Alliance Trust celebrates 54 years of rising dividends – Alliance Trust has published results for the year ended 31 December 2020. Over the year, the share price increased to a near record high and the return to shareholders was 9.4%. In an volatile year, the net asset value total return of 8.5% lagged the 12.7% return on the MSCI All Country World Index.
Despite many dividend cuts as a result of the pandemic, helped by its accumulated reserves, the company has increased its total ordinary dividend by 3% in 2020, marking the 54th consecutive annual increase in dividend. The company dipped into its £99m of revenue reserves, using about £10m of these, to support this year’s dividend. A plan to convert its merger reserve into a distributable reserve (to be voted on at his year’s AGM) would add a further £645m to Alliance Trust’s potential dividend pot [making the dividend more or less cast iron, we think].
The chairman notes that returns from investing in global equities have been dominated for the last three years by a small number of the world’s largest growth stocks (most notably in the US and China). The impact of the pandemic in 2020 was to amplify the market’s level of concentration in these stocks. The portfolio is underweight larger companies as a group and has proportionately more capital invested in a broader range of stocks. This was the principle reason for the underperformance last year. Encouragingly, in recent months, there have been signs that this dominance by a narrow group of companies is easing. Despite the headwinds of 2020, overall, Alliance Trust’s equity portfolio has more or less matched the benchmark since Willis Towers Watson was appointed in 2017 (returning 41.3% to the index’s 41.4%).
The manager’s report says that: “the portfolio was particularly hard hit in the Covid-related correction in the first quarter of the year, when value and smaller to mid-cap companies most sensitive to economic conditions, such as Airbus, Aercap or Capita, were penalised. The portfolio then recovered some ground in the second and third quarters of the year as fundamentals came back into focus, allowing the strength of businesses to show through.
However, our Stocks Pickers’ focus on high quality companies meant that we did not fully participate in the strong rally of low-quality, cyclical stocks that occurred in November and December after vaccines for Covid-19 were approved“….”Up to 45% of the MSCI ACWI return over the period came from just five stocks, namely, Facebook, Amazon, Apple, Microsoft and Google (Alphabet)”
Positives and negatives
“Our best contributor was NVIDIA Corporation (NVIDIA), which was purchased in 2019. This is an American technology company that designs graphics processing units for the gaming market as well as computer electronics systems for the mobile computing and automotive industry. The company’s computer chips are used in a variety of end markets, including complex computing applications such as Artificial Intelligence (AI) and autonomous driving. NVIDIA was perfectly positioned to benefit from the major trends of cloud computing, AI and online gaming and was up 115% over the year. It reported strong earnings momentum, driven by a dramatically higher demand for cloud computing and gaming. Additionally, the announcement that the company plans to acquire ARM Holdings, a British designer of computer processing units, was viewed favourably by market participants, as this will help to round out NVIDIA’s overall product portfolio.
Baidu, the largest Internet search engine in China with over 70% market share, was also a positive contributor to the portfolio’s returns. Baidu is a technology-driven company and has been investing heavily in autonomous driving and AI, as well as in areas such as computer vision, healthcare, quantum computing, natural language, robotics, machine and deep learning and high-performance computing. The company is attractively valued, particularly when considering its stakes in iQIYI (online video platform that is a key growth driver due to an increased willingness to pay for premium content as well as strong advertising demand), Ctrip (online travel website) and its excess capital (net cash position). Despite some volatility during the year, due to temporarily depressed profitability along with investors’ general fears about the Chinese economy, Baidu has delivered strong returns over the whole period, up 66% in 2020. Baidu is now starting to monetise its research and development spend over the last few years and has seen mobile-app traffic growth and a recovery in advertising revenue. The company has a strong market position to benefit from the long-term growth of domestic consumer spending in China.
Another contributor to the Company’s portfolio performance was e-commerce and cloud-computing leader, Amazon, up 71% over the year. The company benefitted from increased demand for its retail and cloud services as consumers transitioned to shop online versus in stores, and its cloud business also benefited from increased demand. The company delivered very strong retail results over the year, surpassing analyst expectations. Advertising revenues continued to be in line with our Stock Picker’s expectations. Despite the market rotation out of technology and tech-related companies since November 2020, our Stock Pickers believe Amazon is exceptionally well positioned to capitalise on secular growth trends in e-commerce, cloud computing and advertising and has attractive future growth prospects.
Stocks that detracted from performance
Unsurprisingly, of the stocks held in the portfolio, it was aerospace stocks that lagged most, given the impact of coronavirus and the effect of lockdowns on the travel industry. Airbus was the worst contributor over the year, down 27%. Prior to the pandemic, Airbus, the French aerospace corporation, had a strong cash balance sheet and whilst there were certain one-off cash outflows expected, the company was able to withstand pressures with €30bn of available liquidity (compared to €12.5bn of net cash in 2019) and to support its customers and suppliers when prudent. Airbus also announced prudent steps to ensure its ongoing resilience such as a €15bn credit facility, a delay to the dividend payment of €1.4bn, suspending top-up pension funding as well as other cost and operational measures. A proportion of Airbus’ net cash is customer pre-payments, but its commercial aircraft backlog is overwhelmingly in the narrow-body segment (80%+), which has a long order book (and lower risk of cancellations, though some are inevitable). Airbus operates what it calls ‘watch tower’ lists where customers can change their place in the delivery queue. This is important as some airlines suffered after the global financial crisis when they cancelled orders and rejoined at the end of a long list. In short, our Stock Picker believes management are doing all the right things to manage the impact of the crisis and are well placed over the long term to deliver strong returns.
Another aerospace company that detracted value over 2020 is AerCap. AerCap is the global leader in aircraft leasing with one of the most attractive order books in the industry. AerCap serves approximately 200 customers in approximately 80 countries with comprehensive fleet solutions. The market heavily penalised the company in the earlier part of the year as a result of the impact of the Covid-19 pandemic on its airline customer base. However, our Stock Picker maintained confidence in the resilience of the company and its ability to manage through the turmoil and bounce back. The company saw a strong price rebound in November as the vaccine news emerged. Over the full year, the stock was down 28%.
The fact that operating leases are enforceable legal obligations that airlines have to pay when their planes are half empty, or grounded, or even when they have entered bankruptcy for reorganisation, provided our Stock Picker with some reassurance. If an airline does not pay its lease, the aircraft lessors quickly repossess the aircraft and work toward placing it with another airline. This is how they avoid credit losses even when customers stop paying. Clearly, in the unprecedented environment of 2020, Aercap did suffer earnings revisions, given pressure on lease rates and rents and asset impairment. However, the company took proactive steps to manage its position throughout the pandemic and has a strong balance sheet and liquidity position. During the year, the company was able to issue long-term unsecured debt at attractive rates, lower than the company’s pre-2020 average cost of debt. The company’s strong liquidity position should provide AerCap with attractive opportunities to deploy its capital as the recovery continues.
Together, Airbus and AerCap detracted 1.5% from the relative performance of the Company’s portfolio versus the benchmark.
Capita, the UK technology firm, was another company that contributed negatively to the Company’s portfolio return. The stock was down 76% over the year. Despite this negative momentum, our Stock Picker remains positive on the company.
Capita provides critical software and outsourcing services for a wide range of public and private sector customers. Our Stock Picker believes that large investments made by the company over the last two years, in people and processes, should pay off over time. There are positive signs of a turnaround – operating performance on contracts and employee engagement metrics, the critical foundations of the business, are improving. Operating cash flow is beginning to improve as the strategy of fixing underperforming contracts, improving operational efficiency, renewing contracts on better terms and targeting higher margin digital BPO (Business Processing Outsourcing) contracts comes through. For now, these positive developments have been swamped by the impact of Covid-19, meaning that achieving sustainable free cash flow (FCF) has been pushed out by one to two years. Likely disposals at attractive multiples from the Software division should act as a positive catalyst for the share price. If executed successfully, this would highlight the remainder of the business, offering a greater than 20% FCF yield with a materially strengthened balance sheet.”
ATST : Alliance Trust celebrates 54 years of rising dividends