Chairman's Statement
Your board is delighted to announce that, with shareholder approval at our Annual General Meeting, your company will have achieved 36 consecutive years of dividend growth. We are proud of this progressive dividend policy and the company's continued recognition as one of the Association of Investment Companies' 'Dividend Heroes'.
Highlights of the year
· A rising dividend for 36 consecutive years
· Second highest yield in its sector
· Investment performance ahead of benchmark
· New borrowing secured at much lower interest rate
In a key development during the year, the company announced the refinancing of the first tranche of its long-term borrowings, replacing it with new borrowings at a much lower interest rate. This has many potential benefits for shareholders, such as enhancing earnings per share and the flexibility to grow the dividend faster.
A year of positive asset returns for shareholders
This has been a strong year for Merchants in both absolute and relative terms. In a buoyant year overall for global stock markets, Merchants outperformed the FTSE All-Share, its benchmark index. Our Net Asset Value (NAV) total return was +14.5% with debt at market value, outperforming the benchmark total return of +11.3%. This investment return placed the company 6 out of 25 funds in its peer group. The board would like to thank our fund manager, Allianz Global Investors, on a very good year for Merchants.
Gearing helped the NAV performance for the year, adding a net 2% to total return, after taking account of the cost of finance and movements in the value of debt. A full table of attribution is shown on page 10 of the annual report.
You will find more information on the performance of the investment portfolio, including stock selections and portfolio changes, in the Investment Manager's Review on page 18 of the annual report. In a year in which the only certainty was uncertainty, with various geopolitical challenges at play, global economic growth nevertheless steadily improved whilst interest rates have risen, albeit from historical lows.
While the board is pleased to see the outperformance over the last year, longer term trends are important. On a cumulative basis, over 5 years, the NAV total return was 49.1%, which was once again ahead of the benchmark (+45.9%)#.
The company's share price rose by 7.8% over the year, from 452.5p to 488.0p. On a total return basis (which includes net dividends) the value of the shares increased by 13.3%.
# The benchmark for the year ended 31 January 2018 was FTSE All-Share Index and prior ro that it was FTSE 100 Index
A genuine high yield UK equity fund: 36 consecutive years of dividend growth
The board is recommending a final dividend of 6.3p (2017: 6.1p) which will increase the total dividend for the year to 24.8p (2017: 24.2p), a rise of 2.5%. Significantly, this will be the 36th consecutive year in which we have grown the dividend and we are proud to be recognised 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 monitors the company's yield relative to other investment trusts in the UK Equity Income sector. At 31 January 2018, the company's yield of 5.2% ranked Merchants second highest in the sector – and well above the sector average of 3.5%. The company has consistently offered its shareholders a high yield and dividends have grown ahead of inflation over the long term. This period under review was generally a good year for the level of dividend receipts generated by Merchants' portfolio holdings. In addition, the weakness of sterling against the US dollar early in the year (which has now reversed) helped, since almost a third of income comes from dividends paid in foreign currencies. The improved level of income generation, and the benefits of debt refinancing, have allowed the directors to raise the dividend by a greater amount than in recent years.
It remains the board's aim to continue Merchants' distinguished dividend track record. We are confident that the manager's policy of identifying individual stocks with strong franchises and sound finances, and ones that it believes can deliver a high level of income and good overall return, will facilitate that. The board believes that, by investing in a portfolio of such stocks, Merchants can continue to create security and growth of income over the medium to long term.
The final dividend of 6.3p will be paid on 30 May 2018 to shareholders on the register on 20 April 2018. The dividend is fully covered by the revenue generated by the company's portfolio and there are significant reserves.
Stewardship and engagement
The manager devotes considerable resources to stewardship responsibilities on behalf of shareholders. Allianz Global Investors engages on matters including governance, capital management, remuneration, strategy, sustainability and other issues. The manager votes at all general meetings of portfolio companies and also engages regularly with executives and boards. A new section in the Investment Manager's Review on page 27 of the annual report has been included for shareholders, giving some background to the twenty three corporate engagements that have taken place during the year. Further detail on environmental, social and governance issues, and stewardship is shown in the Strategic Report on page 51 of the annual report. It also sets out where shareholders can see the voting decisions that Allianz Global Investors have made on their behalf.
New borrowing at much lower interest rates
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 £112 million, all deployed in the market for investment purposes. Our gearing averaged 19.7% throughout the year, compared to 22.7% last year. At the end of the year, our gearing level was 18.1% compared to 19.0% at 31 January 2017.
Towards the end of the financial year we refinanced a debenture taken out in 1987 (when the Bank of England base rate stood at 8.375%) with new borrowing at a much lower interest rate (2.96%). This replacement of the expensive debenture with lower cost borrowing is significant for the company. Not only does it reduce interest payment costs significantly (the weight average cost of debt decreased from 8.5% to 6.1%), enhancing the revenue earnings per share, but it also reduces capital costs and presents the possibility of growing the dividend faster in the future.
The debt refinancing allows the investment manager to invest with a long-term view. Having secured the new borrowing for the next 35 years at an interest rate of just under 3%, the investment manager is able to invest in a selection of higher yielding stocks listed on the FTSE All-Share Index, whose average dividend yield is 4% at the time of writing.
This year's annual report
We regularly review the content and layout of Merchants' annual report to ensure that, as well as providing statutory information, the report is informative, interesting and visually compelling. The board is mindful of the ever-increasing numbers of private individuals who have chosen to buy Merchants' shares in recent years, so this year's report carries new case studies as well as expanded profiles on the Company's largest holdings. There is also a new Investment Process section, where the manager explains its long-term value focus, underpinned by fundamental analysis, and how this informs stock selection. In addition, there is more information on stewardship and engagement activities as described above.
We hope that these enhancements will provide insight into our investment management process. As always, we welcome feedback from all shareholders, as well as suggestions that we can consider for future years.
The Board
There have been no changes to the composition of the board during the year. Details of the directors are set out on page 54 of the annual report.
Strategy and Strategic Report
The Strategic Report is on page 42 of the annual report. At our annual strategy day last year, we took a more in-depth look at the matters we consider at each board meeting, including our position relative to our peer group and benchmark, borrowing strategy and a review of marketing strategy.
Increasing demand for Merchants' shares
1. Marketing communications
As a board, we are keen to grow the number of individual shareholders that hold Merchants' shares and we carefully consider the level of marketing expenditure that should be allocated to targeted marketing activity. The Merchants' marketing programme includes electronic communications with existing and potential investors and substantial liaison with national and industry journalists, since positive press coverage can be highly influential.
Targeted online and print advertising is also undertaken on a very selective basis, where the potential benefits are judged to merit the cost. The most recent campaign has focused on the company's 'Dividend Hero' status, with the following strapline: 'Experienced. Disciplined. Determined. All you want from a hero.'
Online trading platforms have largely replaced the traditional stockbroker as the destination for investors wishing to buy shares in recent years and our communication programme targets both platform providers and investors. Marketing activity has been instrumental in creating sustained and ongoing demand for Merchants' shares through these platforms. Approximately 42.2% (2017: 38.4%) of the company's shares are now held by investors on these platforms, an increase of 3.8% (or an extra 4.1 million shares) in just one year.
We are keen to sustain this demand since this can reduce discount levels and ultimately lower running costs, which benefits all of the company's shareholders.
2. Meeting shareholders
As part of our strategy to keep the company 'front of mind' for existing and potential shareholders, the investment manager and other members of the Allianz Global Investors team dedicate considerable time to promoting Merchants around the country in a comprehensive schedule of meetings that targets institutions, private investors and the wealth manager community. Roadshow activity is a proven way of maintaining relationships with key analysts and holders of the company's shares, as well as encouraging share purchases from new buyers.
Enhanced online access for Merchants' investors
The Merchants Trust website (www.merchantstrust.co.uk) is the company's 'shop window' and is at the heart of our marketing communications strategy. As well as the very latest performance statistics, visitors to the site can also access a wealth of information, including: 'Video Hub' face to face interviews with the investment manager; useful information on platform investing; educational content; and a complete literature library of current and historical documents.
During the period under review, the website was redesigned in a 'responsive' format that provides an optimal viewing experience for visitors using all forms of devices – mobile phones, tablets and desktop computers. As well as a much cleaner 'look and feel', the redesign has added substantial new content that the board believes shareholders will appreciate. Via the site, visitors can also sign up to receive monthly Merchants fact sheets by email, as well as other useful information.
Key Investor Information Document (KIID)
Key Investor Information Documents (KIIDs) were published in January 2018 for investment trusts and many other investment products. The KIID is a standardised pan-European document containing product, risk, charges and other information. It is a regulatory requirement that investors are provided with a KIID before they invest and your chosen platform provider or stockbroker should provide you with a copy before accepting your investment instructions. The KIID's standardised format is intended to allow potential investors to compare funds easily. However, there are concerns in the industry that differing interpretations of the requirements may have resulted in KIIDs that prove to be unhelpful for investors. We take the view that any prospective investor should not rely solely on the KIID when making their investment decision. There is more information about the KIID on page 106 of the annual report.
Annual General Meeting
We strongly encourage shareholders on the register or with letters of representation from their nominee on the register to attend the annual general meeting of the company. This will be held on Wednesday, 16 May 2018 at 12 noon at Grocers' Hall, Princes Street, London EC4Y 0JP. For those shareholders unable to attend, filmed AGM video content will be added to the Merchants' dedicated website as soon as it becomes available.
Outlook
When I wrote to shareholders at the end of September, in the Half-yearly Report, I noted the rising risk profile for the UK economy and these concerns remain as valid now as they were six months ago. There remain further 'speed bumps' in the form of geopolitical and economic risks that will create short-term volatility along the way. High levels of consumer debt and the impact of inflation on real earnings, as well as uncertainty in the corporate sector caused by Brexit are all concerns. However, interest rates, although nudging upwards, remain very low by historic standards. Add to this the weak pound (which helps exporters), historically high employment levels and the fact that the UK stock market is predominantly exposed to economies outside the UK, and one can begin to understand why markets have remained near to all-time highs since September.
In uncertain times, it is useful to remember that The Merchants Trust will celebrate its 130th anniversary in 2019 and that the company has a long and distinguished history of delivering income and capital returns through many uncertain periods over the years. The investment manager continues to invest in a portfolio comprising solid businesses with good prospects for growth and attractive dividends that are priced at a level from which they can deliver good total returns for shareholders.
Looking ahead we think it's vital to continue doing what we've always done at The Merchants Trust. We leverage Allianz Global Investors' investment expertise to ensure The Merchants Trust always has a portfolio of attractive UK stocks. Above all, we believe that the company is well positioned to continue meeting its objectives of paying a high and growing dividend yield and delivering attractive total returns, for both existing and new investors, for many years to come.
Simon Fraser
Chairman