Shires Income PLC – Half Yearly Report

INVESTMENT OBJECTIVE

The Company's investment objective is to provide shareholders with a high level of income, together with the potential for growth of both income and capital from a diversified portfolio substantially invested in UK equities but also in preference shares, convertibles and fixed income securities.

BENCHMARK

The Company's benchmark is the FTSE All-Share Index (total return).

HIGHLIGHTS

PERFORMANCE (TOTAL RETURN)

INTERIM  BOARD REPORT – CHAIRMAN'S STATEMENT

Market Background

The UK equity market delivered solid returns through the six month period to the end of September, with the benchmark FTSE All-Share Index rising by more than 8% in total return terms. The positive return was driven by continued outperformance of growth stocks and by the Oil & Gas sector, which was the best performing sector in the index due to rising oil prices in the period. In contrast, value and income sectors, which tend to be the mainstay of the portfolio, were weaker, with Telecoms and Financials the weakest of all. Furthermore, given investors' preoccupation with the potential negatives from Brexit, it is unsurprising that the performance of smaller companies lagged their larger counterparts by almost 4% over the period.

As it has done for the past two years, politics has dominated investor sentiment towards the UK market, with the threat of the impending exit from the EU causing many to steer clear of committing capital to the market. As we enter a crucial period of negotiations there is limited clarity on the outcome, but the Manager's base case remains for a deal to be agreed, avoiding the worst case scenario of a “hard Brexit”.

While politics have weighed on the economy, causing GDP growth to lag other developed markets and Sterling to remain weak, many of the underlying economic indicators are more positive. Retail sales held up well in the period, purchasing managers' indices remain expansionary and unemployment is at a low level. Inflation has stabilised close to 3% and there are unlikely to be many more interest rate rises from the Bank of England in the medium term given the uncertainties over the growth outlook.  While challenges caused by less favourable demographics and the UK's poor productivity growth will not easily be resolved, the economy is not as bad as many fear.

Indeed, the potential is very much there, if political headwinds can abate, for the UK market to experience some form of bounce back from this point. UK equities remain on a significant valuation discount to other markets, and offer a material yield premium. In addition, the UK market is well diversified, with over half of revenue coming from overseas, mitigating any near term risks and creating an attractive opportunity for income investing.

Investment Performance

The Company's net asset value (“NAV”) total return for the six month period ended 30 September 2018 was 4.3%. This compares to a total return of 8.3% from the benchmark, the FTSE All-Share Index. The share price total return for the period was -0.2%. This shorter term performance relative to the benchmark is disappointing, however the Company continues to deliver an income yield considerably in excess of the wider market, together with some capital appreciation.  It is also worth noting the Company's longer term performance record where the NAV total return has outperformed the benchmark index in four out of the past five financial years and, for the five year period ended 30 September 2018, produced a total return of 47.4% compared to a total return of 43.5% from the FTSE All-Share Index.   

The share price at the end of the period was 253.0p, reflecting a discount of 7.2% to the net asset value (including income) of 272.7p per share, compared to a discount of 3.1% at the beginning of the period. The average discount over the period was 3.3%, with the wider discount appearing towards the end of the period. The Board and Manager keep the level of discount under constant review.

The higher yielding Telecoms, Tobacco and Financials sectors all lagged the market during the period which, given the Company's relatively high exposure to these sectors, had a negative impact on relative performance.  Conversely, the Company has consistently had an underweight exposure to the Oil & Gas sector due to its cyclical nature and, in a period when oil prices rose strongly, this was also a detractor. Relative performance was also impacted by the widening of the discount to net asset value of Aberdeen Smaller Companies Income Trust and the performance of the preference share portfolio which, while delivering a high level of income,  tends to lag equities in a strongly rising market.

Dividends

A first interim dividend of 3.0p per share in respect of the year ending 31 March 2019 was paid on 26 October 2018. The Board declares a second interim dividend of 3.0p per share, payable on 25 January 2019 to shareholders on the register at close of business on 4 January 2019. Subject to unforeseen circumstances, it is proposed to pay a further interim dividend of 3.0p per share prior to the Board deciding on the rate of final dividend at the time of reviewing the full year results.

The current annual rate of dividend is 13.00p per share, representing a dividend yield of 5.1% based on the share price of 253.0p at 30 September 2018. The Board considers that one of the key attractions of the Company is its high level of income and recognises that, in the current economic environment, there is likely to be a continuing demand for an attractive and reliable level of income. Whilst the Company aims to cover its annual dividend cost with net income, the Board is conscious of the significant revenue reserves, which amounted to 1.3 times the annual dividend cost as at 30 September 2018 hence providing added security on the sustainability of the dividend.

Gearing

The Company has a £20 million loan facility of which a total of £19 million was drawn down at the period end. Net of cash, this represented gearing of 21.2%, compared to 20.8% at the start of the period.  The Board continually monitors the level of gearing and, although the absolute level may look high relative to some other investment trusts, strategically we take the view that it is deployed notionally into fixed interest securities which bring diversification to the Company's total revenue stream and with lower volatility than would be expected from a portfolio invested exclusively in equities. The Board takes the view that the combination of fixed income securities and equities allows for an appropriate level of risk within the portfolio in order to achieve the overall investment objective.

Investment Income

Income from the preference share portfolio has been maintained and continues to deliver a stable source of income to the Company.

The income forecast for the remainder of the financial year is stable, even without the inclusion of potential special dividends, and with a healthy level of revenue reserves, the Company remains in a good position to continue delivering a high level of income.

Outlook

Since the end of the period, there has been increased volatility in markets, with a combination of rising interest rates and global geopolitical concerns causing some material sector and stock moves. However, with economic growth globally still positive and earnings growth remaining strong, the Manager remains reasonably confident on the potential for equities to deliver positive returns. 

While the UK economy continues to move at a slower pace than many developed economies, there are clear attractions to UK equities and the Manager recently upgraded the UK to be its preferred equity market.  Brexit worries have driven international investors away from the UK and the market is relatively inexpensive. While the shape of Brexit remains uncertain, many companies are insulated by their overseas earnings and dividends paid by UK companies are a significant contributor to total return.

The Board continues to believe that the Company's portfolio is well diversified in terms of asset class, sector and geographic exposure and that, despite the various uncertainties facing markets at the current time, the Investment Manager's focus on investing in good quality companies with strong fundamentals should benefit the portfolio over the longer term in meeting the Company's investment objective.

Robert Talbut

Chairman

19 November 2018