Troy Income & Growth plc Half-Year Report

Troy Income & Growth Trust Plc

Interim Results For The Six Months To 31 March 2022

The investment objective of Troy Income & Growth Trust is to provide shareholders with an attractive income yield and the prospect of income and capital growth through investing in a portfolio of predominantly UK equities.

INTERIM BOARD REPORT

Performance

The Company delivered a Net Asset Value (“NAV”) per share total return of +1.8% and a share price total return of +1.8% over the six months to 31 March 2022. Over the same period, the FTSE All-Share Index (“the Index”) produced a total return of +4.7%. The weighted average NAV total return for the AIC UK Equity Income sector over the six months to 31 March 2022 was +2.0%.

Performance was highly polarised over the two quarters of the period. In the first three months the Company's NAV rose +8.3% against an Index return of +4.3%, concluding a strong calendar 2021 for equity markets. However, over the latter quarter, trends driving stock markets shifted dramatically, with the Company's NAV falling -5.9% against the Index return of +0.5%. Such sharp moves for your Company are unusual against a long history of markedly lower volatility than the Index, and reflect a period of divergent performance and volatility in global markets, that was dominated by macroeconomic events.

The Company paid a dividend of 0.49p per share for each of the first and second quarters.  Further details of the Board's outlook for dividends are contained later in this report.

Background

We have seen material divergence in asset prices and themes leading stock markets over the past six months. News flow in the final quarter of 2021 was dominated by the emergence of the Omicron COVID-19 variant, however, markets proved relatively robust, to the benefit of your Company. The spectre of inflation was already looming in 2021, and, over the past three months, market sentiment has shifted further, driven by the inter-related factors of i) ongoing inflationary pressures as the world reopens at differing speeds, ii) central banks signalling meaningful interest rate rises in the year ahead in an attempt to control inflation and iii) the shocking invasion of Ukraine by Russia in February. In addition to the humanitarian and political crises, the latter has further exacerbated inflationary pressures. Across your Company's portfolio of investments, there is negligible direct exposure to Russia and Ukraine, although, of course, it is the indirect impacts that may be more widely felt.

Commodities have been in particular focus given Russia and Ukraine's roles as major producers of several key economic inputs, including oil, gas, and wheat. Global prices have spiked violently, perhaps no better exemplified than by oil, where prices rose to just over $100 (WTI) by the end of March, having spiked as high as $124 – an extraordinary shift from the historically low levels seen in the midst of the pandemic. Central banks have been stirred into decisive action in an attempt to curb these pressures. The UK base rate has risen to 0.75% after three increases in quick succession. Likewise, the upper bound of the US Federal Reserve's target rate has risen to 0.50%, with significant further rises likely this year. Market expectations have moved rapidly in anticipation of this tightening, sending government bond yields upwards to levels not seen since before the COVID-19 pandemic.

The short-term consequence for equity markets has been a marked bifurcation. The share prices of those companies involved in the production of raw materials have benefitted, at the expense of those dependent on them. At the same time, upwards revisions in market-wide discount rates have penalised more highly rated, higher growth stocks. The divergence is illustrated perhaps most starkly by the FTSE All-Share Index, where energy and mining companies have in aggregate risen double-digits in the first calendar quarter of 2022, while Information Technology and many high-quality companies favoured by the Managers in the Industrials and Consumer sectors have fallen heavily. Given the Index's high weighting to large energy and mining companies, it has achieved a positive return for the calendar year to date, while other equity indices, including the S&P 500 and MSCI World, have fallen. Given your Company's aversion to these cyclical and capital-intensive sectors, returns over this unusual period have been more similar to these latter two indices than to the FTSE All-Share Index.

Portfolio

Your Company is characterised by a low level of portfolio turnover, with the Managers targeting long holding periods in companies capable of consistent free cash flow growth, instead of attempting to shift exposures based on short-term dynamics. As a result, the focus remains on the core sectors that have typified the Company over the past 13 years. A major positive in times of weakness is the opportunity to modestly increase the level of activity, adding value through tactical purchases in preferred areas. Amidst times of rapidly changing expectations, markets can often overreact as they attempt to find a new equilibrium. The Managers have added to a handful of companies where they believe this to be the case, including quality industrials Diploma and Halma, the global franchise firm InterContinental Hotels Group, and 3i Infrastructure the holder of various highly resilient assets.

The core of the portfolio remains little changed, with the largest holdings in Consumer Staples (e.g. Diageo, Nestle, Unilever), B2B-focussed software (Experian, RELX, Paychex), Healthcare (AstraZeneca, GlaxoSmithKline), and quality industrials such as Croda. While the individual business models differ, all these companies share commonality in highly recurring revenue streams, clear structural growth drivers, pricing power, and resilient operations in times of economic stress.

Discount Control Mechanism

The Discount Control Mechanism (“DCM”) was active during the period with the Company repurchasing 17.4m shares. These shares are now held in treasury. The DCM was implemented in 2010 in order to provide liquidity to both buyers and sellers of the Company's shares and to maintain the close linkage between the price of those shares and their underlying NAV. The DCM reduces discount volatility, which remains much lower than for the peer group as a whole. All transactions are NAV enhancing.

Dividends

The current quarterly dividend rate is 0.49p per share and the second quarterly dividend will be paid on 29 April 2022. The Board anticipates the payouts for the remainder of the year being at least maintained at this level, in the absence of unforeseen circumstances. The Managers anticipate robust growth in dividends from the underlying portfolio companies this year and, as the quantum becomes clearer, the Board expects to begin increasing the dividend to Shareholders while also rebuilding dividend cover.

Reduction in Management Fee

In January the Board was pleased to announce a reduction in the annual management fee payable to the Company's Investment Managers. With effect from 1 January 2022, the Company moved to a tiered annual management fee of 0.55% of net assets (i.e., excluding any gearing facility) up to £250 million and 0.50% of net assets above £250 million. This compares to the previous fee of 0.65% and so the new fee represents a reduction of 15% up to £250 million of net assets (£250,000 per annum cost saving) and a reduction of 23% on net assets greater than £250 million. This fee reduction reflects the commitment of both the Board and the Managers to creating value for Shareholders and to ensuring the Company's ongoing charges are competitive.

Outlook

The market reaction since the start of 2022 suggests investors were overly complacent about the risks of inflation and higher rates heading into the year. But it is important to recognise that expectations have adjusted meaningfully over a short period of time. Therefore, while probability is firmly weighted in favour of interest rates rising materially over the course of 2022, share prices have already moved significantly to try and price this in. The divergence of performance by sector and industry has been short and sharp. Commodity producers have been in favour whilst growth stocks have sold off but the Managers see reason for a broader shape to returns from here. The market-wide re-pricing to reflect changing rate expectations happens fast, and is the over-arching reason for the short-term relative underperformance of your Company.

The important question from here is how companies will fare operationally in the year ahead. The Managers have been busy dissecting results and meeting management teams over the past few months. The vast majority of companies are operating and executing admirably. This is reflected in the fact that many of the weaker share price performers in the near term are core holdings that have contributed most positively to returns over the past couple of years, and longer term. Experian, Croda, Unilever and Next are such examples. Some holdings, such as American Express, actively benefit from an inflationary environment, and some have moved rapidly to offset impacts, while others will take more time to work through the pressures. Importantly, the Managers see little that threatens the long-term durability and capacity for free cash flow and dividend growth from most of your Company's investments. This wider perspective is important – in uncertain times it is easy to shorten one's time horizon to the detriment of good long-term investing. The Managers are challenged to maintain this wider perspective and take advantage of opportunities where the stock market's reaction appears overdone.

Heightened uncertainty and volatility seem likely to characterise the months ahead. Markets are wrestling with the near-term outlook and conflicting headlines are all around. Cost of living concerns, the inverting yield curve, and increasingly hawkish signalling from central banks are pointed to as precursors of an imminent recession. Meanwhile, others highlight the positive economic data points, such as strong labour markets and healthy household balance sheets, as reasons to be more optimistic. Whatever emerges, the Managers see scope for higher quality stocks to fare better, particularly as inflation shocks inevitably start to pressure economic growth. The portfolio looks healthy and this is reflected in the expectation that almost every holding will report dividend growth this year, with many having already done so. The Company's unwavering focus on real growth, strong business models, and sustainable dividends should drive value creation, which can reasonably be expected to feed through into relatively attractive capital and income returns for Shareholders.

David Warnock

Chairman

27 April 2022