In April 2012, Neil Woodford, then fund manager of two of the UK’s biggest income funds revealed that he had finally sold the last of his shares in Tesco (LSE: TSCO)
Writing in the Telegraph, he explained his rationale: “I have held Tesco shares in my funds for most of the past 20 years, during which time it has proved to be a very successful long term investment, but I now find myself worrying more than ever about the risks – both macro-economic and business specific risks – that this investment now entails”.
The star manager, who now runs the Woodford Equity Income Fund and the Woodford Patient Capital Trust, still believed that Tesco was a cheap asset and a great British business. But he was presented with other, more compelling and less risky investment opportunities elsewhere.
History repeating?
As can be seen from the five-year chart below, Woodford made the correct call by selling his fund’s Tesco shares and I think history could well be repeating itself with Rolls-Royce (LSE: RR) currently.
From hitting an apparent peak in 2014, the shares have been on a steady downward trend since Rolls-Royce first warned on profits. The falls have intensified since the company announced the results of its strategic review on fears that a recovery would take longer than most investors had expected, coupled with a potential dividend cut.
In his blog post of 9 December 2015 Woodford echoed these fears, stating that the company has become more challenged over the last couple of years, which has weighed significantly on its share price.
He felt some of these problems simply represented growing pains, as the business transitioned between civil aerospace engine designs and made investments in new capacity to deliver its substantial forward order book. But he also noted that it had suffered from the deteriorating global economic environment, especially in its marine business that has been negatively impacted by the slump in oil industry exploration activity.
Final straw
It would appear that the final straw was the “very disappointing” November trading update that has resulted in the shares being cut across all of the investment guru’s mandates.
Woodford believed the problems currently being experienced across the military aerospace and marine business had now spread to the civil aerospace side of the business. This has resulted in material downgrades to both profits and cash expectations, leading the investor to believe that the 2016 dividend will be cut. These events have shaken his confidence in the business, which he has held for the last 10 years through his current mandates and previously at Invesco Perpetual.
Indeed, analysts have been trimming their EPS figures all year: the broker average EPS figure for 2015 earnings (taken from the 24 brokers that covered the stock) has fallen from 62.45p in December 2014 to 52.26p currently, according to Stockopedia data. Personally, I think this will fall further going into 2016 as the strategic review begins to work through the business.
On the sidelines
In summarising, Woodford clearly states that if his caution is misguided he’ll revisit the investment. But for now the proceeds of the sale have been put into shares that meet his 3-5-year high single-digit annualised return expectation.
While some investors may see this as an opportunity to top up their holding in a top quality UK business, I’m with Mr Woodford on this occasion – and will be joining him on the sidelines awaiting the green shoots of a recovery.