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The Merchants Trust Plc - Final Results

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THE MERCHANTS TRUST PLC

Final Results for the year ended 31 January 2020

The following comprises extracts from the company's annual report for the year ended 31 January 2020.  The full annual report is being made available to be viewed on or downloaded from the company's website at www.merchantstrust.co.uk .  Copies will be posted to shareholders shortly.

MANAGEMENT REPORT

Chairman's Statement

This is my first year-end as Chairman, and while I am delighted to be reporting that the year to 31 January 2020 was a very positive one for shareholders, this is of course tempered by the subsequent brutal impact of COVID-19 on economies, markets and people's health around the world.

Nonetheless, I am pleased to report that Merchants Trust produced a return to its shareholders substantially higher than the benchmark in the year under review, despite a climate of political and Brexit uncertainty.

Highlights of the year

* 18.7% increase in the NAV total return against 10.7% benchmark return

* 18.6% rise in the share price

* 4.2% increase in the dividend

* 38th successive year of dividend growth

* Cost of debt more than halved over three years

* 4,150,000 new shares issued at a premium to NAV

Income remains strong

We pride ourselves on the income we provide for our shareholders and we are very pleased to retain our AIC Dividend Hero status. We have this year provided one of the very highest yields in our peer group as part of an attractive total return for investors and we aim to continue to do so. Our dividend reserves of 28.2p per share, put aside from income over the years, support our aim. The payment of a fourth quarterly dividend of 6.8p on 29 May 2020, giving a full year dividend of 27.1p confirms our 38th successive year of dividend growth - a record of which we are extremely proud. Furthermore, the dividend growth we have been able to provide of 4.2% is ahead of the year end rate of inflation of 1.8% and therefore a real increase for shareholders. We are as focused on dividends as you are.

A year of positive performance

The year under review was a very successful one and the trust's total return Net Asset Value with debt at market (NAV) rose by 18.7% compared with a 10.7% increase in our benchmark, the FTSE All Share index, on a total return basis. The portfolio also significantly outperformed the benchmark and there are more details in the attribution table on page 10 of the annual report. Demand for our shares remained strong throughout the year and we were able to issue 4,150,000 new shares in aggregate over the year during periods when the trust was trading at a premium to Net Asset Value. Since the year end, a further 1,746,423 new shares were issued.

A full investment report containing an analysis of the company's performance is shown on page 12  of the annual report, and the portfolio performance attribution is explained by our investment manager Simon Gergel from page 15. I would also encourage you to read more in the same section about the interesting stock stories that have played out during the past year.

Active management plays its part

The board has long been a supporter of our manager's active approach and value style of investing and this approach showed its merit again this year. We are pleased to note that Simon Gergel, Matthew Tillett and the rest of the investment team delivered strong performance over the 12 months to the end of January 2020 by continuing to focus on high quality UK companies at reasonable valuations with above-average yields.

It wasn't a completely comfortable ride. In a year that was markedly different between the first half and the second half, our investment team held, and indeed extended, their contrarian positioning earlier in the year, which meant that, in a highly polarised market environment, relative performance at the halfway point was weak. This positioning, though, provided excellent outperformance of a flat market in the second half, boosted by a move by investors back towards value shares later in the year.

A clear-cut General Election result and the return of a government with a sizeable majority and a perceived market-friendly approach also helped the investment managers' strategy towards the end of the year as UK equities became more attractive to both domestic and overseas investors.

The portfolio also benefits from the manager's active positioning to take advantage of the non-UK earnings of a large proportion of UK-listed stocks. This gives the trust a level of diversification and means that it is not wholly exposed to the UK domestic economy but can benefit from overseas growth too.

It is also encouraging that we are seeing media and analyst coverage of Merchants that recognises the positive performance that has been generated not only during the year under review but over a longer period too.

Reducing the costs and the level of gearing in the trust

Shareholders will be aware that, in line with its peers, the board of Merchants has long had the view that an element of gearing of the trust can enhance investment returns and increase dividend generation and that this is consistent with a long-term investment horizon.  Between 2016 and 2020 this gearing has been between 15.4% and 27.4% of the portfolio. Two elements of gearing have a meaningful impact on shareholder returns: the cost of debt and the level of gearing.

As I hope you will be aware from previous communications, our board has been working to reduce the costs of debt. This year we have cut it to 3.8%, from a starting point of over 8.5% in 2017 and 6.1% in 2018. Although restructuring the debt incurred a one-off cost which reduced the NAV by 0.5%, it now produces greater earnings potential and a boost to the trust's capital account. The one-off hit to the NAV was experienced mid-way through the year when the more expensive debt was paid down and replaced with a revolving credit facility (RCF). As you can see from our performance figures, it hasn't detracted from a strong year for Merchants, and it will surely pay off to shareholders from now on.

The debt structure is now a mix of short-, medium- and long-term debt, giving a more flexible profile to the debt structure which our managers can use as needed.

At the end of the year the decision was made to reduce gearing to 15%, by paying down £16m of the RCF and that reduction was duly carried out on 29 January 2020, shortly before the yearend and before the market crash. Your board and the investment manager felt it was prudent to reduce risk in the portfolio following strong investment markets during the final quarter of 2019.

Share issuance: taking the opportunity to grow

As I noted earlier, thanks to the strong performance and demand in the market as a result of the marketing efforts we undertake, we have been in a position to issue new shares over the year. Shareholders unfamiliar with this mechanism may wonder what benefit they gain from this activity. Simply speaking, there is advantage to be had from increasing the scale of the trust, not least from fixed costs being spread over a larger fund. As scale increases, so does the attractiveness of the trust's shares to professional investors, who value liquidity in the company's shares. As issuance can only take place at a premium to NAV, it also adds value incrementally to NAV on each issuance.

Due to the demand we are seeing, as in previous years your board and investment manager will be seeking shareholder authority to issue up to 10% more shares in the coming year.

Strategy

At our annual strategy day, we once again took a more in-depth look at the matters we consider at each board meeting, including our objectives and key performance indicators. The Strategic Report follows on page 39 of the annual report.

In summary, the meeting found the key performance indicators we closely monitor still to be appropriate. We reviewed the investment philosophy, including the value style of investing, and we also found this to be appropriate for our objectives. We examined the structure of the portfolio and style exposures, in detail. Finally, from an investment perspective, we discussed the use of flexible debt and the trust's gearing policy.

From a sales and marketing perspective, we analysed competitive strategies from the peer group and considered our strategy for distribution via wealth managers and retail investment platforms.

Board succession

I would like to thank Paul Yates, who will step down from the board on 1 May 2020 after nine years, for his stalwart contribution to the Merchants Trust. His wise advice, deep investment experience and good humour have been very much appreciated by the Board and the investment management team.

I am delighted to announce the appointment of Karen McKellar to replace Paul on 1 May as a Non-Executive Director on the board, subject to election by shareholders at the AGM. Karen (formerly known as Karen Robertson) has had a long career as an investment manager at Standard Life, managing the Standard Life Equity Income Investment Trust as well as several large UK equity open-ended funds. The board looks forward to having the benefit of her investment expertise.

Annual General Meeting

Following the Prime Minister's announcement on 23 March 2020 of stay at home measures and possible further restrictions and the continuing impact of COVID-19 we have been unable to agree a format and set a date for the Annual General Meeting. Whilst this is usually held in May in all likelihood it will be delayed. At the time of writing we are awaiting direction as to what new arrangements will be permitted and  will therefore be sending a Notice of the AGM as soon as it is possible to set a date.

As usual questions received from shareholders and answers from the board will be added to the Merchants website subsequent to the AGM.

Fourth interim dividend

Due to the need for us to postpone the AGM and with it the usual opportunity for shareholders to approve a final quarterly dividend the board has declared a fourth interim dividend in its place. Therefore, a quarterly dividend of 6.8p per ordinary share, in line with the third quarter's dividend, is payable on 29 May 2020 to holders on the register at the close of business on 24 April 2020. This means that the total dividend for the 2019/20 year is 27.1p, an increase of 4.2% on the previous year.

Outlook

The impact of COVID-19 is a very present shadow at the moment and, as we write, markets have produced sharply negative returns in the first weeks of our new financial year. There is clearly going to be a significant impact on the economy, corporate profitability and dividend income in addition to people's health. We are already seeing numerous company boards taking a cautious approach to payouts and some have decided to postpone or cancel dividend payments. Since some of the companies we own are in this position this will undoubtedly reduce the income stream for the trust in the new financial year.  We will continue to monitor this situation closely, however, as Simon Gergel discusses in his Investment Manager's Review, Merchants started the year in a strong position and the dividend was comfortably covered by last year's earnings. In addition, the ability of an investment trust to be able to smooth dividend payments by building up reserves following strong performance and draw upon them in more challenging years is a positive feature of our structure.  

As long-term investors, we are confident of our future returns and the investment team are actively reviewing individual company exposures and risks, and making portfolio adjustments, where necessary, to manage the income stream and to take advantage of exacerbated pricing anomalies. Our managers believe that, after the sharp pull back in the market, the UK stock market is offering good value and is one of the cheaper world markets. Against this backdrop they continue to seek out strong, structurally well positioned companies, paying above-average dividend yields, and trading on attractive valuations.

I hope this has given a flavour of the positive year experienced by The Merchants Trust for the year under review and I urge you to read the further detail contained in this report, as it will provide you with the full context and analysis of the past 12 months.