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Happy 30th
In this 30th episode of the A Value View podcast, Jon and Simon discuss dividends once again. With Merchants having reached its 42nd consecutive year of paying an increased dividend, just how has the trust managed this? And, what does the state of play look like for the future, not only for income, but for the UK equity market in general? Takeovers, banks, the economic outlook and the effects of political uncertainty all come under the spotlight.
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JC: Hello and welcome to A Value View from The Merchants Trust. In each podcast, Simon Gergel, Fund Manager at The Merchants Trust, offers his thoughts on developments affecting the UK market and what it means for investors. Simon, it's good to join you again on this, our 30th edition of A Value View. First off, congratulations.
SG: Thanks, Jon. Yeah, it’s amazing, isn't it? It's great to be back again and fantastic that we've had 30 episodes. That's brilliant.
JC: Well, it's incredible, isn't it? When I think back now it's been, you know, over the years we've spoken together in the studio, we've been through the middle of the pandemic, speaking on Zoom. We've had various different ways of connecting with each other, when one's been around and one's not. And we're still here.
SG: Yeah, I think my favourite one was when we had your face showing on top of a, like a tripod, a bit like one of those Daleks because of during the Pandemic when you couldn't be here in person.
JC: That's right. We fashioned our own bit of technology, which was a laptop on top of a chair, on top of a stool, I think. But it did the trick. It felt like we were face-to-face. But I think, you know, over the years we've covered so much interesting material. I think so much that’s hopefully of value to investors when it comes to what The Merchants Trust is and what makes you tick. And I mean, it's been a real pleasure to have the opportunity to do that.
SG: Thank you. It's mine too.
JC: Well, thank you. Well, let's jump in. On another episode - episode 30, where we're going to cover off some more of those themes that we've touched on and thought about over the years. But in particular, the topic of dividends. That's the top of the agenda for this episode 30 of A Value View. And there's a lot to talk about when it comes to dividends. The Merchants Trust announced its final dividend. Simon, can you talk us through this a little? I think it's a good story here.
SG: Yes, and I'm delighted to say that it was the 42nd consecutive year in which The Merchants Trust has raised its dividend. So, this is one of the key objectives for the Trust is to pay a high and rising income stream every year, and for 42 years in a row, the board of directors have been able to raise the dividend. I think the other thing that was encouraging last year, in the last financial year is that we reported record earnings per share. So, the earnings per share, if you like, are the income we are accruing in the Trust from the portfolio, divided by the number of shares and we're back up to a peak, having seen a massive dip down during the Pandemic. And, of course, the great thing about investment trusts, which we discussed many times over the last 30 episodes, is that the directors could put money away in the good years to keep growing the dividend through the tougher years. We did that in the financial crisis, and they've done it again through the Pandemic. So, yes, delighted to see, back at record earnings and back at another increased dividend. And the dividend increase was about 2.9% for the year and surplus income was put back into reserves to rebuild those dividend reserves for the next rainy day.
JC: And it's that unique structure of the Trust, isn't it, as you say, that enables you to have this amazing record of 42 years, even better than 30 years or 30 episodes of the podcast, but 42 years. What was it in particular that has led you to be able to achieve the 42nd-year dividend growth?
SG: Well, I think it's been the speed of recovery of company earnings, company cash flow and therefore company dividends, since the Pandemic. Quite frankly, in the middle of 2020, when we saw a whole raft of dividend cuts, as companies were being very precautionary, it was difficult to know how long that would last and what the outlook would be. But, we've seen a very quick recovery and we're now seeing industries like banks and like energy, making either record profits or certainly very strong profits and actually really strong cash generation which is allowing high dividends, good dividend growth and also a number of buybacks, which again if a company buys back its shares, it reduces the share count and allows them to pay a higher dividend per share. So, all of that is really helping the banks, the energy companies, but also many other companies as well are seeing much stronger earnings and cash generation and allowing good dividend growth.
JC: Well, I'd like to come back to, you mentioned the banks, come back to them in a little bit, actually. But, before we do, it's not just, of course, The Merchants Trust dividend that you're focusing on. A number of leading companies in the Trust have announced dividends as well. What have you seen there? And what's it meant for investors in particular?
SG: Yeah, I mean, it's not completely one-way traffic. We have had a couple of house builders, for example, where, as house prices have come under pressure and housing transactions have dropped, and as mortgage rates went up, effectively fewer people were buying new houses, we saw their profits under pressure and therefore they've had to cut their dividends. So, we are seeing one or two companies cut dividends and one or two for other very specific reasons, but generally, most businesses whether they're industrial, consumer, financial, are seeing decent dividend growth and a rebuilding of cash flow. So, overall across the portfolio, we're seeing positive trends.
JC: And this leads me on to a broader question around your current thinking on the states of play for UK equities, a subject matter that we always touch on. When we last spoke, I challenged you on your more bullish ‘glass half full’ position while the FTSE recorded its highest ever close recently. So, it looks like that glass, at least for now, maybe more than half full. What's driving this, Simon?
SG: Well, I think firstly, we've got to be clear that we are seeing globally stronger equity markets. Some of the US has been leading the way until recently.
JC: The UK sort of just part of a wider story in that respect.
SG: Partly, although in March, the UK was one of the stronger markets outperformed the US. I think the UK had been left behind. But I think the valuation of many UK companies is starting to attract interest, whether that's companies buying back their own shares or one or two takeovers coming through, and maybe that's starting to get a bit of traction. I think it's too early to say, but I think that's quite possible that you'll get that traction in the UK because evaluations are attractive and, of course, as we have discussed many times in the 30 episodes is that the vast majority of revenue sales and profits for UK listed companies comes from abroad. So, these aren't necessarily pure plays on the domestic economy, in any case.
JC: OK, let's just build on that, actually. You talk about takeover offers and moves to take over businesses. Talk us through a couple of those, Tyman in particular is an interesting business. A UK business that makes a lot of its money in the States. Exactly the example of what you've just given there. What are we seeing there?
SG: Absolutely. So, their products are housing related. They make, for example, hinges, brackets, locks for windows and doors. They have a very large market share in the US in those types of products. They also have products in the UK and in Europe and elsewhere. And another company in their industry has approached them recently and announced that they want to buy them in an agreed takeover, which is largely cash, but also offering shares. And this company would be effectively putting together two related products in America and offering their customers - the manufacturers or the house builders or whoever it is a combined product set, so there'll be some cost savings they could generate as well. And it's yet another example of the low valuation of the UK appealing to a foreign company who can see an opportunity there. We’re yet see if that takeover bid goes through, but, it's interesting that they've been approached.
JC: But it's not just foreign direct investment into the UK, we're talking about when it comes to these takeovers. Another in a very similar sector involves housebuilders.
SG: Yes. Also within our portfolio a couple of months ago, we saw Redrow housebuilder approached by Barrett Developments. And Barrett's want to buy Redrow and move from having two brands to having three brands to help them be more efficient in the housing market. One of the problems you get as a housebuilder is often the plots of land you can buy have hundreds, if not thousands, of plots to build homes. And if you just have one brand, it's very hard to sell more than a certain number of homes every week. But if you can have a more upmarket brand like Redrow and a more mass market brand like Barrett on the same site, you can often sell significantly more houses because you've actually got two sales offices with different brands. That's the idea behind this merger is to have three brands actually, in their portfolio and get even more efficiencies out of that.
JC: So, consolidation in the housing sector, then housebuilding sector. Might we see more of that? Because there are others out there, of course. Or is this an isolated incident?
SG: I think it's always possible when you have a combination of modestly priced companies, and the UK has a lot of those, and also cash-rich buyers, or maybe even private equity with money. And if interest rates, particularly if interest rates are stable, or even declining, that makes it easier to finance take-over bids. We didn't get that many during 2022, sorry, 2023. I think the problem there was interest rates were going up and were very volatile. It was hard to structure a transaction, but I think it's a bit easier when interest rates are more stable.
JC: And well, just picking up on your point on interest rates. We've seen a lot of change in interest rate expectations this year, both in the UK and the US. What's your take on this?
SG: Yes, So it's interesting. We came into the year with the market getting very excited about interest rate cuts, and projections at that point, if I remember correctly, were for the US to have up to five interest rate cuts in 2024. I think subsequent to that, we've seen slightly stickier inflation than expected and slightly stronger growth. Now, in some ways, stronger economic growth is good news. But it does mean that the Federal Reserve won't be in such a hurry to cut interest rates and expectations now are for only one or maybe two interest rate cuts, so fewer than there were. And we're seeing a similar pattern in the UK. We are still expecting, or the market is still expecting, interest rates cuts as we go through the year in the UK, but maybe not as many as were forecast at the beginning of the year.
JC: So, if we need to continue to adapt and live with rates at a slightly higher rate than perhaps we thought they might come down to by the close of this year.
SG: Exactly, and that's not necessarily bad news if it means it's a stronger economy, but the types of companies that normally do well when interest rates are coming down, such as consumer-related… companies sensitive to mortgage rates to consumer borrowing costs. They had a very strong performance at the tail end of 2023 and a more subdued performance at the beginning of this year. So, it'll be interesting to see how they perform.
JC: I just want to go back to that point you mentioned just a bit earlier on around the banks. I want to dig a little deeper into the performance of some of the stocks that you're invested in, the reporting season, of course, well underway for some of the bigger players and not least the banks and insurers, where the Trust is and has been for quite some time, well invested. What are you expecting to see here? And what has performance been like, first and foremost, for some of those that you're invested in?
SG: Well, we've generally seen pretty good performance out of the larger banks? We own companies like Barclays, Lloyds Bank, and in fact, we bought Bank of Ireland, which is obviously an Irish bank.
JC: So, that's interesting. So what was the move? What was the reason for that move?
SG: I think the main thing, the main idea behind it, is very similar to the arguments for Lloyds and Barclays, which is the whole banking industry has been transformed since the financial crisis and in fact, the Irish banking industry was hit even harder by the financial crisis than the British one. So, you now have banks with much stronger capital bases, lower leverage and much more conservative approaches, and they're generating now strong profits and robust cash flows. And so overall, we like that environment, particularly given the valuations of banks are still very modest. Ireland, in particular, has a slightly better economic outlook than the UK at the moment. And also the banking market is more consolidated and has been consolidating, which I think is particularly attractive. And so that was another argument for having another bank with a similar theme, but actually in a slightly different geographic location, as a little bit of diversification, as well as exposure to the Irish economy, which we quite like. So, we have now exposure to three quite large banks in the portfolio, and they've all been performing, quite well, operationally and indeed in share prices more recently.
JC: And as you look at those stocks in the sector in particular going forward, what's your anticipation there?
SG: I mean, we can't really talk about where we expect individual companies to perform.
JC: No.
SG: But as an industry, we do see robust profit generation from the banks and very strong cash generation. The question, of course with banks always is what's going to happen to the economy. If you get a recession, then bad debts will pick up and profits will be under.
JC: But what you're saying is that the banks are more resilient now than perhaps they've been for a long time. Certainly, since before the great financial crash.
SG: Absolutely, they should be. We're always conscious with banks, there's a lot of leverage in the system. And you can never know from the outside exactly what lurks in a bank. So, you always, as an investor, you always have to be a little bit careful with financials in general in banks in particular. But, as we see it today, banks do look much more conservatively positioned and more sensibly managed than they were certainly in the financial crisis and most of the time since then.
JC: Just a final question, Simon, and back to the FTSE. We've been singing its praises and enjoying the fact that perhaps things are looking a little rosier for the London index. How significant has the recent uptick been? Do you think that perhaps at last, we're starting to see the FTSE play catch up with global competitors?
SG: I hope so. I mean it, it's long overdue in many ways.
JC: Somebody needs to love it!
SG: I think the reasons why the UK has been out of favour, I think of all dropped away and we've talked about this a little bit in the past, but they come down to me to economics and politics. On economics, there was a view that somehow the UK was a sick man of Europe, to use a phrase coined by others, and if you look at economic growth since before the Brexit referendum to now, it looks very similar in the UK to much of Europe and the rest of the G7. Maybe not as strong as America, but certainly similar to many European countries.
JC: The German economy particularly struggling at the moment.
SG: Absolutely, and inflation was a bit higher in the UK, but it's now trending in the same direction, looks reasonably under control. So economics doesn't look that different. Politics - we had a succession of issues with the Brexit referendum, there was the whole Jeremy Corbyn / Boris Johnson period in 2019. We then had issues like the Pandemic and the war in Ukraine. And then, just as we were coming out of all of that we had Liz Truss and Kwasi Kwarteng for a period. I think what you get now is actually much more stable. I think, clearly we have a general election coming up soon. It looks like Keir Starmer is most likely to win. I'm not making a brave…
JC: We would never say for sure, would we? But the polls as they stand at the moment seem to be very clear on this and very definitive.
SG: Absolutely. But I think from a financial markets point of view, the gap in policy between both sides is actually pretty modest, in terms of what's likely to happen, and I think markets would not take it too badly either way, if Labour win or if Conservatives win. So, we see political risk as relatively low in the UK and one thing we have learned from Kwasi Kwarteng being Chancellor is the markets will tell you what you can and can't do in terms of borrowing and taxation anyway. So, I think we could be quite relaxed in the UK, in a way that if I was sitting in some of the other countries in the world looking at the elections they've got coming up, I might be more concerned about market risk. So sorry, a very long answer, but for various reasons, we actually think the outlook for the UK is pretty solid at the moment.
JC: Well, we'll certainly come back to questions around the UK, the election, of course, and the performance of the economy in the next 30 episodes of A Value View. But, for now, Simon, I'm afraid we are out of time. Thank you for joining us. And thank you for listening to A Value View from The Merchants Trust. You can find out more about The Merchants Trust and read and watch Simon's latest investor notes by going to merchantstrust.co.uk. Thanks again for listening until next time from all of us here at The Merchants Trust, it's goodbye.