and investors seem to have over-rewarded signs that some of its acquisitions are improving. We have reduced our shareholding during the year on valuation, as discussed above, but continue to back it on account of the stewardship from the founding family, including the CEO who is the son of the founder, its high quality franchise, hard currency earnings and net cash balance sheet.
Prodia Widyahusada is an Indonesian medical diagnostics business. It was reported as a new purchase in the Interim Report and has not been owned for the full year. We have been fortunate with the timing of our investment. During the year it reported strong results linked to the introduction of new services such as drive-in and teleconsultation, and strong demand for its tests, some of which have a role in testing for coronavirus. Our investment case is not based on the pandemic but based on the company’s record of quality, economies of scale as it grows, and a strong social license.
Reunert is a South African conglomerate consisting of three businesses, a cables business, an office equipment business, and an electrical engineering business. We discussed this in the Interim Report but it has reported strong results and an attractive dividend despite reduced economic activity in South Africa.
City Lodge Hotels is a Hotel chain owner and operator in South Africa, Botswana and Kenya. We reported this company as a top detractor in the 2020 Annual Report. Although in 2021 it appears as a contributor as economies start to re-open, we note that it is still a detractor since first investment in late 2019. We were attracted to the company because it was profitable and free cash flow generative even at historically low occupancy levels (50-60%) – although it took a ‘direct hit’ from Covid, it was this level of background profitability that meant it survived at all. We supported a rights issue in 2020.
Quiñenco is a Chilean holding company controlled by the Luksic family with assets in banking, beverages and shipping. Shareholders in the UK may know the Luksic family better for their controlling stake in Antofagasta, a copper mining company listed in London. Over long periods they have been successful in a number of joint ventures with partners such as Heineken, Citibank and Kuehne + Nagel. They also have a fantastic record of buying and selling stakes in cyclical businesses as well as building them. One recent and relevant example of their time horizon at work is their purchase of a shipping company called CSAV (known as “Vapores”) from near bankruptcy in 2011. Since then Quiñenco have raised capital, rehabilitated the company and merged it into Hapag-Lloyd. 2021 has seen very positive results from Vapores and allowed Quiñenco to pay a special dividend, representing an approximate 10% yield. The company describes this dividend as a payment following a “10-year journey” – shipping rates remain high and we hope for further large dividends.
Top Ten Contributors – Year ended 31 December 2021
| Company | Country of Listing | Contribution to Return % |
| Cyient | India | 2.45 |
| Prodia Widyahusada* | Indonesia | 2.00 |
| Reunert | South Africa | 1.81 |
| City Lodge Hotels | South Africa | 1.64 |
| Quiñenco | Chile | 1.55 |
| Tata Consumer Products | India | 1.15 |
| Sundaram Finance | India | 0.93 |
| Brac Bank | Bangladesh | 0.90 |
| Integrated Diagnostics | United Kingdom | 0.87 |
| RCL Foods** | South Africa | 0.79 |
* Company not held at start of period
** Company not held at end of period
Negative
Philippine Seven is a 7-Eleven convenience franchise operating in the Philippines. We reported this as a detractor in the last Annual Report and discussed it in the last Interim Report. It is particularly sensitive to local movement restrictions as the bulk of its locations are in urban and business locations – commuters and office workers are key customers. We are relaxed that one day restrictions will ease but in the meantime the company continues to evolve – rejigging some store formats and locations to reflect that some habits may permanently have changed. The business has a good balance sheet and a supportive major shareholder (the Taiwanese company, President Chain Store). As a result the period of ‘hibernation’ for many of its shops has not impaired decision making.
IAM Chile is a holding company with a 50% stake in Aguas Andinas, Chile’s largest water utility. We discussed this as a detractor in the Interim Report and earlier in this report in relation to uncertainty in Chile around constitutional reform and adding to our investment.
Grupo Herdez is a Mexico listed foods business, 50% owned by the Hernandez-Pons family and in its fourth generation. It is structured with 100% ownership of an ice-cream business and series of longstanding 50:50 joint ventures with multinational brands such as McCormick (jams and teas), Barilla (pasta) and Hormel (branded foods). We reported this company as a contributor in 2020 and it appears as a detractor in 2021. During this two year period we don’t believe there have been changes in the fundamental qualities of the business. We continue to admire its ability to establish multi-decade long relationships with high quality multinational partners. It has a conservative track record and strong market share in a wide range of categories. The company has bought back a significant portion of its own stock in the last two years – we enjoy it when families with good long-term track records repurchase shares.
Bank OCBC Nisp is a local Indonesian subsidiary of Singaporean bank OCBC. Our investment case here is based on the strength of the combined ownership from its Singapore based parent OCBC and the local Surjaudaja family who founded the bank and are involved in management today. Of note they refuse to take balance sheet risk with families who defaulted during the Asian Financial Crisis. OCBC Nisp has a decent track record over the last few years but its conservative stance means that loan growth and therefore profit growth has been sluggish – state owned banks are falling over themselves to lend, making margins unattractive for a rational player such as OCBC Nisp. In the long-term state owned banks tend to come a cropper, and in any event, OCBC Nisp has been working hard to increase non-loan revenue – the OCBC brand is strong in wealth management for example.
Guaranty Trust Bank is a Nigerian bank, with a proven and long-serving management team. It was weak over the period as it continued to navigate difficult economic conditions. During 2021, the bank completed its transition into a holding company structure, which will allow it to see new opportunities in very under-penetrated businesses such as payments, pensions and asset management. The Bank survived the 2009 banking crisis in Nigeria and the 2016 – 2017 devaluation with flying colours so has clear and recent proof of conservatism. As noted in note 2 below, we are applying a discount to the value of our Nigerian holdings due to difficulties in repatriation of Naira to hard currency.
Top Ten Detractors – Year ended 31 December 2021
| Company | Country of Listing | Contribution to Return % |
| Philippine Seven | Philippines | -1.49 |
| IAM Chile | Chile | -1.06 |
| Grupo Herdez | Mexico | -1.01 |
| Bank OCBC Nisp | Indonesia | -0.85 |
| Guaranty Trust Bank | Nigeria | -0.77 |
| CAP Nigeria | Nigeria | -0.61 |
| NESR* | USA | -0.59 |
| Hochschild Mining | United Kingdom | -0.43 |
| Anadolu Efes* | Turkey | -0.37 |
| Concepcion Industrial | Philippines | -0.26 |
* Not held at start of period
For further information contact:
Stewart Investors
Investment Manager
Tel: 0131 473 2900
Juniper Partners Limited
Company Secretary
Tel: 0131 378 0500
The Income Statement, Statement of Financial Position, Statement of Changes in Equity and Cash Flow Statement follow.
Income Statement
| Year ended 31 December 2021 | Year ended 31 December 2020 | |||||
| Revenue | Capital | Revenue | Capital | |||
| return | return | Total | return | return | Total | |
| £'000 | £'000 | £'000 | £'000 | £'000 | £'000 | |
| Income | ||||||
| Investment income | 2,061 | - | 2,061 | 872 | - | 872 |
| Gains/(losses) on investments held at fair value through profit or loss | - | 3,010 | 3,010 | - | (424) | (424) |
| Foreign exchange (losses)/gains | - | (36) | (36) | - | 8 | 8 |
| Total income | 2,061 | 2,974 | 5,035 | 872 | (416) | 456 |
| Expenses | (740) | - | (740) | (624) | - | (624) |
| Profit/(loss) before taxation | 1,321 | 2,974 | 4,295 | 248 | (416) | (168) |
| Taxation | (285) | (242) | (527) | (70) | (380) | (450) |
| Profit/(loss) for the year | 1,036 | 2,732 | 3,768 | 178 | (796) | (618) |
| Return/(loss) per share | 1.94p | 5.10p | 7.04p | 0.33p | (1.49p) | (1.16p) |
The Total column of this statement represents the Statement of Comprehensive Income of the Company. The Revenue return and Capital return columns are supplementary to this and are prepared under guidance issued by the Association of Investment Companies. All revenue and capital items in the above statement derive from continuing operations. Return/(loss) per share is calculated on 53,533,770 shares (2020: 53,533,770), being the weighted average number in issue during the year. | ||||||
Statement of Financial Position
| As at 31 December 2021 |
As at 31 December 2020 | |
| £'000 | £'000 | |
| Non-current assets | ||
| Investments held at fair value through profit or loss | 48,677 | 44,720 |
| Current assets | ||
| Receivables | 173 | 271 |
| Cash and cash equivalents | 1,436 | 1,504 |
| 1,609 | 1,775 | |
| Current liabilities | ||
| Payables | (204) | (205) |
| Net current assets | 1,405 | 1,570 |
| Non-current liabilities | ||
| Deferred tax liability on Indian capital gains | (350) | (326) |
| Net assets | 49,732 | 45,964 |
| Capital and reserves | ||
| Ordinary share capital | 535 | 535 |
| Share premium | 3,133 | 3,133 |
| Special reserve | 49,315 | 49,315 |
| Capital reserve | (4,202) | (6,934) |
| Revenue reserve | 951 | (85) |
| Total equity | 49,732 | 45,964 |
Shares in issue at year end | 53,533,770 | 53,533,770 |
Net asset value per Ordinary share | 92.90p | 85.86p |
Statement of Changes in Equity
| For the year ended 31 December 2021 | Ordinary share capital | Share premium | Special reserve | Capital reserve | Revenue reserve | Total |
| £’000 | £’000 | £’000 | £’000 | £’000 | £’000 | |
| Balance at 31 December 2020 | 535 | 3,133 | 49,315 | (6,934) | (85) | 45,964 |
| Profit for the year | - | - | - | 2,732 | 1,036 | 3,768 |
| Balance at 31 December 2021 | 535 | 3,133 | 49,315 | (4,202) | 951 | 49,732 |
|
For the year ended 31 December 2020 | Ordinary share capital | Share premium | Special reserve | Capital reserve | Revenue reserve | Total |
| £’000 | £’000 | £’000 | £’000 | £’000 | £’000 | |
| Balance at 31 December 2019 | 535 | 3,133 | 49,315 | (6,138) | (263) | 46,582 |
| Loss for the year | - | - | - | (796) | 178 | (618) |
| Balance at 31 December 2020 | 535 | 3,133 | 49,315 | (6,934) | (85) | 45,964 |
Share premium. The share premium represents the difference between the nominal value of new Ordinary shares issued and the consideration the Company receives for these shares. This is a non-distributable reserve.
Special reserve. Created from the Court cancellation of the share premium account which had arisen from premiums paid on the Ordinary shares at launch. Available as distributable profits to be used for the buy back of shares. The cost of any shares bought back is deducted from this reserve. The cost of any shares resold from treasury is added back to this reserve. This is a distributable reserve.
Capital reserve. Gains and losses on the realisation of investments, realised exchange differences of a capital nature and returns of capital are accounted for in this reserve. Increases and decreases in the valuation of investments held at the year end, and unrealised exchange differences of a capital nature are also accounted for in this reserve. The realised portion of this reserve is distributable.
Revenue reserve. Any surplus/deficit arising from the revenue profit/loss for the year is taken to/from this reserve. This is a distributable reserve.
Cash Flow Statement
| Year ended 31 December | Year ended 31 December | ||
| 2021 | 2020 | ||
| £’000 | £’000 | ||
| Net cash outflow from operations before dividends, interest, purchases and sales | (642) | (679) | |
| Dividends received from investments | 2,060 | 859 | |
| Interest from deposits | - | 1 | |
| Purchases of investments | (13,862) | (14,823) | |
| Sales of investments | 12,915 | 12,074 | |
| Cash inflow/(outflow) from operations | 471 | (2,568) | |
| Taxation | (503) | (124) | |
| Net cash outflow from operating activities | (32) | (2,692) | |
| Decrease in cash and cash equivalents | (32) | (2,692) | |
| Cash and cash equivalents at the start of the year | 1,504 | 4,188 | |
| Effect of currency (losses)/gains | (36) | 8 | |
| Cash and cash equivalents at the end of the year | 1,436 | 1,504 | |
Principal Risks and Risk Management
| The Board has carried out a careful assessment of the principal and emerging risks facing the Company, these risks, together with a summary of the mitigating action the Board takes to manage these risks, are set out below. | |
| Emerging Risks – Environmental, Social & Governance (“ESG”) factors | |
| Risk | Mitigation |
|
Failure to consider the impact of ESG factors adversely affects the Company’s reputation and financial performance. New specific risk identified in year |
ESG is fully embedded within the Investment Manager’s investment strategy, please refer to pages 14 and 15 of the Annual Report for a full description of the Investment Manager’s approach to ESG factors. The Board provides regular challenge to the Investment Manager in respect of their approach to ESG, and receives updates in respect of the changing ESG disclosure requirements. |
| Principal Risks | |
| Risk | Mitigation |
| Investment objective and strategy An inappropriate or unattractive objective and strategy may have an adverse effect on Shareholder returns or cause a reduction in demand for the Company’s shares, both of which could lead to a widening discount. No change to this risk | The Board conducts an annual strategy reviews and consider investment performance, shareholder views and developments in the marketplace as well as emerging risks which could impact the Company. The Board reviews changes to the shareholder register at quarterly Board meetings and engages the Administrator to continually monitor the discount at which the Company’s shares trade, reporting regularly to the Board and buying back shares when appropriate. |
| Investment performance Poor investment performance may have an adverse effect on Shareholder returns. No change to this risk | The Board reviews investment performance at each quarterly Board meeting. The Investment Manager reports on the Company’s performance, transaction activity, individual holdings, portfolio characteristics and outlook. Investment performance and the portfolio composition has been monitored specifically in light of the Covid-19 pandemic. The Investment Manager is formally appraised at least annually by the Management Engagement Committee. |
| Financial and Economic The Company’s investments are impacted by financial and economic factors including market prices, interest rates, foreign exchange rates, liquidity and credit which could cause losses to the investment portfolio. No change to this risk | The Board regularly reviews and agrees policies for managing market price risk, interest rate risk, foreign currency risk, liquidity risk and credit risk. These are explained in detail in note 13 to the financial statements on pages 37 to 43 of the Annual Report. The Board recognises that macro-economic and geopolitical factors may impact the Company's portfolio. However, other than being aware of such events there is little that the Board can do to mitigate against these events. |
| Operational The Company is reliant on third party service providers including Stewart Investors as Investment Manager, Juniper Partners as Company Secretary and Administrator, J P Morgan as Depositary and Custodian and Computershare as Registrar. Failure of the internal control systems of these third parties could result in inaccurate information being reported or risk to the Company’s assets. No change to this risk | Operationally, Covid-19 is affecting each of the Company’s key service providers and each has put in place the appropriate arrangements for their staff to work from home should government guidance require. To date these services have continued without disruption and the operational arrangements have proven adequate. The Board will continue to monitor these arrangements. The Audit Committee formally reviews each service provider at least annually, considering their reports on internal controls. Further details of the Company’s internal control and risk management system is provided on pages 58 and 59 of the Annual Report. |
| Regulatory The Company operates in a regulatory environment. Failure to comply with s1158 of the Corporation Tax Act 2010 could result in the Company losing investment trust status and being subject to tax on capital gains. Failure to comply with other regulations could result in financial penalties or the suspension of the Company’s listing on the London Stock Exchange. No change to this risk | Compliance with relevant regulations is monitored on an ongoing basis by the Company Secretary and Investment Manager who report regularly to the Board. The Board monitors changes in the regulatory environment and receives regulatory updates from the Company Secretary, Lawyers and Auditors as relevant. The Board has been updated on any regulatory changes proposed in respect of the response to the Covid-19 pandemic as required. |
Statement of Directors' Responsibilities in Respect of the Annual Financial Report
In accordance with the Disclosure Guidance and Transparency Rules, we confirm that to the best of our knowledge:
- The financial statements contained within the Annual Report for the year ended 31 December 2021, of which this statement of results is an extract, have been prepared in accordance with applicable United Kingdom Generally Accepted Accounting Practice (United Kingdom Accounting Standards, comprising FRS 102, and applicable law), give a true and fair view of the assets, liabilities, financial position and net loss of the Company; and
- The Strategic Report includes a fair review of the development and performance of the business and the position of the Company, together with a description of the principal risks and uncertainties that it faces.
In addition, each of the Directors considers that the Annual Report, taken as a whole, is fair, balanced and understandable and provides the information necessary for shareholders to assess the Company’s performance, position, business model and strategy.
Going Concern
The Directors believe, in the light of the controls and review processes reported in the Report of the Audit Committee on page 58 of the Annual Report and bearing in mind the nature of the Company’s business and assets, which are considered to be readily realisable if required, that the Company has adequate resources to continue operating for at least twelve months from the date of approval of the financial statements. For this reason, they continue to adopt the going concern basis in preparing the accounts.
Related Party Transactions
Related party transactions with the Directors, for the year ended 31 December 2021 are disclosed in the Directors’ Report on page 46 of the Annual Report. At the year end no amounts were due to the Directors (2020: nil).
The AIFM, the Investment Manager and the Company have entered into the Investment Management Agreement. Pursuant to the terms of the Investment Management Agreement, the AIFM has delegated to Stewart Investors the management of the Company’s portfolio subject to its and the Directors’ overall supervision. Details of transactions during the year are disclosed in note 3 of the Annual Report. Amounts outstanding at the year end are shown in note 8 and note 9 of the Annual Report.
There were no other related-party transactions.
Notes:
1. ScotGems plc is a public company limited by shares, incorporated and domiciled in England and Wales, and carries on business as an investment trust. Details of the Company’s registered office can be found in the Annual Report.
The accounts are prepared in accordance with the Companies Act 2006, United Kingdom Generally Accepted Accounting Practice (Accounting Standards “UK GAAP”) including Financial Reporting Standard (FRS) 102 “The Financial Reporting Standard applicable
in the UK and Republic of Ireland” and the Statement of Recommended Practice “Financial Statements of Investment Trust Companies and Venture Capital Trusts” (“the SORP”) issued by the Association of Investment Companies in April 2021.
All of the Company’s operations are of a continuing nature.
The accounts have been prepared on a going concern basis under the historical cost convention, as modified by the revaluation of investments held at fair value through profit or loss.
Estimates and judgements are continually evaluated and are based on historical experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances.
The following areas are considered to involve a higher degree of judgement or complexity:
Investment valuation
The Company’s AIFM is responsible for ensuring that investments are held at fair value, and may make adjustments in the absence of a market price or where strong evidence exists that the market price or price provided by the pricing source does not represent a fair value for the security. A discount of 35% was applied to investments in Nigeria, and a discount of 5% was applied to investments in Sri Lanka at 31 December 2021. Please refer to note 2 below for further details.
The accounts have also been prepared on the assumption that approval as an investment trust will continue to be granted.
The functional and reporting currency of the Company is pounds sterling as most investors in the Company are based in the United Kingdom.
2. Fair Value Hierarchy
The fair value hierarchy used to analyse the fair values of financial assets and liabilities are described below.
The levels are determined by the lowest (that is, the least reliable or least independently observable) level of input that is significant to the fair value measurement for the individual investment in its entirety as follows:
Level 1 - investments with prices quoted in an active market;
Level 2 - investments whose fair value is based directly on observable current market prices or is indirectly being derived from market prices; and
Level 3 - investments whose fair value is determined using a valuation technique based on assumptions that are not supported by observable current market prices or are not based on observable market data.
The table below provides an analysis of financial assets and financial liabilities based on the fair value hierarchy described above. Short term balances are excluded from the table as their carrying value at the reporting date approximates to their fair value.
The Company held the following categories of financial instruments as at 31 December 2021:
| Level 1 | Level 2 | Level 3 | Total | |
| £’000 | £’000 | £’000 | £’000 | |
| As at December 2021 | ||||
| Listed equities | 46,701 | 1,976 | – | 48,677 |
| Total | 46,701 | 1,976 | – | 48,677 |
Level 2 investments are based indirectly upon quoted market prices. The Fair Value Pricing Committee at the AIFM (who are independent from the Investment Manager) assess whether market prices represent fair value, based on a number of factors.
Nigeria
The Central Bank of Nigeria sets the official exchange rate. The Fair Value Pricing Committee believes that significant delays with repatriation are evidence that the official exchange rate does not reflect fair value. At 31 December 2021 a discount of 35% was applied to all Nigerian assets. This discount is generated daily using the ratio of an observable parallel rate to the official exchange rate. At 31 December 2021 the carrying value of Nigerian investments (after applying the discount) was £1,467,000 (2020: £2,413,000).
Sri Lanka
There have been delays in repatriation of cash from Sri Lanka which the Fair Value Pricing Committee believes is evidence that the exchange rate does not represent fair value. At 31 December 2021 a discount of 5% was applied to all Sri Lankan assets. The 5% discount is the ratio of an interbank rate to the official rate, whilst this interbank rate was in use during the year. At 31 December 2021 the carrying value of Sri Lankan investments (after applying the discount) was £509,000 (2020: £495,000, however no discount was applied at 31 December 2020, therefore this value is included in Level 1 listed equities).
The Company held the following categories of financial instruments as at 31 December 2020:
| Level 1 | Level 2 | Level 3 | Total | |
| £’000 | £’000 | £’000 | £’000 | |
| As at December 2020 | ||||
| Listed equities | 42,307 | 2,413 | – | 44,720 |
| Total | 42,307 | 2,413 | – | 44,720 |
3.
| Year ended 31 December 2021 |
Year ended 31 December 2020 | |
| Reconciliation of profit/(loss) before taxation to net cash outflow before dividends, interest, purchases and sales | £’000 | £’000 |
| Net profit/(loss) on activities before finance costs and taxation | 4,295 | (168) |
| Net (gains)/losses on investments | (3,010) | 424 |
| Currency losses/(gains) | 36 | (8) |
| Investment income | (2,061) | (872) |
| Decrease in other payables | (1) | (3) |
| Decrease/(increase) in prepayments and other receivables | 99 | (52) |
| Net cash outflow from operations before dividends, interest, purchases and sales | (642) | (679) |
4. These are not statutory accounts in terms of Section 434 of the Companies Act 2006. Full audited accounts for the year to 31 December 2021 will be sent to shareholders in March 2022 and will be available for inspection at Broadgate Tower, 20 Primrose Street, London EC2A 2EW, the registered office of the Company. The full annual report and accounts will be available on the Company’s website www.scotgems.com.
5. The audited accounts for the year ended 31 December 2021 will be lodged with the Registrar of Companies.
