In a recent update on his fund’s performance, Neil Woodford showed where he has made and lost money in the 12 months to the end of June.
Allied Minds (LSE: ALM) is one of the best performers in his portfolio, but Rolls-Royce (LSE: RR) and Drax (LSE: DRX) were a drag.
What’s next for these three companies is less obvious than it may seem at first sight.
Why Allied Minds?
Allied Minds had an average weight of 2.95% in Woodford’s portfolio — a percentage that is almost in the middle of the highest and the lowest exposure to any stock in his fund. It signals that if you invest in it, you’d do well to be careful with regard to the amount of stock you end up owning.
Its performance contribution, at 3.21%, tops the ranking by some distance, which reflects a higher level of risk compared to that of several other holdings in Woodford’s portfolio.
One obvious question now is whether the shares of Allied Minds have lost their sparkle?
Consider that its equity valuation is up 114% in the last year of trade, but its shares now change hands around their one-year median of 473p, for an implied forward valuation of 123 times based on the group’s market cap of £1bn divided by forward revenues of £8.3m — trailing revenues stood just below £8m.
You’d expect a much higher growth rate for revenues or earnings or both to bet on its stock.
After all, the biggest highlight of 2014 was its IPO, which was priced at 190p, for an implied market value of about £400m. It raised proceeds of $155m. Based on its funding needs, Allied Minds should be safe for a couple of years at least, in my view.
No other key financial metric is available, though, and that’s because the company is at an early stage of maturity. A truly attractive feature is the sector where Allied Minds operates, given that it focuses on the commercialisation of scientific discoveries from universities and federal government institutions in the US.
While I’m really tempted to add its stock to my portfolio at this price, I need more evidence that the business can generate earnings and positive cash flows before committing to it for the long term.
Rolls & Drax: What Do They Have In Common?
The shares of both companies have fallen off a cliff in recent weeks, yet I think that Rolls-Royce offers more value than Drax at present time.
Regulatory risk is a significant hurdle for Drax because the UK government is amending its green policy, withdrawing subsidies to the energy sector.
In Woodford’s portfolio, Drax had an average weight of 1.55% and recorded a performance contribution of -0.98% — it’s the worst performer ahead of GlaxoSmithKline (-0.91%), the second-largest holding in his portfolio, with an average weight of 6.49%.
Drax’s valuation has not recoverd since its 30% drop on 8 July, when the group announced that the government had decided to “remove the Climate Change Levy (CCL) exemption for renewable electricity generated after 1 August 2015″, which prompted lower guidance for cash flows and earnings.
The power producer has begun a strategic review of its operations, gauging its “long-term options” — in these situations, a takeover becomes the most likely outcome.
If you are tempted to bet on that, however, consider that its shares trade on forward earnings multiples north of 30x, and that Drax would cost up to £1.5bn or more, which isn’t exactly small change in this market, although it could draw the attention of infrastructure funds.
In fairness, I’d rather bet on Rolls-Royce, which is not a bargain but whose shares trade on lower forward net earnings multiples in the mid-teens.
Rolls Rallies
With an average weight of 2.96% and a performance contribution of -0.57%, Rolls has been a rather disappointing investment for Woodford, but the tide may be turning.
Only a few weeks after a profit warning pushed down its stock close to its lowest level for almost four years, Rolls has rallied (+16% since 27 July) on the back of several rumours according to which activist investors could have a strategy to turn around the ailing engine maker.
“Rolls-Royce Holdings PLC on Monday said its top leaders met with ValueAct Capital Management after the activist investor raised its stake to more than 5% in the British aircraft-engine maker,” Dow Jones reported on Monday.
That’s all we know, and it’s encouraging — but there are plenty of risks that could still sink the valuation of Rolls.
