TIDMMRCH
RNS Number : 5947N
Merchants Trust PLC
26 September 2023
LEI: 5299008VJFXCUD2EG312
THE MERCHANTS TRUST PLC
Half-Yearly Financial Report
For the six months ended 31 July 2023
Interim management report
Economies, markets & Merchants' performance
Shareholders will recall that in the Full Year report to 31
January 2023 I was able to reflect on a period in 2022 where
Merchants had thrived due to the prospect of rising inflation and
interest rates and a corresponding decline in the share prices of
highly rated 'growth' shares. Throughout that period, Merchants'
portfolio of shares of good businesses bought at reasonable
valuations had performed extremely well.
The first half of this year has been more difficult. As
anticipated, central banks around the world employed aggressive
interest rate hikes to cool rising inflation. In the UK, the Bank
of England raised rates four times and by a total of 1.5% (from
3.5% to 5%) during the reporting period, with a further
quarter-percent rise after the period end in August. Towards
mid-year there were undoubtedly signs of some inflationary
pressures subsiding but core inflation (which discounts volatile
energy and food prices) had remained stubbornly high. The core
inflation rate in the UK was 6.9% in July, up from 6.2% in
February, whilst during the same period the headline inflation rate
fell from 10.4% to 6.8%. These higher than expected levels of
inflation have kept central bank rhetoric on the side of potential
further rises, even if they are equally mindful of not driving the
economy into recession.
The UK stock market is also affected by global equity market
trends. After a fall from grace for technology and other high
growth shares during 2022 due to the high inflation and rising
rates backdrop, there has been a sharp reversal in the first half
of 2023, with a rally in technology shares, particularly the
largest 'mega-caps' that dominate the US market. This has supported
higher growth stocks more broadly, rather than more value oriented
companies. The early part of the year also saw a stark reminder of
the risks in the banking sector when Silicon Valley Bank in the US
found itself with a mismatch between bond assets it had invested
heavily in and its obligations to provide liquidity to depositors.
Investors were also unsettled shortly thereafter when Credit Suisse
was forced by regulators into a rescue takeover by UBS. UK
regulated banks have had stronger capitalisation requirements since
2008 and so this kind of scenario has been less of a concern
domestically.
These conditions were not ideal for our investment manager and
his value investing style. A relatively flat total return for the
UK equity market masked the return of the dispersion between
outperforming growth stocks and underperforming value stocks and
Merchants' Net Asset Value (NAV) total return was -2.2%, compared
to the benchmark's return of +0.8%. Our portfolio manager Simon
Gergel describes the drivers of this underperformance in more
detail within his Investment Manager's Review. Merchants' long-term
record however remains strong and we believe that long term
performance is the best continuing validation of Merchants'
consistent strategy of providing a high and rising income, together
with long-term growth in capital for our shareholders.
Despite an overall flat performance of the UK equity market the
corporate sector has performed well and improving cash generation
has continued to support the ongoing recovery in dividend income
for the trust. This has given the board confidence to raise the
dividend for shareholders and to do so at a higher rate than had
been possible since the start of the pandemic. Last year the first
half year dividends increased by 0.7% and this year the increase is
3.6%.
Image of the UK remains an issue
For a long time there have seemed to be reasons for investors to
avoid the UK equity market. 'Old economy' stocks, Brexit, pandemic
uncertainty, political turmoil and, latterly, concerns over the
UK's domestic inflation and interest rate environment are a few of
the reasons mentioned.
However, the UK equity market is not the same as the UK economy.
Many of the larger market capitalisation stocks in the UK equity
market are global multinationals which are much more tied to the
global economy for their revenue generation than the UK economy.
Many are largely unaffected by the tribulations of the UK
economy.
Our investment manager feels strongly that the UK equity market
often seems to be affected by negative investor sentiment over the
UK economy and domestic outlook. As a result of this the UK equity
market has become one of the cheapest markets in the world. Our
investment manager continues to see considerable value
opportunities within the market. Companies with robust business
models and supportive long-term trends are now overlooked by
investors who cannot see past a gloomy UK economic environment. The
manager continues to actively manage the portfolio and take
advantage of these new opportunities as they arise.
Market demand
Although this has been a challenging first half for the Trust,
we have seen continuing demand for our shares illustrated by the
share price continuing to trade around par with the Net Asset Value
(NAV) for much of the period. Periodically the shares have traded
at a premium to NAV, where we have consequentially issued new
shares in the Company. Over the period 6,660,000 new shares were
issued at an aggregate value of GBP37.9m, with a further 275,500
issued since 31 July up to the point of publishing these results.
(As has been mentioned in previous reports shares are only ever
issued at a premium to the prevailing Net Asset Value, to make the
process accretive to existing shareholders. The board continues to
believe that a growing trust benefits all shareholders as the
company's fixed costs can be spread over a wider base.)
Our strong and consistent long-term performance and our income
generation, illustrated by our 41-year Dividend Hero status as
defined by the Association of Investment Companies (AIC), are in
our view the key factors behind ongoing shareholder and investor
demand for Merchants' shares.
Earnings
As noted above, we have continued to see an improvement in
corporate earnings following the lows of the pandemic. Earnings per
share (EPS) for the six months under review reached 17.4p (2022:
16.0p) which is now also comfortably above the pre-pandemic level
of 16.1p for the equivalent period in 2019 (2020 financial year).
Our investment manager necessarily remains somewhat cautious
however on near-term earnings, given ongoing economic uncertainties
and rising costs for businesses.
That said, the impact of the pandemic upon UK company dividend
distributions was so profound, with some cuts and rebasing proving
more permanent, it is very pleasing to be back well above
pre-pandemic levels.
Dividends
There are two pleasing effects from the positive earnings noted
above. Firstly, it has given the board confidence to propose an
increased dividend and, secondly, it allows us to continue
rebuilding revenue reserves that were partially utilised in order
to continue our strategy of paying a high and rising dividend to
shareholders through the pandemic. Not all trusts are able to
provide such income support and smoothing during tough times, which
is why Merchants is one of only 20 companies to be awarded the
AIC's coveted Dividend Hero status from a universe of well over 400
listed companies.
The board has declared a second quarter dividend for the current
financial year of 7.1p per ordinary share, payable on 10 November
2023 to shareholders on the register at close of business on 6
October 2023. A Dividend Reinvestment Plan ('DRIP') is available
for this dividend for which the relevant Election Date is 20
October 2023 and the ex-dividend date is 5 October 2023. We are
pleased to advise that for CREST-registered shareholders, dividend
payments are enabled in CREST. This means that for the first half
of the 2024 financial year, the aggregated dividend will be 14.2p
compared with 13.7p for the same period last year, a 3.6%
year-on-year rise.
Shareholder contact
In 2022 we marked our first opportunity to host an in-person
Annual General Meeting for shareholders since the pandemic. It was
therefore a pleasure for the board to be able to once again host
shareholders in May 2023. The board was pleased to see the event so
well supported by shareholders and there was a lively dialogue
between many of those shareholders, the board and our investment
manager. I would like to thank those shareholders who managed to
attend, but for those who couldn't, a video of my introduction and
portfolio manager, Simon Gergel's investment update is available on
Merchants' website under the 'Videos, Podcasts & Reading'
tab.
As you will hopefully be aware we spend considerable effort
ensuring our reporting is informative and interesting for
shareholders. It was a pleasure therefore to once again be
nominated in the 'Best Report and Accounts, Generalist' award at
the Association of Investment Companies' annual awards. Having been
a winner for three consecutive years, we were naturally
disappointed not to have lifted the accolade this year, however
congratulations to the winner and we are sharpening our pencils
again ready for next year.
We continued to have positive press coverage during the period,
but of particular note was a national press profile piece. After
having already received a "buy" recommendation from The Times'
'Tempus' column in January, The Daily Telegraph's 'Questor' column
at the end of March highlighted: "A strong track record of capital
growth enhances Merchants Trust's reputation for long-term
performance". After taking a deeper look at Merchants, columnist
Robert Stephens concluded "With Merchants having a stunning track
record of dividend growth over recent decades, plus an excellent
history of capital returns, it offers a long-term solution to a
long-term problem. Buy."
Board
We reported in our latest Annual Report that the planned
retirement dates of two directors had been noted and that the board
would commence the process of conducting searches for suitable
successors making use of external search consultants. That process
has been initiated with the appointment of an external recruitment
firm to assist with the process and we will keep shareholders
informed as appropriate. In the Annual Report we confirmed the
board's support of the FCA's encouragement of greater diversity on
boards and we disclosed in line with the Listing Rules (LR
9.8.6R(9)). At present the board consists of three women and two
men, and there are no directors with a minority ethnic background.
We will be reporting on the outcome of the current recruitment
exercise over the next few months.
Outlook
Central banks around the world continue to tread a tentative
path around reducing inflation whilst trying to avoid recession.
Recession may ultimately be unavoidable depending on how aggressive
central banks decide to be. We note however that whilst that
scenario can provide a challenge to the financial markets, assets
such as the listed shares of companies often start to outperform
well before the trough of an economic cycle. Our manager reminds us
that any signals that inflation is moderating and that interest
rates may fall could lead to investor sentiment improving very
rapidly.
Uncertainty such as we have now is the enemy of calm and
rational markets and so one might reasonably expect markets to
continue to be very sensitive to news flow in the near term. For
the dedicated stock picker this continues to provide opportunities
where strong companies become caught up in general negativity and
become, in the view of our manager, mispriced. He continues to see
numerous opportunities to invest in good companies at attractive
prices in the UK stock market which is one of the cheapest in the
world and is currently trading near a 20-year low whilst its peer -
the US equity market - is close to a 20-year high.
Whether the tech rally witnessed so far this year in the US is
indicative of global markets having once again got ahead of
themselves from AI-driven tech euphoria is still to be determined.
Our manager continues to focus on the fundamentals of companies
with strong business models and which are backed by clear long-term
supportive themes. He continues to avoid distraction from short
term news flow and stock market momentum. Merchants is positioned
with a long-term focus and a clear emphasis on the value provided
by the companies we invest in. We will maintain this focus in order
to pursue continuing growth in income together with above-market
total returns for Merchants' shareholders.
Colin Clark
Chairman
25 September 2023
Principal Risks and Uncertainties
As identified in the Annual Report, the principal risks are now
considered to be emerging risks, followed by the risks of market
decline.
The principal risks and uncertainties facing the company,
together with the board's controls and mitigation, are those
described in the Annual Report for the year ended 31 January 2023
published in April 2023 and are listed below:
-- Emerging risks, such as significant geopolitical risks.
-- Risk of market decline adversely affecting investments and returns.
-- Investment strategy risk leading to a failure to meet the company's
objectives, such as income generation and dividend growth.
-- Risk of poor performance in difficult markets for the portfolio.
The board's approach to mitigating these risks and uncertainties
is set out in the explanation with the Risk Map in the Annual
Report. In the board's view these will remain the principal risks
and uncertainties for the six months to 31 January 2024.
Going Concern
The directors have considered the company's investment objective
and capital structure both in general terms and in the context of
the current macro-economic background. Having noted that the
portfolio is liquid as it consists mainly of securities which are
readily realisable, and through continuous assessment of the
company's financial covenants, the directors have concluded that
the company has adequate resources to continue in operational
existence for the foreseeable future. The directors have also
considered the continuing risks and consequences of macroeconomic
and unanticipated shocks on the operational aspects of the company
and have concluded that the company has the ability to continue in
operation and meet its objectives in the foreseeable future. For
this reason, the directors continue to adopt the going concern
basis in preparing the financial statements.
Responsibility Statements
The directors confirm to the best of their knowledge that:
-- The condensed set of financial statements contained within
the half-yearly financial report has been prepared in accordance
with FRS102 and FRS104, as set out in Note 2, the Accounting
Standards Board's Statement 'Half-Yearly Financial Reports';
and
-- The interim management report includes a fair review of the
information required by The Financial Conduct Authority's ('FCA')
Disclosure and Transparency Rule 4.2.7 R of important events that
have occurred during the first six months of the financial year and
their impact on the condensed set of financial statements, and a
description of the principal risks and uncertainties for the
remaining six months of the financial year; and
-- The interim management report includes a fair review of the
information concerning related parties transactions as required by
the Disclosure and Transparency Rule 4.2.8 R.
Colin Clark
Chairman
25 September 2023
Enquiries:
For further information, please contact:
Allianz Global Investors UK Limited
Stephanie Carbonneil
Head of Investment Trusts
Tel: 020 3246 7256
Investment Manager's Review
Major geopolitical events seem to have occurred at the start of
recent financial years, with the Covid pandemic spreading to Europe
in February 2020 and the Russian invasion of Ukraine in February
2022. The start of this year was not quite on the same scale, but
there were important events, nevertheless. Financial markets were
rocked by the collapse of Silicon Valley Bank (SVB) in California
and the forced rescue of Credit Suisse by Union Bank of
Switzerland. Throughout the early months of the year, there was
also a boom in the valuation of the large US technology stocks
driven by excitement over generative artificial intelligence (AI).
There was a hope that AI could lift the technology sector out of a
post-Covid slowdown. This hope was boosted when Nvidia announced a
surge in orders of its graphics chips that fuel AI.
Perhaps the dominant theme to affect the UK stock market was the
continued and stubborn rise in inflation. Western central banks had
to raise interest rates aggressively to try to stem inflationary
pressures. As interest rate expectations increased, bond yields
rose and mortgage costs went up, raising concern about the
prospects for consumer spending and the economy more broadly.
Interest rate increases were also a contributory cause to the
Silicon Valley collapse, as rising bond yields hit the value of
SVB's bond portfolio and exposed specific vulnerabilities.
In the UK, 10 year government bond yields rose from 3.3% to 4.3%
over the period, with 2 year yields rising even higher, as the Bank
of England raised interest rates from 3.5% to 5%. Inflation
statistics exceeded expectations for most of the period, even as
inflationary pressures started to subside in the US and Europe,
leading to a narrative that the UK had a worse inflationary problem
than elsewhere. It was only in July, when reported inflation came
in lower than expectations, that investors became a bit more
optimistic about UK inflation and the prospects for interest rates.
Sterling strengthened against the dollar in a move that generated
little attention, especially compared to the weakness of sterling
last year, when Liz Truss was prime minister. The pound rose from
$1.23 to $1.28, well above the $1.07 hit last September.
The combination of rising economic concerns, stress in parts of
the banking system and a surge in excitement about AI, led to a
sharp polarisation within stock markets. In the US, most of the
stock market gains were made by a handful of large technology
companies. In the UK, whilst the overall UK stock market return was
modest, with the market trading in a fairly tight range, there was
a large gap between the strong performance of higher growth
companies, and the weak performance of more lowly valued companies.
Large companies outperformed medium and smaller sized companies.
The latter tend to be more cyclical and more exposed to the
domestic economy. The UK stock market also suffered from continued
investor outflows, on concerns about the UK's inflation and
interest rate outlook.
Sector performances were mixed. In many cases, the overall
sector move reflected the average of a wide range of different
share price movements. For example, within banks, HSBC benefitted
from a relative "safe haven" status and produced a 13% total
return, whilst Barclays and NatWest gave negative returns of
between -14% and -18%. Of the largest sectors, the most notable
move was the 16% drop in the industrial metals & mining sector
on concern about weak growth in the important Chinese economy.
Pharmaceuticals and personal care outperformed, due to their
defensive characteristics, whilst banks and energy performed close
to the market average.
The dispersion in share prices was also driven by a number of
competing forces that affected businesses. Some industries, like
tourism and leisure benefitted from a continued recovery to more
normal levels of activity. Other industries, like chemicals and
packaging, had to deal with an excess of inventory built up
during the Covid period, which had to be worked off, impacting
sales. Rising interest rates affected businesses in different ways,
especially in the financial sectors. House building in the UK
slowed in response to rising mortgage costs. In addition, companies
had to deal with volatility in commodity costs and exchange
rates.
Performance
It was a difficult period for our value-oriented investment
approach. The portfolio total return was -2.3%, compared to a
benchmark return of +0.8%. The underperformance was due to stock
selection within sectors. Sector strategy was net positive, as the
portfolio benefitted from a high exposure to the construction &
building materials sector, which performed well, and a low exposure
to metals & mining, which was weak.
The top ten individual positive and negative stock contributions
to the relative performance are shown in the table. These top ten
contributors only account for about a third of the
underperformance, with the rest accounted for by a tail of smaller
impacts, reflecting broad underperformance of lowly valued
companies this year.
Two of the largest three negative contributors were HSBC and
AstraZeneca. Neither was owned in the portfolio, and both are very
large companies that performed well, boosting the FTSE All-Share
return. There were smaller but similar impacts from not owning
Rolls Royce and Flutter.
Three financial companies were among the top ten negative
contributors. Shares in the wealth manager St James's Place fell in
July, as the company announced a fee reduction for certain
longstanding clients who have been with the firm for a decade.
Whilst this will impact profitability, St James's remains a very
strong business with an attractive growth profile that we do not
believe is reflected in the valuation. OSB (Onesavingsbank) also
fell in July as the company announced that a certain group of
mortgage customers were moving off variable rate mortgages, onto
cheaper fixed rate deals, at a faster pace than previously. This
meant that the bank had to change its expectations for the
profitability of these customers. We believe the shares
over-reacted to the news, and we took advantage of the depressed
valuation to add to the holding. Financial trading company IG
Group's shares fell in March, when it reported a relatively quiet
quarter for trading activity by its client base, but overall
profitability has been supported by higher interest rates. IG's
trading is always subject to market volatility, but it is a highly
profitable market leading business, and remains well positioned,
with long term growth opportunities.
Elsewhere, the consumer goods company PZ Cussons, which owns
Original Source, Imperial Leather and other brands, suffered from a
post-Covid drop in sales of its Carex soap and sanitiser business,
as well as economic volatility in its large African business.
However, we believe the relatively new management team is making
considerable progress in improving the quality of the company which
has good potential. National Express, now called Mobico group,
suffered from a shortage of drivers and high cost inflation in its
school bus operations in the USA, and its UK bus business. Finally,
the specialist recruitment company SThree de-rated sharply on
economic concerns, although the business has been quite resilient
and has an excellent long term growth record.
Looking at the positive individual stock contributors, the top
three were all stocks that were not owned in the portfolio, but
fell sharply, pulling back the FTSE All-Share return. These were
the two mining companies Anglo American and Glencore, and the
financial stock Prudential.
Three of the top ten contributors are involved in the building
industry, with all three having a large exposure to the USA, where
construction and housing trends have been stronger than the UK.
Tyman, which has a large market share in components for doors and
windows, saw its shares rally from a very low valuation on optimism
about a recovery in the business, supported by strong profit margin
improvement reported in North America. The building materials giant
CRH reported robust trading and excited investors with a proposed
shift of its primary stock market listing to the USA. Ground
engineering company Keller also performed well, with its key US
operation seeing a strong margin improvement.
Elsewhere, BMW responded well to resilient conditions and high
levels of profitability in the car industry and reinsurer SCOR
performed well on the back of strong industry pricing. Pets At Home
outperformed on the back of trading results, where it reported 13%
sales growth in its vet business and 6% growth in its retail stores
last year, despite a difficult consumer environment. Finally, BAE
Systems followed last year's strong gains with further
outperformance on the back of increasing defence spending and good
operational performance.
Contribution to Investment Performance relative to the FTSE
All-Share Index
Positive Performance Negative Performance
Stocks Impact % Stocks Impact %
Overweight
(holding larger
than index weight)
St James's
Tyman 0.3 Place -0.5
BMW 0.3 PZ Cussons -0.3
SCOR 0.2 OSB -0.3
Pets At Home 0.2 Mobico -0.3
CRH 0.2 IG -0.3
BAE Systems 0.2 SThree -0.2
Keller 0.1
Underweight
(zero holding
or weight
lower than index
weight
Anglo American 0.5 HSBC -0.6
Prudential 0.3 AstraZeneca -0.4
Glencore 0.3 Rolls Royce -0.3
Flutter -0.2
Portfolio Changes
The wide range of share price movement in the UK equity market,
coupled with high dispersion between valuations, has created many
new investment opportunities and also the potential for sales from
the portfolio. In response, we have been quite active, adding four
new companies and selling out of five, as well as making
significant changes to other position sizes.
Three of the four new holdings were medium sized companies,
whilst the other was a straight switch within the banks sector. We
are generally finding the best value among medium sized companies,
which may be off the radar of global investors. In our opinion,
persistent outflows from UK equity funds have led to forced selling
pressure on many sound companies, without enough new money to
arbitrage out the value opportunities. Conversely, four of the five
disposals were large companies.
We made a new investment in building materials company
Marshalls. Well known for its paving products, Marshalls is
diversified into commercial, infrastructure, new housing and repair
& maintenance products. It has an attractive and growing
presence in more sustainable areas, like concrete products with a
low carbon footprint, and complete roofing solutions with
integrated solar panels. Due to difficult trading conditions in the
new housing and renovation markets, Marshalls traded on a modest
valuation for the quality of the company and its strong market
position.
We also bought Inchcape, the world's largest independent car
distribution company, which has exclusive relationships
representing over 50 brands in more than 40 countries. Some of
these relationships date back decades. Inchcape is consolidating a
fragmented market as car manufacturers need strong partners in the
smaller markets, to provide the latest digital capabilities to
consumers and to manage an increasingly complex industry structure.
We had sold out of Inchcape shares on valuation grounds in 2021.
Since then, the company has grown rapidly via acquisition, with
almost half group profits now coming from Latin America. Some
short-term concerns over a large recent transaction, had upset
investors, providing an opportunity for us to re-invest at what we
believed to be a compelling valuation, and below the price we had
sold at in 2021. We did not believe the share price reflected the
inherent strengths of the company, or the considerable strategic
progress it has made in the last two years.
The other two new purchases were switches within financial
sectors. We bought Lancashire Holdings, a medium sized reinsurance
company with a strong presence in the Lloyd's of London market.
Lancashire has a disciplined approach to insurance, only committing
capital when it views pricing as favourable. In the last two years,
it has built up its book of business rapidly as reinsurance pricing
has improved, and it should be a beneficiary of this stronger
market environment, as well as from higher interest rates, which
boost investment returns. We funded Lancashire partly by selling
Swiss Re. Although Swiss Re is also exposed to the same improving
market conditions, its exposure is diluted by a more diversified
business model, and its valuation was significantly higher than
Lancashire where we saw more upside.
In the banks sector, we switched out of NatWest into Lloyds.
Both banks are well capitalised and benefitting from better
industry conditions than in recent years, with higher interest
rates boosting margins and relatively low bad debt charges, despite
economic uncertainty. Both banks were modestly valued, but we had a
preference for Lloyds, given the scale advantage of its leading
position in UK consumer banking and an improving cash generation
profile.
Turning to the sales, we sold out of BAE Systems which has been
in the portfolio for many years. BAE is Britain's largest defence
manufacturer and also the country's largest manufacturing business.
BAE has been trading well, with a large order book and sound
prospects. Selling the shares brought mixed emotions. However, our
job is not simply to own strong businesses on behalf of
shareholders, we are looking for exceptional investment
opportunities. BAE shares had been very strong performers, with the
share price doubling over the preceding two years, even excluding
dividends. Our assessment was that the shares had moved up to a
fair valuation, and therefore we decided to exit the position to
fund more attractive situations. We wrote up the BAE Systems
investment as a case study in the 2023 annual report, reflecting
its strong contribution to last year's results.
The other two complete disposals were Vodafone and Ashmore. In
our investment process, there are three reasons for selling an
investment. First, it may reach our target price. BAE systems was
such a case. Second, the investment view may have changed. And
third, there may be better opportunities elsewhere. Both of these
sales were examples of the second reason: a change in investment
view. Changes of opinion are often the most psychologically
difficult decisions. They usually follow a period of poor stock
performance. Either, we have to admit to being wrong about our
initial investment decision, or we have to recognise that something
has fundamentally changed to challenge our initial view. Both can
be uncomfortable, but it is important to be as objective as we
can.
Investing in Vodafone had been a poor investment decision.
Having not owned the company for many years, due to concerns over
the highly competitive industry structure and the need for
persistently high capital expenditure, we bought a position during
the pandemic as we liked its strong cash generation, a high
dividend yield and limited economic sensitivity. We also saw some
signs that the business was performing better. However, that
business improvement proved short-lived. We sold part of the
investment last year, close to the original cost price, as our
level of conviction declined, but we held onto the rest, and only
sold it in June after another trading disappointment. Whilst the
share price was lower, we had to recognise that our initial
investment case was wrong, and we did not have sufficient
confidence to maintain a position.
Ashmore was a slightly different situation. It is a leading
emerging market, predominantly fixed income, fund management
business, with a strong culture and a differentiated market
position. Merchants has owned Ashmore previously and made a good
return. When we bought back into the shares in 2021, Ashmore's
funds had been through a period of poor performance, and it had
seen outflows. Our investment case was built around the potential
for a cyclical recovery in the emerging markets asset class,
improvement in the company's funds' performance and ultimately a
strong pick up in profitability. However, performance and flows
were worse than we expected, making it more challenging for the
business to retain assets and to take advantage of an eventual
recovery. Like Vodafone, we had already sold part of the holding
earlier in the year as our level of conviction declined and we
decided to sell the rest.
Apart from these new purchases and total disposals, we made a
large number of changes to position sizes. The biggest additions
included Drax, the UK's largest renewable power generator,
Energean, which is ramping up production of gas in Israel, helping
the country to reduce its dependence on highly polluting coal fired
power generation, and the pharmaceutical and vaccines business GSK.
All three are lowly priced companies where we have high conviction.
The biggest partial sales included the building materials company
CRH, which had performed very well as discussed above. We also
reduced three consumer companies that had all rallied and re-rated
closer to fair value. Unilever and Tesco have relatively defensive
business models, manufacturing and selling every-day food and
consumer products. The car company BMW is a more cyclical business,
but trading in the industry has been robust, despite a nervous
consumer environment, as limited car production during Covid had
kept new and used car supply constrained and boosted prices.
As well as making portfolio changes, we continued to actively
engage with companies in the portfolio as part of our ongoing
stewardship process. Many of these engagements covered the risk of
climate change and how companies plan to reduce their greenhouse
gas emissions over time, particularly in the extractive and energy
industries. In the case of banks, the issue is more about how they
incorporate climate change risks into their business processes,
both in terms of credit risk and in terms of the emissions of the
companies they finance. We also had several engagements on more
traditional governance areas, such as capital allocation policies
and remuneration structures. A particular feature of the
discussions this year, has been how companies think about returning
surplus capital to shareholders, either via share buy-backs or
special dividends. With many shares trading at low valuations, the
case for buy-backs is stronger than it may have been
historically.
Income
We have been pleased by the steady improvement in the income
generation of the portfolio, with strong dividend growth continuing
in industries like banking and oil & gas, which have seen a
substantial recovery in profitability since the pandemic period.
Higher inflation is also feeding through to higher dividend growth,
either in industries where pricing is directly linked to inflation,
like utilities, or more indirectly through higher nominal sales and
profits. We have been encouraged by the operational progress that
many of the portfolio companies have made, which also supports
their dividend growth.
Of course, it has not all been plain sailing. The consumer
environment is difficult, and sectors like housing are seeing a
sharp slowdown. This means that there are likely to be some
dividend cuts in the portfolio in the months ahead. But we do not
envisage wholesale dividend cuts like we saw during the pandemic or
the Great Financial Crisis, partly due to the considerably stronger
balance sheets of many of the businesses in the portfolio.
Overall, higher income receipts have boosted Merchants revenue
earnings per share to 17.4p, an increase of 8.7% compared to 16.0p
last year.
Economic and Market Outlook
In our opinion, the UK stock market offers exceptional
opportunities for investors. According to Goldman Sachs, the UK
stock market is trading close to its lowest absolute valuation in
the last 20 years, in terms of price to earnings ratio, at the same
time that the USA is trading close to its highest level. That is
unusual in itself. But, in addition, the dispersion of valuations
across the UK stock market (the gap between growth and value
stocks) is around the widest it has been in 50 years, according to
Morgan Stanley. These are conditions, that I don't remember seeing
before in my career. Many sound businesses are trading on depressed
valuations, offering the potential to make very healthy capital and
income returns. To understand why this is the case, and why
conditions may change, it is worth discussing the circumstances
that have led to this unusual situation.
Since the Brexit referendum in June 2016, the UK stock market
has been out of favour with international investors, and it has
gradually de-rated. Initially, this was driven by fears over the
economic impact of Brexit itself, and this was exacerbated by the
tortuous political wranglings with the EU during Theresa May's and
Boris Johnson's premierships. Political uncertainty increased, when
Jeremy Corbyn, a hard-left leaning politician looked like he could
win the general election in 2019. Then, just as the Brexit and
political uncertainty started to fade, following Johnson's emphatic
election win in 2019, the Covid pandemic hit in early 2020, and the
UK seemed to suffer especially hard, providing another reason for
foreign investors to stay away. Next, as the pandemic was fading
into the rear-view mirror, the Russian invasion of Ukraine caused a
huge inflationary spike that particularly affected Europe, giving
global investors reason to stay clear of the whole continent.
Further political uncertainty ensued when Liz Truss became prime
minister for a brief period in 2022 and unsettled the financial
markets with what were perceived as unfunded tax cuts. Finally,
more recently, as discussed above, the UK's inflation rate has been
higher and more sticky than the rate in the US and the EU, creating
a narrative that the UK has a more challenging outlook.
These concerns about the UK, have led to steady outflows from UK
equity funds in recent years. This comes on the back of a
structural, forty-year period, where domestic pension funds and
institutions have gone from owning around half the UK stock market,
to only 4%. The selling has largely been due to the increasing
maturity of defined benefit pension funds, and accounting rules
which encouraged funds to sell equities and buy bonds. This selling
pressure has exacerbated the de-rating of the stock market, and
widened the gulf between those companies that are popular with
global investors - typically the large multi-nationals and the
higher growth / higher return companies - and the rest. It has
often felt like there were no buyers for some of the medium sized
and smaller companies, and it not surprising that we have seen a
step-up in the number of portfolio companies buying back their own
shares, to take advantage of the bargain prices available.
Whilst some people may see this set of circumstances as a reason
to shun UK equities, we see the glass as half-full. The selling
pressure by domestic pension funds and institutions really cannot
go much further, as they own very few UK equities. Furthermore, the
government is keen to promote the UK stock market, and to get
domestic savers and institutions to support investment and
innovation. This may take time to have any effect, but the
relentless selling should be nearly finished. The latest inflation
numbers suggest that the UK is nearing the peak of the inflation
cycle and any visibility on peak interest rates could lead to a
significant change in depressed investor sentiment. UK politics
seems to be becoming less polarised, with the policy gap between
Rishi Sunak and Sir Keir Starmer quite narrow, removing one of the
often-cited reasons for avoiding UK investments. Most importantly,
the valuations of many UK companies are compelling, especially
compared to their peers overseas, despite the majority of sales of
UK listed companies actually coming from abroad. We would expect to
see a resurgence in takeover activity, as companies and private
equity funds look to take advantage of this situation. The cost of
debt and volatility of interest rates may keep some of these
investors on the sidelines for a while longer, but once the
interest rate cycle looks more supportive, sentiment could change
rapidly.
We are therefore excited about the prospects for Merchants'
portfolio. It is diversified across industries and geographic
exposure, as well as between defensive and more cyclical
businesses. But it is a portfolio of strong businesses, trading on
very modest valuations, and paying an income stream well in excess
of the broader stock market.
Simon Gergel
Allianz Global Investors
THE MERCHANTS TRUST PLC
Twenty Largest Equity Holdings as at 31 July 2023
Value % of Benchmark
Name GBP'000s Holdings Weightings Sector
------------------------- -------- -------- ------------ ---------------------------------------------------
GSK 41,318 4.7 2.4 Pharmaceuticals & Biotechnology
Shell 40,308 4.6 6.9 Oil, Gas & Coal
British American Tobacco 32,694 3.7 2.5 Tobacco
Rio Tinto 29,355 3.4 2.4 Industrial Metals & Mining
BP 28,724 3.3 3.6 Oil, Gas & Coal
DCC 27,511 3.1 0.2 Industrial Support Services
IG Group 26,753 3.1 0.1 Investment Banking & Brokerage
WPP 25,889 3.0 0.4 Media
Energean 25,071 2.9 0.1 Oil, Gas & Coal
Inchcape 24,555 2.8 0.1 Industrial Support Services
SSE 24,355 2.8 0.8 Electricity
Tate & Lyle 24,330 2.8 0.1 Food Producers
Imperial Brands 23,447 2.7 0.7 Tobacco
Redrow 20,706 2.4 0.1 Household Goods & Home Construction
Drax Group 20,321 2.3 0.1 Electricity
Barclays 19,912 2.3 1.0 Banks
Next 19,729 2.3 0.4 Retailers
St. James's Place 19,270 2.2 0.2 Investment Banking & Brokerage
Pets At Home Group 18,077 2.1 0.1 Retailers
Grafton Group 17,693 2.0 0.1 Industrial Support Services
% of Total Invested
510,018 58.5 Funds
-------- --------
Portfolio Analysis as at 31 July 2023
Benchmark
Sector % Held weighting
Financials 22.6 22.2
Consumer Staples 14.0 15.0
Industrials 18.1 12.2
Consumer Discretionary 14.8 11.9
Energy 12.2 10.8
Utilities 7.0 3.5
Health Care 7.5 11.3
Basic Materials 3.9 7.4
Real Estate 2.0 2.4
Net current liabilities -2.2
100.0
------------------------- -------
May not add up due to roundings
** Total Assets include current liabilities
THE MERCHANTS TRUST PLC
Summary of Unaudited Results
INCOME STATEMENT
For the six months ended 31 July 2023
Revenue Capital Total Return
GBP'000s GBP'000s GBP'000s
(Note 1)
Losses on investments held at fair
value through profit or loss - (45,784) (45,784)
Losses on foreign currencies - (15) (15)
Income from investments 27,147 - 27,147
Other income 655 - 655
Investment management fee (556) (1,033) (1,589)
Administrative expenses* (603) (2) (605)
--------- --------- -------------
Profit (loss) before finance costs
and taxation 26,643 (46,834) (20,191)
Finance costs: interest payable and
similar charges (937) (1,700) (2,637)
Profit (loss) on ordinary activities
before taxation 25,706 (48,534) (22,828)
Taxation (679) - (679)
Profit (loss) after taxation attributable
to ordinary shareholders 25,027 (48,534) (23,507)
========= ========= =============
Earnings (loss) per ordinary share
(Note 4)
(basic and diluted) 17.36p (33.67p) (16.31p)
BALANCE SHEET GBP'000s
As at 31 July 2023
Fixed Assets
Investments held at fair value through profit or
loss 893,161
Net current liabilities (19,293)
-------------
Total assets less current liabilities 873,868
Creditors: amounts falling due after more than one
year (66,838)
Total net assets 807,030
=============
Called up share capital 36,699
Share premium account 220,520
Capital redemption reserve 293
Capital reserve 521,378
Revenue reserve 28,140
-------------
Equity shareholders' funds 807,030
=============
Net asset value per ordinary share 549.8p
The net asset value as at 31 July 2023 is based on 146,794,887
ordinary shares.
*Administrative expenses for 2022 included the London Stock
Exchange block listing fee of GBP170,000.
THE MERCHANTS TRUST PLC
Summary of Unaudited Results
INCOME STATEMENT
For the six months ended 31 July 2022
Revenue Capital Total Return
GBP'000s GBP'000s GBP'000s
(Note 1)
Losses on investments held at fair
value through profit or loss - (18,646) (18,646)
Gains on foreign currencies - 29 29
Income from investments 22,997 - 22,997
Other income 439 - 439
Investment management fee (515) (957) (1,472)
Administrative expenses* (690) (1) (691)
--------- --------- -------------
Profit (loss) before finance costs
and taxation 22,231 (19,575) 2,656
Finance costs: interest payable and
similar charges (634) (1,137) (1,771)
Profit (loss) on ordinary activities
before taxation 21,597 (20,712) 885
Taxation (490) - (490)
Profit (loss) after taxation attributable
to ordinary shareholders 21,107 (20,712) 395
========= ========= =============
Earnings per ordinary share (Note
4)
(basic and diluted) 16.04p (15.74)p 0.30p
BALANCE SHEET GBP'000s
As at 31 July 2022
Fixed Assets
Investments held at fair value through profit or
loss 841,088
Net current liabilities (11,753)
-------------
Total assets less current liabilities 829,335
Creditors: amounts falling due after more than one
year (66,782)
Total net assets 762,553
=============
Called up share capital 33,731
Share premium account 157,058
Capital redemption reserve 293
Capital reserve 547,640
Revenue reserve 23,831
-------------
Equity shareholders' funds 762,553
=============
Net asset value per ordinary share 565.2p
The net asset value as at 31 July 2022 is based on 134,924,887
ordinary shares.
*Administrative expenses for 2022 included the London Stock
Exchange block listing fee of GBP170,000.
BALANCE SHEET GBP'000s
As at 31 January 2023
Fixed Assets
Investments at fair value through profit or loss 909,638
Net current liabilities (30,454)
-------------------------
Total assets less current liabilities 879,184
Creditors: amounts falling due after more than one
year (66,809)
Total net assets 812,375
=========================
Called up share capital 35,034
Share premium account 184,239
Capital redemption reserve 293
Capital reserve 569,912
Revenue reserve 22,897
-------------------------
Equity shareholders' funds 812,375
=========================
Net asset value per ordinary share 579.7p
The net asset value as at 31 January 2023 is based on
140,134,887 ordinary shares.
THE MERCHANTS TRUST PLC
STATEMENT OF CHANGES IN EQUITY
Called Share Capital
Up Premium Redemption Capital Revenue
Share Account Reserve Reserve Reserve Total
Capital GBP'000s GBP'000s GBP'000s GBP'000s GBP'000s
GBP'000s
----------- ----------- ------------- ----------- ----------- -----------
Six months ended
31 July 2023
Net assets at 1
February 2023 35,034 184,239 293 569,912 22,897 812,375
Revenue profit - - - - 25,027 25,027
Dividends on ordinary
shares (Note 3) - - - - (19,784) (19,784)
Capital loss - - - (48,534) - (48,534)
Shares issued during
the period 1,665 36,281 - - - 37,946
Net assets at
31 July 2023 36,699 220,520 293 521,378 28,140 807,030
----------- ----------- ------------- ----------- ----------- -----------
Six months ended
31 July 2022
Net assets at 1
February 2022 31,926 118,047 293 568,352 20,432 739,050
Revenue profit - - - - 21,107 21,107
Dividends on ordinary
shares (Note 3) - - - - (17,708) (17,708)
Capital loss - - - (20,712) - (20,712)
Shares issued during
the period 1,805 39,011 - - - 40,816
Net assets at
31 July 2022 33,731 157,058 293 547,640 23,831 762,553
----------- ----------- ------------- ----------- ----------- -----------
THE MERCHANTS TRUST PLC
CASH FLOW STATEMENT
Six Months Six Months
ended 31 ended 31
July 2023 July 2022
GBP'000s GBP'000s
Operating activities
(Loss) profit before finance costs
and taxation (20,191) 2,656
Add: Losses on investments held
at fair value 45,129 17,696
Add: Losses (gains) losses on foreign
currency 15 (29)
Purchase of fixed asset investments
held at fair value through profit
or loss (132,771) (176,160)
Sales of fixed asset investments
held at fair value through profit
or loss 107,145 130,106
Transaction costs (655) (950)
Increase in other receivables (2,473) (1,569)
Decrease in other payables (116) (87)
Less: Overseas tax suffered (679) (490)
Net cash outflow from operating
activities (4,596) (28,827)
Financing activities
----------- ----------------------
Interest paid (2,475) (1,725)
Dividends paid on cumulative preference
stock (21) (21)
Dividends paid on ordinary shares (19,784) (17,708)
Share issue proceeds 37,946 41,109
Net cash inflow from financing
activities 15,666 21,655
----------- ----------------------
Increase (decrease) in cash and
cash equivalents 11,070 (7,172)
----------- ----------------------
Cash and cash equivalents at the
start of the period 11,465 18,626
Effect of foreign exchange rates (15) 29
Cash and cash equivalents at the
end of the period 22,520 11,483
Composed of:
Cash at bank 22,520 11,483
THE MERCHANTS TRUST PLC
Notes to the Financial Statements
Note 1 - Financial Statements
The half-yearly financial report has been neither audited nor
reviewed by the company's auditors. The financial information for
the year ended 31 January 2023 has been extracted from the
statutory financial statements for that year which have been
delivered to the Registrar of Companies. The auditors' report on
those financial statements was unqualified and did not contain a
statement under section 498 of the Companies Act 2006.
The total return column of the Income Statement is the profit
and loss account of the company.
All revenue and capital items derive from continuing operations.
No operations were acquired or discontinued in the period.
Allianz Global Investors UK Ltd acts as Investment Manager to
the company. Details of the services and fee arrangements are given
in the latest annual report of the company, which is available on
the company's website at www.merchantstrust.co.uk.
Note 2 - Accounting Policies
The Company presents its results and positions under 'The
Financial Reporting Standard applicable in the UK and Republic of
Ireland' (FRS 102), which forms part of the Generally Accepted
Accounting Practice ('UK GAAP') issued by the Financial Reporting
Council.
The condensed set of financial statements has been prepared on a
going concern basis in accordance with FRS 102 and FRS 104,
'Interim Financial Reporting' and the Statement of Recommended
Practice - 'Financial Statements of Investment Trust Companies and
Venture Capital Trusts' ('SORP'). The context of the current
macro-economic background has been thoroughly considered and the
directors have concluded that there are no material uncertainties
related to going concern. They have also been prepared on the
assumption that approval as an investment trust will continue to be
granted.
The interim financial statements and the net asset value per
share figures have been prepared in accordance with FRS 102 using
the same accounting policies as the preceding annual accounts.
Note 3 - Dividends on Ordinary Shares
Dividends paid on ordinary shares in respect of earnings for
each period are as follows:
Six months Six months
ended ended
31 July 31 July
2023 2022
GBP'000s GBP'000s
Third interim dividend 6.9p paid
15 March 2023 (2022 - 6.85p) 9,669 8,758
Final dividend 7.0p paid 26 May
2023 (2022 - 6.85p) 10,115 8,950
19,784 17,708
----------- -----------
In accordance with FRS 102 section 32 'Events After the End of
the Reporting Period', dividends payable at the period end have not
been recognised as a liability. Details of these dividends are set
out below.
Six months Six months
ended ended
31 July 31 July
2023 2022
GBP'000s GBP'000s
----------------------------------- ----------- -----------
First interim dividend 7.10p paid
24 August 2023 (2022 - 6.85p) 10,412 9,208
Second interim dividend 7.10p
payable 10 November 2023 (2022
- 6.85p) 10,422 9,242
20,834 18,450
----------- -----------
The dividends above are based on the number of shares in issue
at the period end. However, the dividend payable will be based upon
the number of shares in issue on the record date and will reflect
any purchase or cancellation of shares by the company settled
subsequent to the period end.
Note 4 - Earnings per Ordinary Share
The earnings per ordinary share is based on a weighted number of
ordinary shares 144,134,526 (31 July 2022 - 131,625,080) in
issue.
Note 5 - Fair Value Hierarchy
Investments and derivative financial instruments are designated
as held at fair value through profit or loss in accordance with FRS
102 sections 11 and 12.
FRS 102 sets out three fair value levels.
Level 1: The unadjusted quoted price in an active market for
identical assets or liabilities that the entity can access at the
measurement date.
Level 2: Inputs other than quoted prices included within Level 1
that are observable (i.e., developed using market data) for the
asset or liability, either directly or indirectly.
Level 3: Inputs are unobservable (i.e., for which market data is
unavailable) for the asset or liability.
With the exception of those financial liabilities measured at
amortised cost, all other financial assets and financial
liabilities are either carried at their fair value or the balance
sheet amount is a reasonable approximation of their fair value.
As at 31 July 2023, the financial assets at fair value through
profit and loss of GBP893,086,000 (31 July 2022: GBP841,080,000; 31
January 2023: GBP909,618,000) are categorised as follows:
Level Level Level
1 2 3 Total
GBP'000s GBP'000s GBP'000s GBP'000s
Financial assets at fair value
through profit or loss at 31 July
2023
Equity investments 893,161 - - 893,161
Financial instruments - - - -
Derivative financial instruments
- written call options - (75) - (75)
------------ --------- --------- ---------
893,161 (75) - 893,086
------------ --------- --------- ---------
Financial assets at fair value
through profit or loss at 31 July
2022
Equity investments 841,088 - - 841,088
Financial instruments - - - -
Derivative financial instruments
- written call options - (8) - (8)
------------ --------- --------- ---------
841,088 (8) - 841,080
------------ --------- --------- ---------
Financial assets at fair value
through profit or loss at 31 January
2023
Equity investments 909,638 - - 909,638
Financial instruments - - - -
Derivative financial instruments
- written call options - (20) - (20)
------------ --------- --------- ---------
909,638 (20) - 909,618
------------ --------- --------- ---------
For exchange listed equity investments the quoted price is
either the bid price or the last traded price depending on the
convention of the relevant exchange. For written options the value
of the option is marked to market based on traded prices. Financial
instruments valued using valuation techniques level 3 have, in the
absence of relevant trading prices or market data, been valued
based on the directors' best estimate.
Note 6 - Status of the Company
The company applied for and was accepted as an approved
investment trust for accounting periods commencing on or after 1
February 2013, subject to it continuing to meet eligibility
conditions at section 1158 Corporation Taxes Act 2010 and the
on-going requirements for approved companies in Chapter 3 Part 2
Investment Trust (Approved Company) (Tax) Regulations 2011
(Statutory Instrument 2011/2999).
Note 7 - Transactions with the Investment Manager and related
parties
As disclosed in the annual report, the existence of an
independent board of directors demonstrates that the company is
free to pursue its own financial and operating policies and
therefore, under FRS 8: Related Party Disclosures, the investment
manager is not considered to be a related party. The company's
related parties are its directors.
There are no other identifiable related parties as at 31 July
2023, 31 July 2022 and 31 January 2023.
The half-yearly financial report will be sent to shareholders at
the end of September 2023 and will be available to members of the
public from the company's registered office at 199 Bishopsgate,
London EC2M 3TY or by calling the Investor Services Helpline on
0800 389 4696.
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END
IR NKPBNCBKDNCB
(END) Dow Jones Newswires
September 26, 2023 02:00 ET (06:00 GMT)
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