City of London beat the FTSE All-Share Index over the year ended 30 June 2015, delivering a total return on net assets of 6.4% and a return to shareholders of 7.2% against a 2.6% return for the index. The NAV and shareholder return were in the same ball park as the 7.0% return posted by the UK Equity Income OEIC sector. City of London benchmarks itself against the AIC UK Equity Income sector which it beat as the size weighted average for the AIC sector delivered a 6.2% return for the period. The dividend was increased from 14.8p to 15.3p, the 49th consecutive year of increasing dividends.
The company remains popular with investors, 22.9 million shares were issued at a premium to net asset value, for proceeds of £86.9m, enhancing net asset value by 0.13%.
The manager’s report says, reflecting the weakness in the oil price, the oil sector was a major underperformer over the year with a negative return of 21.6%. As the oil price fell in the second half of 2014, the portfolio’s holdings in the sector were reviewed and what were considered the two weakest companies, Statoil and ENI, were sold. Holdings were maintained in Royal Dutch Shell and BP although the portfolio was under represented in the two stocks relative to the FTSE All-Share Index. In April 2015, Royal Dutch Shell bid for oil independent BG which owns valuable LNG operations as well as oil interests off the coast of Brazil. On a long term basis, this was a good moment to acquire BG with its valuation relatively depressed. At the beginning of July 2015 and slightly over five years after the Macondo oil spill disaster in the Gulf of Mexico, BP reached a settlement with the US authorities for penalties, damages and claims in-line with market expectations. Looking forward, both Royal Dutch Shell and BP should benefit from improved profitability of their downstream (refining and marketing) operations. In addition, both companies will be looking to preserve upstream oil exploration and production profit margins by reducing the costs they pay to suppliers. With this in mind, the portfolio’s two small holdings in the oil equipment and services sector, Cape and Prosafe, were sold because they operate in areas that appeared to be particularly vulnerable to cost cutting from oil companies.
The mining sector faced similar pressure to the oil sector with supply increasing at the same time as demand softened. The multi-year growth in demand from China for commodities such as iron ore (used for steel) had encouraged mining companies to invest in new capacity.
The two main mining holdings in the portfolio, BHP Billiton and Rio Tinto, are among the lowest cost producers. BHP Billiton spun out its non-core assets into a new company, South 32, and this holding was sold. In addition, the holding in Anglo American was reduced given its above average balance sheet gearing although it has an impressive, diverse range of assets, including the De Beers diamonds business.
In contrast to the underperforming oil and mining companies, the star performers in the portfolio over the twelve months were the three housebuilders. Taylor Wimpey which was originally bought in July 2014 returned 71%, while the holdings of Persimmon (bought 2012) returned 64% and Berkeley (bought 2013) returned 49%. The quoted housebuilders benefited from strong demand for new houses given low interest rates and the shortage of available homes. All three housebuilders in the portfolio have land banks of over five years and are committed to returning a substantial proportion of profits to shareholders in the form of dividends. At the end of the financial year, the Company’s stake in its three housebuilding holdings was worth 4.3% of the portfolio.
In addition a further 4.9% of the portfolio was held in Real Estate Investment Trusts (REITs) which own offices, shopping centres and industrial property. Over the year, REITs benefited from strong investor demand for good quality property and rising rents for London Offices. Land Securities and British Land remained the two largest REIT holdings in the portfolio and returned 19.4% and 17.2% respectively. Two new REITs were bought. Hansteen is a specialist in high yielding industrial property in the UK and Europe. Tritax Big Box owns large warehouses needed by retailers to fulfil orders for the online market.
In the general retail sector, a new holding was bought in N.Brown, an online catalogue and stores retailer with a particular focus on the plus-size apparel sector. Profits were taken in Card Factory. In food retailing, trading conditions were very tough because of the growth of the deep discounters Aldi and Lidl. The holdings in Tesco and WM Morrison were sold given significant uncertainty over their profits and dividends. A holding was retained in J.Sainsbury where it was felt the business had been better managed in recent years and its brand was relatively strong.
In media, a new holding was bought in ITV while Euromoney Institutional Investor was sold. ITV, the UK’s leading commercial free to air broadcaster, is a beneficiary of improving advertising as a result of better UK economic growth. It is also a successful maker of television programmes for both the UK and overseas markets. Reed Elsevier, which had a good year with a share price total return of 15.8%, had a corporate reorganisation and was renamed RELX. The portfolio holding was consolidated into the cheaper Dutch line (from the UK line).
In the banks sector, a holding was bought in Lloyds, some six years after it was sold at the time of its acquisition of HBOS. In the intervening period, Lloyds has rebuilt its capital base, the UK government has significantly reduced its stake and the bank has started paying a dividend again (in May 2015). Lloyds has a leading position in UK retail banking and significant dividend growth is expected. They believe there is scope for Lloyds’ share price rating to improve as its recovery continues.
In utilities, the water sector had a tough regulatory review and the holding in Pennon was sold where there was also concern about its waste treatment business. In food producers, Dairy Crest was sold following a sharp rise in its share price after it announced the sale of its milk business.
CTY : City of London expansion continues as it beats benchmark