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Mackenzie draws attention to Downing Strategic’s ‘double discount’

10 September 2020

Downing Strategic Micro-Cap attempts to draw line under its falling share price, claiming portfolio of small listed companies offers over 100% upside.

Downing Strategic Micro-Cap (DSM ) has attempted to draw a line under its falling share price, claiming the portfolio of small listed companies offers more than 100% upside.

Investors have seen the value of their shares halve from the 100p launch price three years ago as former Citywire AAA-rated manager Judith Mackenzie failed to recreate her success in the open-ended Downing UK Micro-Cap Growth fund. 

The shares have lost nearly 30% this year, beset by poor investment choices, Brexit angst, and then the coronavirus crisis, issues Mackenzie addressed in an investor update last week. 

Real Good Food (RGD), the cake decoration whose woes have depressed DSM shares more than any other investment, has had a mixed trading period through the corona‐crisis, the manager said.

However, she still hoped to secure a ‘favourable exit’ for shareholders from the 19% position as the company’s turnaround bore fruit with group revenues up 9% to £67m, helped by improved trading and a reduction in head office costs.

In her letter Mackenzie stood by her decision not to ‘chase returns’ in rising markets and instead keep hold of her ‘significant cash balance’ that equals almost 21% of the portfolio. Instead she has focused ‘inwardly on what we already own to make sure those companies have the necessary attributes to survive and, latterly, thrive’.

With a fifth of the portfolio in cash and another 20% in loan notes unaffected by volatile stock markets, Mackenzie said there was ‘40% of the portfolio which is entirely unaffected by volatility’ and offers ‘downside protection as well as upside perspective’. 

Upside is expected to come from charging cable manufacturer Volex (VLX), which is the second largest holding at 15.2% of the portfolio. Mackenzie (pictured) said ‘bar a recession’ she expected growth in earnings and a re-rating.

‘A further 20% [of the portfolio] is comprised of businesses which we think aren’t trading much higher than what we consider to be a minimum valuation given the quality of earnings and balance sheet strengths underlying,’ said Mackenzie. 

‘From an upside perspective, the opportunity is significant,’ she said. ‘Not only is there over 100% of upside potential to intrinsic value in the portfolio, but investors today can access that upside at a 27% discount to current net asset value (NAV),’ she said. 

‘That points to a 64% double discount.’

While Mackenzie hasn’t deployed the millions of cash she is sitting on, she has made changes to the portfolio this year, disposing of Braemar Shipping Services (BMS) and Gama Aviation (GMAA) as she believed ‘there was better risk-reward’ elsewhere.

Gama was sold in July as Mackenzie lost confidence in management following restatements of its accounts ‘and what we perceive to be misleading accounting practice which flattered cashflow’, she said in the trust’s July factsheet. 

Over £1m has been invested in two unnamed ‘toehold’ investments this year. Mackenzie said one was a ‘recovery and self-help’ play akin to Volex, which Mackenzie said is ‘rated too cheaply’..

‘[The new company] has been through a period of, arguably, over investment and the management team has enacted a plan to right-size the cost base to drive margins higher,’ she said. 

She added that an ‘aggressive policy’ to de-gear in this short term will increase capital efficiency and even though it has been ‘negatively affected by Covid-19’ it is still generating cash.

Mackenzie described the second new investment as an ‘overlooked company’ that grew even quicker during the ‘corona-crisis’ but did not attain a ‘lofty premium’.

‘We have been buying our shares at less than 10x earnings, and we expect the earnings to grow rapidly,’ she said. 

‘Over the medium term, we expect that higher volumes will generate higher revenues and operational gearing on a largely fixed cost base.’

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