Shires Income plc Half-Year Report 2021

SHIRES INCOME PLC

 

HALF YEARLY FINANCIAL REPORT FOR THE SIX MONTHS ENDED 30 SEPTEMBER 2021

 

Highlights

Net asset value per Ordinary share total return A			Share price total return A			Benchmark index total return
Six months ended 30 September 2021	+12.3%		Six months ended 30 September 2021	+11.7%		Six months ended 30 September 2021	+8.0%
Year ended 31 March 2021	+34.0%		Year ended 31 March 2021	+31.2%		Year ended 31 March 2021	+26.7%
Earnings per Ordinary share (revenue)			Dividend yield A			Discount to net asset value A
Six months ended 30 September 2021	7.21p		As at 30 September 2021	4.9%		As at 30 September 2021	6.1%
Six months ended 30 September 2020	6.18p		As at 31 March 2021	5.3%		As at 31 March 2021	5.5%
A   Considered to be an Alternative Performance Measure.

 

 

	30 September 2021	31 March 2021	% change
Total assets (£'000) A	107,505	99,856	+7.7
Shareholders' funds (£'000)	88,506	80,857	+9.5
Net asset value per share	287.01p	262.41p	+9.4
Share price (mid-market)	269.50p	248.00p	+8.7
Discount to net asset value (cum-income) B	6.1%	5.5%
Dividend yield B	4.9%	5.3%
Net gearing B	20.7%	16.5%
Ongoing charges ratio B	1.17%	1.21%
A Less current liabilities excluding bank loans of £18,999,000.
B Considered to be an Alternative Performance Measure.

 

 

Performance (Total Return)

 

	Six months ended	Year ended	Three years ended	Five years ended
	30 September 2021	30 September 2021	30 September 2021	30 September 2021
Net asset value A	+12.3%	+32.2%	+22.9%	+42.3%
Share price A	+11.7%	+33.1%	+24.9%	+53.2%
FTSE All-Share Index	+8.0%	+27.9%	+9.5%	+29.8%
A   Considered to be an Alternative Performance Measure.
All figures are for total return and assume reinvestment of net dividends excluding transaction costs.

 

Chairman's Statement

Market Background

The first half of the financial year was a more stable environment as the global economy continued to recover from the Covid-19 pandemic.  Although we have seen spikes in case numbers in various geographies, including the UK, economic activity has picked up and, in the majority of countries, restrictions on movement and interaction have been significantly reduced compared to last year. Concerns certainly remain, especially as we enter winter in the Northern Hemisphere and the effectiveness of vaccination programmes begins to fade, but for the majority of companies the outlook is clearer than it has been for some time. The rapid resumption of economic activity has, however, brought its own issues.  Global supply chains have felt the strain, with shipping rates rising sharply and delays to the delivery of many goods. Commodity prices have risen and tightening labour markets have led to wage rises in a number of areas. Concerns around inflation have therefore increased and, although some supply chain effects will be transitory, there is every chance of more sustained price pressures than we have seen for some time. The ability of companies to manage these cost pressures will have a significant bearing on profit trends in 2022.

So far, central banks have continued with loose monetary policy and low interest rates. However, there are signs of this changing and commentary from central banks has flagged rate rises on the horizon.  The UK has been exposed to all of these economic changes. High vaccination rates and substantial consumer savings have led to a jump in activity, while supply chain issues and labour market tightness have likely been further increased by the exit from the EU. After a decade of falling interest rates and low inflation we should therefore be alive to a change in direction and the resultant potential impact on equity market valuations.

Despite these concerns, the economic background has been generally supportive for UK equities, with the recovery in earnings outweighing the impact of inflation and higher bond yields on valuations. The FTSE All-Share Index benchmark produced a total return of 8.0% in the six-month period, with the best performing sectors being energy (+20%) and healthcare (+19%). It is rare for these two sectors to both outperform simultaneously, but this market leadership reflects the rising oil price combined with a more defensive skew in the market through the summer as concerns around the effect of the Delta variant of Covid-19 increased.

 

Investment Performance

Over the first half of the financial year the Company's net asset value (“NAV”) increased by 12.3% on a total return basis, outperforming the total return from the FTSE All-Share Index by 4.3%. The equity portfolio delivered positive relative performance, returning 12.0%, while the preference share portfolio returned 7.9%. By sector, the Company benefited from strong relative performance in consumer discretionary, financials and real estate holdings, offset by weaker relative performance from the portfolio's exposure to telecoms and industrials.

The greatest positive contributor to performance on a single stock basis was Sirius Real Estate which rose in value by 50% in the period. The company continued to grow rental income steadily and improved its balance sheet position through a successful bond issue. The German market, on which Sirius is focused, normalised during the period and the premium to NAV for its shares increased.

The next greatest positive contribution came from online gambling firm Entain, which rose by 40%. Entain has continued to trade well, posting growing revenues and with its US joint venture with MGM winning market share in the fast-growing US sports gaming market. At the end of the period Entain was subject to a bid from rival company Draft Kings. Although a final offer was not made in this case due to the complexity of the proposed transaction, Entain has continued to trade well and the Investment Manager continues to see upside to the shares.

Another strong performer was John Laing, which was sold to a private equity firm during the period. We have seen a range of UK companies being sold in the past six months as positive economic data and cheap valuations make the market attractive for acquirers.

The positive rebound in the UK economy could also be seen in a number of domestic industrial names. Morgan Sindall, which provides office fit-out work and construction, delivered a 38% return after being added to the portfolio, while Howden Joinery returned 27% as consumer demand for kitchens remained strong.

Finally, the portfolio also benefitted from strong performance from the holding in Aberdeen Smaller Companies Income Trust, which increased in value by 26%.

The greatest detractors from relative performance in the period were large companies that are not held within the portfolio and which performed well: Glencore, Relx, Ashtead and Experian all delivered strong returns in the period and therefore detracted from relative performance. In each case, the Investment Manager sees either a lack of income or quality as a reason not to hold these companies.

Of the companies held in the portfolio, only two disappointed notably during the period. Both Standard Chartered and Ashmore are financial companies exposed to emerging markets. As emerging markets, and especially China, performed poorly through the summer these two stocks lagged the market, with Standard Chartered falling 13% and Ashmore 15%. In the Investment Manager's view both companies are undervalued and offer exposure to a region with strong growth potential, and remain attractive on a longer-term view.

 

Portfolio Activity

During the period, the Investment Manager added eight new positions to the portfolio and exited four. The imbalance reflects a number of attractive opportunities to enhance the income generated by the portfolio. Overall, there has been a mild skew to add some more value to the portfolio and also some leverage to improving economic growth and a higher interest rate outlook, hence a number of new positions in banks and UK domestic names.

Electrocomponents is a distributor and supplier of electrical components to industry. It has delivered a strong track record of earnings growth over time, building customer loyalty through the breadth and depth of its product offering. The company also has the ability to accelerate growth through acquisitions and delivers a reasonable yield.

Balfour Beaty was added following the exit of John Laing, maintaining exposure to UK infrastructure investment which the Investment Manager sees as an attractive area given the point in the economic cycle. Government support for spending is likely to give higher visibility on projects and revenue than has been seen for some time and the pipeline should support mid-single-digit earnings growth on an attractive price/earnings multiple. The headline yield is around market level but the potential for growth and special dividends makes it attractive for the portfolio.

Bridgepoint was another new addition that maintains some exposure in the portfolio to private markets. It is a leading investor in private growth businesses which listed on the UK market earlier this year. It gives access to a higher growth part of the market with potential for an above market cash return over time.

Nordea Bank is a Swedish listed bank. It has come through the Covid-19 pandemic with a strengthened capital position and is now able to return material capital to shareholders over the next few years. Combined with a high return on capital for the sector and exposure to a rising interest rate environment, this makes it attractive for income.

The Investment Manager also initiated a position in a second European bank, Bawag, which is listed in Austria and focused on Central and Eastern Europe. The bank is a high return business and has grown through acquisitions, yet also sits with a large amount of excess capital, allowing for a period of elevated distributions which makes it attractive for income investing.

A number of additions to the portfolio looked to increase the portfolio's exposure to the UK domestic economy as it rebounds from the pandemic. OneSavingsBank (“OSB”) is a UK lender specialising in loans to professional landlords. The area it operates in results in the bank earning a higher return on capital than large scale UK banks.  It should benefit from the recovery in the UK economy and a tight property market. Redrow is a UK housebuilder and offers similar exposure to UK growth. The business is cash generative and attractively valued compared to peers, with an above market level dividend yield. With the housing market remaining tight and continued demand for new-build properties, the Investment Manager has a positive outlook for the sector.

The final new position was in Drax. Drax is a UK power producer, with attractive positioning in the near term as it is a beneficiary of high energy costs, and particularly UK natural gas prices. In the longer term, Drax is attractive due to its shift to generate power using biomass which, when combined with a carbon capture scheme, allows it to generate negative carbon emissions.

The exits from the portfolio fell into two parts: Either companies which were bid for and where the Investment Manager took profits, or where the Investment Manager saw them as fully valued after outperformance and chose to move on. In the first category, Avast and John Laing received bids.  In the second category, Londonmetric Property and Dechra Pharmaceuticals both performed well and, with less upside, were sold. 

 

Investment Income

The revenue earnings per share for the period were 7.21p, which compares to 6.18p for the equivalent period last year. Across the portfolio there have been increases in investment income. This partially reflects the resumption of dividends by companies after the pandemic impacted shareholder returns last year. Companies generally have a more confident outlook, while regulatory barriers to payments, for example in the banking sector, have now been lifted. 

By company, there were meaningful increases in dividends from BHP and Rio Tinto, which have benefited from a period of particularly high iron ore prices. In the energy sector, Diversified Energy has continued to grow its dividend and BP and Royal Dutch Shell have increased their dividends after cutting them sharply in 2020. Banks in general have come out of the pandemic with a high level of capital and, after suspending dividend payments, are able to return excess capital this year. This has largely come back to shareholders in the form of buybacks, but recent additions to the portfolio, Bawag and Nordea Bank, have enhanced overall income generation.

 

Dividends

A first interim dividend of 3.2p per Ordinary share in respect of the year ending 31 March 2022 (2021: first interim dividend – 3.0p) was paid on 29 October 2021.  The Board declares a second interim dividend of 3.2p per Ordinary share (2021: second interim dividend – 3.0p), payable on 28 January 2022 to shareholders on the register at close of business on 7 January 2022.

Subject to unforeseen circumstances, it is proposed to pay a further interim dividend of 3.2p per Ordinary share in respect of the financial year and, as in previous years, the Board will decide on the level of final dividend having reviewed the full year's results, taking into account the outcome of the revenue account for the year and the general outlook for the portfolio's investment income at that time. However, it is the Board's current intention that the final dividend will be no less than 4.2p per Ordinary share (2021: 4.2p), resulting in a total dividend for the year of at least 13.8p per Ordinary share (2021: 13.2p).

 

Gearing

The Company's gearing level (net of cash) was 20.7% as at 30 September 2021 compared to 16.5% at the start of the period. There were no changes to the Company's borrowing arrangements during the period, with £19 million of the Company's £20 million facility being drawn down at the period end. £9 million of this amount continues to be drawn down on a short-term basis through a revolving credit facility and can be repaid without incurring any financial penalties. The facility matures in September 2022.

As in previous years, the Board takes the view that the borrowings are notionally invested in the less volatile fixed income part of the portfolio which generates a high level of income, giving the Investment Manager greater ability to invest in a range of equity stocks, some with higher yields but other strongly growing businesses with much lower yields but with the prospect of stronger growth. This combination means that the Company can achieve a high level of dividend but also deliver some capital appreciation to shareholders.

 

Outlook

Going into 2022, the global economy faces a number of headwinds which are likely to result in growth slowing when compared with 2021. These include an economic slowdown in China and some degree of interest rate normalisation across the globe as many central banks have already signalled a more hawkish stance going forward. In addition, the outlook for the next six months is clouded to some extent by the impact of Covid-19 as we go through the winter period, including the recently discovered Omicron variant. It seems quite possible that we will see continued rising case numbers and there is the potential for increased restrictions being imposed in the UK and elsewhere at some stage although renewed lockdowns in the UK appear unlikely at present. Any measures that would inhibit the current growth trajectory would clearly be taken negatively by financial markets and does therefore create a short-term risk.  Provided lockdowns can be avoided, the economy looks in good health and activity is likely to remain high with good economic growth prospects into 2022, although we should expect to see more commentary on cost and wage inflation and its impact on company earnings. This creates a risk to the earnings outlook which, combined with the likely start of the process of normalisation of interest rates, may restrict the upside in equity valuations.

The defensive nature of the portfolio should provide protection against too much downside and the Investment Manager continues to see plenty of upside potential for the companies in the portfolio. Banks will be significant beneficiaries of any higher rates, for example, and, more broadly, those companies that can pass through cost inflation to clients will benefit from revenue growth. This latter ability is something the Investment Manager increasingly looks for when they assess the quality of companies in the portfolio.  Importantly, the Investment Manager also sees continued potential for income growth from the portfolio after the dividend cuts of 2020 are unwound. This combination should give confidence in the future prospects from the portfolio and for the Company overall.

 

Robert Talbut

Chairman

2 December 2021