Scottish Investment Trust (SCIN) has announced its final results for the year ended 31 October 2018. During the year, the share price total return was +1.9% and the NAV total return was +1.1%. SCIN does not have a formal benchmark but it says that, by way of comparison, the sterling total return of the international MSCI All Country World Index (ACWI) was +3.4% while the UK based MSCI UK All Cap Index total return was ‑1.3%. The board says that it does not expect the Company’s portfolio to match any particular index return over any defined period due to the contrarian nature of the portfolio’s composition but says that SCIN’s contrarian approach aims to achieve above‑average returns over the longer term. The report highlights that:
- SCIN’s Regular dividend has increased by 6% to 21.2p per share
- This is the 35th consecutive year of regular dividend increase
- SCIN is also providing an additional special dividend of 4p per share.
SCIN’s dividend
The year to 31 October 2018 was the first year of SCIN’s higher and more frequent dividend. The board says that, last year there was a step change increase in the regular dividend, lifting it by nearly half, as well as a shift to quarterly dividend payments. The contrarian style does not explicitly target higher yielding investments but is expected to generate a higher than average level of income through an investment cycle. If there are occasions when the portfolio does not generate a sufficient level of income to cover the requirements of the regular dividend, the Board considers that it would be appropriate to utilise the Company’s healthy revenue reserve.
The board says that shareholders now have a clearer indication of the income that they can expect to receive from their investment while gaining a more regular income stream. Following this step change increase, the Company has one of the highest stated dividend yields among its global investment trust peers.
Over the past year, earnings per share rose by 12.8% to 26.0p (2017: 23.1p). The Board has recommended a final dividend of 6.2p which, if approved, will mean that the total regular dividend for the year will increase by 6.0% to 21.2p and will be the 35th consecutive year of regular dividend increase. The Board’s says that its target is to declare three quarterly interim dividends of 5.3p for the year to 31 October 2019 and recommend a final dividend of at least 5.3p for approval by shareholders at the Annual General Meeting in 2020. The final dividend will be reviewed in accordance with the Board’s desire to continue the long track record of annual dividend increases and the aim of the Company to provide dividend growth ahead of UK inflation over the longer term. The chairman says that SCIN is less likely to pay discretionary special dividends in future years but, as the income generated for the year to 31 October 2018 is substantial, the Board has recommended a special dividend of 4.0p.
Manager’s commentary on SCIN’s portfolio
“We have a number of holdings in retailers and these produced some of our largest gains during the year. Each was different but, generally, we thought pessimism surrounding long‑established retailers had reached a crescendo, creating ‘ugly duckling’ opportunities. US department store operator Macy’s (+£12.1m) produced better than expected results, aided by a revitalised approach and an improved consumer environment. US retailer Target (+£4.9m) benefited from the same themes and the introduction of a more convenient store format. UK supermarket retailer Tesco (+£4.8m) is making good progress towards rebuilding the profitability of its domestic business after well documented problems. The combination with Booker should deliver superior purchasing power. US retailer GAP (+£2.2m) has continued to see strong results from the Old Navy and Athleta brands, albeit this has been largely overshadowed by a lack of progress at the namesake brand. UK retailer Marks & Spencer (‑£2.2m) is undergoing a far‑reaching transformation overseen by turnaround expert Chairman Archie Norman. We continue to believe that the company, which remains very profitable, has a great brand which can be revived.
US pharmaceutical company Pfizer (+£6.5m) gained as the company’s lowly valuation was re‑evaluated in light of a promising pipeline of new products. UK company GlaxoSmithKline (+£4.3m) reassured investors about the sustainability of the dividend after sensibly opting to buy Novartis’s share of their consumer healthcare joint venture rather than pursuing a more ambitious acquisition. The new CEO is determined to better commercialise the company’s gargantuan R&D efforts.
Energy stocks were volatile but generally performed well over the year as resurgent oil prices and efforts to reduce costs boosted cash flows. Our largest gain in this sector came from UK listed oil major Royal Dutch Shell (+£2.9m) which has done an excellent job of transforming its portfolio and managing costs, driving a rebound in cash flow. We also saw gains from TGS Nopec Geophysical (+£2.7m), Hess (+£2.5m) and Total (+£2.1m).
UK listed miner BHP Billiton (+£3.9m) gained as the more favourable commodity price environment, alongside productivity improvements, helped drive solid cash flow and dividend growth. Our investments in unloved gold miners, including Newcrest Mining (‑£3.2m) and Newmont Mining (‑£3.4m), delivered negative returns. Gold has been out of favour in recent years, but we think it looks well placed for a recovery. We see gold as both a potential safe haven and a potential beneficiary if the inflationary environment picks up.
European banks have recovered well in recent years, benefiting from attractive valuations and a more settled regulatory environment. However, this year was tougher as uncertain European politics and concerns regarding emerging markets weighed on sentiment. We made losses in our holdings in ING (‑£8.7m) and BNP Paribas (‑£4.9m). UK listed but emerging market exposed bank Standard Chartered (‑£7.0m) was impacted by the slowdown in these markets. We increased our holding in Sumitomo Mitsui Financial Group (+£1.0m) as we considered it likely to be a beneficiary of any rise in bond yields in Japan.
Mexican cement producer Cemex (‑£3.8m) was hampered by a combination of headwinds and we sold our holding due to the changing political climate in Mexico. We also sold our holding in US industrial conglomerate General Electric (‑£4.0m) as a quick succession of leadership changes led to a reset of expectations for earnings and the dividend. BASF (-£2.9m) declined as trade tensions weighed on stocks sensitive to economic growth. Swiss based recruiter Adecco (-£3.1m) performed poorly as the outlook for European economic growth remained muted.
Japanese electronics and entertainment group Sony (+£4.3m) gained as an extensive restructuring delivered growing profits following years of losses. Our investment in US telecommunications provider Verizon Communications (+£2.9m) rose as it focused on upgrading its network to win customers in a mature market and its lowly valuation was reconsidered.
Honourable mentions must also be made for two stocks we sold completely during the year. Rentokil Initial, which was an unloved and underperforming conglomerate and is now a business focused chiefly on pest control, produced a total return for us of +£24m over the period we held the shares. Australian based global wine producer, Treasury Wine Estates, which was for a long time our largest holding, has been an exceptional investment, providing a total return of +£39m over the three years we held the shares. These companies have transformed and their progress is now more widely recognised. While their prospects remain promising, we believe they are now reflected in the share prices and consider that the balance of risk and reward is no longer as favourable.”
Manager’s commentary on outlook
“In my youth, I read The Ragged Trousered Philanthropists by Robert Tressell. Looking back, the book presented socialist ideas in a more digestible form and the title was meant to illustrate the irony of poverty stricken ‘philanthropists’ performing gruelling work for inadequate pay on behalf of avaricious masters.
I always considered the title very clever, as it summed up the thrust of the book, and as I look at today’s stockmarket, I wonder if the author would have managed a wry smile at the gigantic malinvestment in the ecommerce area. Today, investors are acting as philanthropists as they subsidise unprofitable user growth by ‘disruptive’ entrants in a variety of areas. Investments connected with internet shopping, food delivery, ride hailing services, scooter rentals, music streaming and video streaming, to name just some, are strongly favoured by investors despite their continued propensity to burn cash. That the consumer appreciates a service sold below the cost of production is not a surprise. The challenge is converting a subsidised, or free service, to a sustainably profitable business model. The lack of scepticism about the difficulty of achieving this is a symptom of ten years of cheap money.
In recent reviews, I have noted some concern with regard to investor attitudes to risk driven by a fear of missing out. The mania for cryptocurrency get‑rich‑quick schemes proved to be brief but was concerning as it represented a proxy for both the ease and speculative nature of financial conditions. The investor infatuation with all things technological was also highlighted as a concern as the area appeared to be awash with both cash and excessive optimism. The premium smartphone boom has peaked, social media is now subject to increasing regulatory pressure and the ecommerce business model will have to evolve further. We have minimal exposure to these areas as we see elevated expectations and thus scope for disappointment.
It is now increasingly popular for politicians to pledge tax cuts and increased spending in anticipation of these actions generating improved future growth (and hence tax revenues). This may well prove correct but, equally, once politicians get a taste for this type of strategy, it is the first step on the road to currency debasement via inflation. That said, this is likely to be a lengthy journey, as a large number of stakeholders favour the status quo.
Generally speaking, the spread of valuations across the market is wide and we continue to identify opportunities that we believe will generate good long‑term returns for shareholders.
As I have previously noted, as contrarian investors we actively seek unfashionable and unpopular investments that we believe can recover. This is where we find the best balance between risk (expectations are low) and reward (things can get better). Our investment approach is designed to anticipate and benefit from change and we will continue to seek out opportunities with potential to profit the long‑term investor.”
About the Scottish Investment Trust
The Scottish Investment Trust PLC invests internationally and is independently managed. Its objective is to provide investors, over the longer term, with above‑average returns through a diversified portfolio of international equities and to achieve dividend growth ahead of UK inflation.