Temple Bar suffers Shell shock

Shell has cut its dividend for the first time since the Second World War. This is bad news for many UK equity income trusts including Temple Bar.

The quarterly payment is shrinking from 47 cents to 16 cents. The announcement reads as though this may be a long-term measure rather than a temporary one. Shell has plans to reshape its business and that requires a fair bit of capital investment.

The cut takes it from a yield of 11.3% to 4.1%. At these levels, equity income fund managers may no longer feel that they want to own the stock. This is one reason why the share price has fallen by around 16% on the news.

Shell may have looked cheap ahead of the pandemic. However, without a favourable wind of rising demand for oil and rising prices over the long term, it is hard to see how it can achieve meaningful increases in its sales and profits. It is increasingly looking like a classic value trap.

Ahead of this announcement, UK equity income investors had already been hit by the loss of dividends from the UK banks. Many more companies have already announced dividend cuts. Shell though is the biggest dividend payer in the UK stock market. Investors questioned whether BP would follow suit, but it is sticking with its quarterly dividend for now.

There are 25 investment companies within the UK equity income sector, and these adopt a variety of different approaches to generating their dividend income. The wide dispersion in their returns over the past three months illustrates that. Many of them have large positions in Shell and BP, but not all.

One of the worst performing trusts in the sector over the past three months is Temple Bar. It has lost 37.8% in NAV terms and its share price has fallen by the same amount. Only Chelverton UK Dividend Trust has done worse (-40.1%) and its losses were magnified by its split capital share structure.

Temple Bar had 5.5% each in BP and Shell at the end of March. That’s a greater proportion than at the end of January. The then manager, Alastair Mundy must have topped up the position as their share prices fell – Shell had fallen by 29% between the end of January and the end of March and the equivalent move for BP was -25%. That was a big gamble on an eventual recovery in the oil price and one that, in the short term, will have cost the fund dearly. However, Alistair was given an extended leave of absence for health reasons on 17 April and, shortly afterwards, the board served protective notice on the management house – effectively firing the starting gun on a race for other managers to seize control of the trust.

There are other trusts managed in a value style, but Temple Bar was probably one that was most faithful to the approach. Value investing delivered excellent returns in the past but not since the financial crisis in 2008. We believe that a large part of the problem has been the extremely low interest rates and inflation that we have experienced over the past decade. The policy response to the current crisis is for even lower rates and many investors are fearful of deflation.

Many trusts experiencing a sudden loss of revenue at this time will dip into reserves to maintain their dividend. Temple Bar has just over a year’s dividend in reserve – £37m. Remarkably then, even in this worst-case scenario, investors in the trust might at least get their dividend income. A recovery in their capital value may take a while, however. We hope that Alastair’s recovery is far speedier and we wish him all the best.