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Shires Income’s emerging markets and commodity holdings drive underperformance

Shires Income, managed by Ed Beal (pictured), has announced its annual results for the year ended 31 March 2016. During the year, the trust’s NAV fell by 7.0% on a total return basis, thereby underperforming its FTSE All-Share Index benchmark, which lost 3.9%. The company says that its NAV underperformance was due principally to stock specific issues, which principally occurred in the financial sector where the trust was overweight (both through the trust’s direct equity holdings and through its preference share portfolio). The manager says that the underperformance reflects the difficulties experienced in the trust’s emerging market and commodity orientated holdings. The trust’s share price fell by 15.4% on a total return basis over the year, reflecting a widening of the discount (from 0.2% at the start of the year to 9.5& at the end) although the managers highlight that this was not unusual within the investment trust sector, which they say has seen discounts widening from historically tight levels since the start of 2016.

In terms of performance attribution, the managers say that Standard Chartered was the worst performer due to disappointing trading, management change and a rights issue. Close Brothers, Schroders and Prudential also underperformed although, operationally, all three companies’ results were satisfactory and their balance sheets are in good condition in the managers’ view. Another negative area was the exposure to the mining sector, where BHP Billiton underperformed. In terms of positive performers, the managers say that the most notable amongst these were British American Tobacco and Unilever, both of which continued to deliver pleasing dividend growth, and Sage, the accounting software company, delivered another year of good results.

In terms of income generation, the trust’s revenue return for the year was 12.06p per share, compared to 12.92p per share for the previous year. The managers say that, although there were some good dividend increases within the trust’s portfolio, there were also some notable decreases, some of which were related to the weakness in the oil and other commodity prices, including BHP Billiton and Centrica. In addition, the managers comment that Standard Chartered and Tesco have cancelled their dividend payments altogether and that total investment income also fell slightly due to the expected reduction in special dividends. Shire’s Board is proposing an unchanged final dividend of 3.25p per share, which brings total dividends for the year to 12.25p per share, the same as in 2015 (a yield of 6.1% based on the year end share price of 202.0p per share). The board says that, subject to unforeseen circumstances, it is proposed to continue to pay quarterly interim dividends of 3.00p each and will decide on next year’s final dividend having reviewed the full year results. The manager comments that, whilst significant dividend cuts negatively impact earnings per share the trust’s diversified portfolio and fixed interest holdings provide resilience.

The trust’s gearing increased during the year (from 19.4% to 24.9%), which was due both to an increase in borrowings and the fall in asset value. The board comment that, whilst the level looks high, it is deployed notionally in fixed interest securities which bring an element of diversification to the trust’s revenue stream but with lower volatility than would be expected from an equity portfolio.

In terms of portfolio activity, the managers introduced four new holdings during the year.  Rotork (design and manufacture of actuators). The managers say that their business model is one based on assembly, rather than conventional manufacturing and that they are able to generate attractive margins and returns. The managers believe that the impact of the current downturn in commodity prices has been more marked creating an opportunity for them to introduce an initial holding. Capita provides Business Process Outsourcing (white collar services, often with an IT orientation). Drivers for adoption are the cost savings that accrue for both public and private sector buyers. The managers believe that, whilst organic growth will be a key driver of their fortunes there is ample scope for them to engage in merger and acquisition activity as they buy new capabilities or broaden into new geographies. Hansteen owns and manages industrial parks in the UK, Germany and Belgium. The managers say that these can be purchased with low levels of occupancy and rent, on high single digit yields and so Hansteen have attractive opportunities to add value. Imperial Brands is an international tobacco company (its brands and products are available in 160 countries worldwide). The managers say that the company has maintained sound underlying earnings progress aided by cost savings and price increases which in turn have been helped by their brand migrations.

Three holdings were exited. Land Securities was sold as the managers felt that valuations of London prime real estate were becoming increasingly stretched, especially given a belief that interest rates would eventually begin to rise. The managers inherited a small holding in South 32 when it was spun out of BHP Billiton and divested this as, in their view, the assets being spun out were of a more diverse nature and quality and reinvested the proceeds in BHP. BG group was bid for by Royal Dutch Shell. The managers believe that the transaction made sense for Shell and that, for BG, it allowed a crystallisation of value at a time of very high levels of uncertainty about the oil price. The managers chose to participate in the placing conducted by GKN to help finance their purchase of Fokker Technologies and also supported Standard Chartered with their £3.3 billion rights issue conducted at the end of 2015.

The managers say that they continued to build holdings in Ultra Electronics and Elementis whilst they took profits in Associated British Foods after it had performed strongly. Tesco was top sliced following the recovery in its share price as its restructuring began to show signs of gaining traction. Cobham was also top sliced as the managers came to the view that they’re over-indebted following their acquistion of Aeroflex.

Shires Income’s emerging markets and commodity holdings drive underperformance : SHRS

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