Merchants Trust - Final Results

MANAGEMENT REPORT

 

Chairman's Statement

 

This year marks the 130 year anniversary of the formation of The Merchants Trust. The company was founded in 1889 by some of the leading financiers and lawyers of the day and was set up to provide investors with an opportunity to benefit from nascent international growth industries, such as those participating in the North American railway boom. Over time, the company's mandate has evolved to reflect both changing market conditions and investment opportunities.

 

It is a great privilege to be associated with the company as it celebrates 130 years. Much has changed over its timeline since 1889, with the company successfully navigating a variety of crises and challenging market conditions. Since the late 1980s, Merchants' investment universe has been primarily high-yielding, well-established UK companies (including some of the world's largest and best-known multinationals). However, one thing that has not changed is the company's overall objective: to deliver capital growth and healthy dividends to its shareholders. Income remains a theme for the company and its investors now, just as it was back in 1889.

 

Highlights of the year

·      1889 - 2019: celebrating 130 years

·      Dividend hero: 37 consecutive years of dividend growth

·      Dividend growth of nearly 5%, ahead of inflation, and yield remains well above the sector average

·      Earnings growth +8.6%

·      Overall, a challenging year for markets

Your board is proud of the company's record of paying a rising dividend to shareholders each year, so I am delighted to announce that, following our Annual General Meeting, Merchants will have achieved 37 consecutive years of dividend growth. The company continues to offer one of the highest dividend

yields in its sector.

 

A challenging year with sharp moves in individual shares

This has been an unusual year in which investment markets have been particularly volatile, reflecting a succession of macroeconomic concerns and geopolitical factors. Merchants' overall performance has been driven by sharp moves in individual shares, especially at the smaller market cap level. There have been a large number of positive and negative contributions to performance: you will find more information, including stock selections and portfolio changes, in the Investment Manager's Review on page 16 of the annual report.

 

In a challenging year overall for stock markets around the world, Merchants' UK equity portfolio  outperformed its benchmark index, the FTSE All-Share by 0.3%, over the year to 31 January 2019, but ended in negative territory. The company's Net Asset Value (NAV) return was -5.2% compared with the benchmark total return of -3.8% due to the impact of gearing in a falling market. Please refer to the attribution analysis on page 13 of the annual report.

 

The company's share price fell by 3.5% over the year from 488p to 471p which is less than the fall in the NAV as the discount narrowed during the year. With dividends reinvested, on a total return basis, the value of the shares increased by 1.7%.

 

 

37 consecutive years of dividend growth

The board is recommending a final dividend of 6.6p (2018: 6.3p) which will increase the total dividend for the year to 26.0p (2018: 24.8p), a rise of 4.8%. Significantly, this will be the 37th consecutive year in which we have grown the dividend and we are extremely proud of our continued recognition as an AIC 'Dividend Hero'; this is an elite group of investment trust companies that have increased their dividends each year for 20 years or more. The board acknowledges that income is an important

reason why investors choose to buy Merchants shares and it is the board's aim to continue increasing dividends in a sustainable and measured way.

 

The board monitors the company's yield  relative to other investment trusts in the UK Equity Income sector. At 31 January 2019, the company's dividend yield of 5.5% ranked Merchants well above the sector average of 4.0%.

 

The final dividend of 6.6p will be paid on 22 May 2019 to shareholders on the register on 12 April 2019. The dividend is fully covered by the revenue generated by the company's portfolio and there are significant reserves. Following the debt refinancing undertaken at the end of the 2018 financial year, the company's average interest rate reduced from 8.5% to 6.1%. This reduction in costs,

combined with improving income growth in the portfolio, presented the possibility of growing the dividend faster - and ahead of inflation. Pleasingly this aim has been achieved during the current financial year. These factors have also resulted in earnings per share (EPS) showing a steady improvement over the year, reaching a record level of 27.7p for the Company as it celebrates its 130th year.

 

Gearing

Investment Trusts like Merchants aim to enhance their investment returns by borrowing money to buy more assets (known as 'gearing'). The company has gearing in the form of long term debt amounting to £111 million, all deployed in the market for investment purposes. The gearing comprises a long-term debenture maturing in 2023, secured bonds maturing in 2029 and loan notes maturing in in 2052. Overall, our gearing averaged 19.8% throughout the year, compared to 19.7% last year. At the end of the year, our gearing level was 20.5% compared to 17.9 % at 31 January 2018.

 

Board succession

As we announced last year, my intention is to retire from the Merchants Board during the course of this year, having been on the board for ten years and Chairman for nine. Sybella Stanley as Senior Independent Director has been leading the search for my replacement supported by search consultants Spencer Stuart and Nurole.

 

Following our search, I am very happy to say that Colin Clark will join our board in June and become Chairman at the beginning of September. Colin has extensive fund management and board  experience. He worked for Mercury Asset Management for many years both running portfolios and

distribution. More recently he has been on the main board of Standard Life where he was also head of distribution. He retired from Standard Life following the merger with Aberdeen Asset Management. Colin is currently on the board of AXA Investment Managers and Rathbone Brothers Plc.

 

It has been a great privilege to chair Merchants Trust over the course of its thirteenth decade. It is a very well managed trust with a real purpose in producing significant income from a portfolio of UK equities. I would like to thank all our shareholders for your support over this period and I wish the trust all the very best for the future.

 

Outlook

When I wrote to shareholders in late September with the half year results, I noted both the increasing risk profile for the UK economy and the increasing volatility being experienced across global stock markets. This was before we experienced substantial market swings in the fourth quarter of 2018 which saw the FTSE All-Share Index tumble by approximately 10% (total return),  before recovering somewhat in January. This was a period of quite extreme moves at both sector

and stock level.       

 

We remain in a period of heightened geopolitical and economic risk. However, whilst there has been volatility in share prices, the fundamentals of most companies in Merchants' portfolio remain robust, with a resilient outlook for profits and dividends, albeit that the economic outlook is more uncertain than a year ago.

 

Short-term, external setbacks have always challenged the company over its 130 years. In this landmark year, we are able to look back and acknowledge that, over time, the company has successfully delivered capital and income returns through good times and bad. The board continues to believe that the Portfolio Manager and his team's policy of investing in what they believe in, is a sound one. They are aiming to build a portfolio comprising solid businesses with good prospects for growth, attractive dividends and valuable assets that are priced at a level where they believe they can deliver good total returns for shareholders. This means that they are primarily investing on a 'bottom-up basis' rather than identifying opportunities through sector allocation.

 

Looking ahead we think it is vital to continue doing what we've always done at The Merchants Trust. In spite of the mixed economic and political signals all around us, there are good stock opportunities to be found. As Simon Gergel has stated in his update, UK shares are relatively cheap at the time of writing and this is potentially a good environment for active investors like AllianzGI. By focusing on

individual stocks with strong fundamentals that may be temporarily out of favour, the team can continue investing successfully in a diverse portfolio of investments that enables investors to achieve both capital growth and healthy dividends over time.

 

 

Simon Fraser

Chairman

28 March 2019