Scottish Investment Trust increases dividend for 36th consecutive year – The Scottish Investment Trust (SCIN) has reported the following financial highlights for the year to 31 October 2019:
- Total dividend increased by 20.0%;
- Regular dividend increased by 7.5% to 22.80p;
- 36th consecutive year of regular dividend increase;
- Share price total return +1.0% and NAV total return +0.5%.
What follows are exerts from manager, Alasdair McKinnon’s, report.
‘Bursting of the disruption bubble’
“One evening in September 2007, whilst on holiday, a flickering TV caught my attention. I was stunned to see a report that concerns about the financial strength of Northern Rock had dramatically escalated. Rather than accept the reassurances of the authorities, people were queuing around the block to withdraw their money. Admittedly, I had been worried for some time about the debt-funded party that had characterised the previous few years of economic activity but, to me, this was a tangible sign that we had reached the peak of that cycle. I had no exact knowledge of what would happen next but I reasoned that anything that had come to depend on easy money was shortly going to be in difficulty.
As it turned out, money markets and credit conditions continued to deteriorate, which culminated, a year later, in the bankruptcy of Lehman Brothers. Looking back, there are two factors that I continue to find surprising. The first is how bad things got. I would not have predicted, in 2007, the de facto bankruptcy of the Western banking system within a year. The second is how the markets initially reacted to the downturn in the cycle. As credit markets froze and the US headed for recession, the markets’ ‘animal spirits’ decided that emerging markets could ‘decouple’ from developed markets. Further, as emerging markets required a lot of raw materials, the logic was extended such that commodity prices could also ‘decouple’. Accordingly, for about nine months ‘decoupling’ became the hottest investment theme, culminating most memorably in the oil price hitting a high of around $146 per barrel in July 2008. By the end of that year, as economic activity ground to a halt, the oil price was close to $40 which showed that decoupling was always a fanciful notion. Nevertheless, had investors correctly predicted the outcome of these events and acted accordingly in September 2007, they still would have endured a very uncomfortable nine months before their investment decisions came good.
I mention this because it seems that the recently failed IPO of WeWork is a similarly significant event for the ‘unicorn’ party and, perhaps, loss making ventures in general. A unicorn is the term given to private, recently started businesses that have an implied valuation of over $1bn. WeWork was one of the biggest unicorns of all, with an implied valuation of $47bn (for context, a well known company of similar market capitalisation is BMW). Many unicorns present themselves as technology based disrupters but actually operate at vast losses in low margin, cyclical industries with revenue growth only sustained through a subsidised user experience. In effect, these companies require a constant supply of new capital to sustain their business models.
I cannot say with certainty what the ramifications will be of the bursting of this ‘disruption’ bubble but, as I have expressed before, my view is that this particular investment theme has been one of the more egregious by-products of a cheap money environment. I think, if the mood is starting to turn away from these sorts of investments, that the unloved but cheap areas of the market will find favour.”
Gold miners lead gains for the year
“Our gold miners, in aggregate, provided our largest gains during the year. Newcrest Mining (+£12.2m total return), Barrick Gold (+£8.2m) and Newmont Goldcorp (+£7.6m) appreciated as the gold price increased and investors were encouraged by a recent wave of mergers between the big miners and a greater focus on efficiency and capital discipline. Gold is perceived as a safe haven at times of market turbulence but, for us, a more attractive feature is the fact that it acts as a currency which is not susceptible to the devaluing effect that loose monetary policy and unfunded government spending has on paper money.
Returns from the retail sector were, overall, not as pleasing. Strong gains came from US-based Target (+£7.7m), which reaped the reward of a programme to optimise its operations for both online and in-store transactions. We believe this type of ‘multi-channel’ approach is most likely to prosper given the poor economics of online-only sales. UK supermarket Tesco (+£4.3m) also performed well as it continued to make significant strides towards rebuilding profitability. However, US department store operator Macy’s (-£13.2m) was a source of disappointment as a stumble in the turnaround plan wiped out the strong gains from the previous year. We had hoped that Gap (-£9.6m) could unlock value by splitting the business in order to focus on distinct brands but this was undermined by weak sales in its most profitable brand. Marks & Spencer (-£6.9m) performed poorly as it entered into a venture with online food retailer Ocado.
Among our health care holdings, GlaxoSmithKline (+£5.4m) and Roche (+£4.0m) performed well as they advanced plans to reinvigorate their pipeline of drugs. Pfizer (-£2.5m), meanwhile, gave back some of its previous gains as it transforms from health conglomerate to a company focused on innovative pharmaceuticals.
In financials, the subdued yield environment was particularly disadvantageous for our Japanese banks Mitsubishi UFJ Financial (-£2.3m) and Sumitomo Mitsui Financial (-£2.0m). Solid returns came from emerging markets focused lender Standard Chartered (+£4.5m), which resumed share buybacks in a sign of progress with its turnaround plan, but we substantially reduced our holding when it became apparent to us that protests in Hong Kong would be longstanding.
Among our oil holdings, we continue to see exceptional value in the oil majors, which now have the whip hand when procuring services, but Exxon Mobil (-£2.5m) and Royal Dutch Shell (-£2.0m) retreated on concerns about a slower global economy. We sold National Oilwell Varco (-£4.1m) and Diamond Offshore Drilling (-£2.3m) as our analysis showed it would be several years before they again enjoyed pricing power.
Japanese electronic goods companies Sony (-£2.5m) and Nintendo (-£1.3m) were both sold during the period having successfully revived their fortunes. Despite recording losses during this reporting period, they were very fruitful investments over our holding period.
In telecommunications, our new holdings made modest gains AT&T (+£0.6m), Deutsche Telekom (+£0.6m), KPN (+£0.3m), Orange (+£0.6m), Tele2 (+£0.6m) and Telstra (+£0.3m). Their defensive characteristics and attractive dividends are complemented by a shifting regulatory cycle which may incentivise investment in next generation networks. Among our pre-existing telecommunications holdings, China Mobile (-£2.3m) declined, not helped by its Hong Kong listing, while BT (+£1.8m) advanced as investors anticipated a more benign environment.
BHP (+£4.8m), a diversified miner, was aided by high iron ore prices and a focus on capital discipline which has helped fuel a meaningful recovery in cash flows. As this improvement seemed more fully appreciated by investors, we sold our holding during the year.
UK water and waste services company United Utilities (+£3.6m) recorded solid gains as the regulatory backdrop eased, defensive assets found favour with investors and, perhaps most importantly, investors sensed the chance of an unfavourable political environment had diminished.”
UK could be an interesting opportunity
“The stockmarket remains strong but the global economy seems to be slowing. Markets continue to dance to a cheap money tune but recently have shown less appetite for profitless growth at inflated valuations. We think this new mood will spread to other areas of the market where investors have been prepared to accept ever fancier valuations for ‘certain’ growth. We cannot be precise on when this will happen but we do know that ‘sure’ things almost always disappoint and that paying a steep price is a bad starting point.
There has been much talk of a recession lately, but the reality is that, outwith the US, most of the world is already enduring sluggish conditions. Most of our holdings are in the unloved and out-of-favour parts of the market and, arguably, many are already priced for a recession. We think this gives scope to defy low expectations and thus to generate long term gains.
A global recession is a possibility but politicians are alive to this threat. President Trump seems keen to sign a watered down trade deal with China, with one eye on his re-election, while the US Federal Reserve has not only cut interest rates but has again started to inject money into the financial system in a QE-like manner.
We think the Brexit fog is starting to lift and we believe that the combination of a cheap currency and depressed UK stocks relative to other parts of the world could be an interesting opportunity.
I have previously noted that, as contrarian investors, we actively seek unfashionable investments that we believe have underappreciated potential. Where expectations are low there can be significant scope for positive surprises and this is where we believe the best balance between risk and reward exists.”
SCIN: Scottish Investment Trust increases dividend for 36th consecutive year