Mercantile (MRC), the £2.02bn UK all-companies sector fund, reported its annual results to 31 January 2021. MRC’s strategy is built around focussing on identifying tomorrow’s UK market leaders, targeting UK companies outside of the FTSE 100 index that have significant opportunities for growth and which may be overlooked by other investors.
MRC’s chairman, Angus Gordon Lennox, provided the following summary: “Our financial year end results have been dominated by the COVID-19 pandemic and the resulting actions taken by Government which led to significant market falls and increased volatility not seen in many years. The Company’s benchmark fell by over 40% within the first two months of the beginning of our financial year. Nevertheless, over the year to 31st January 2021 as a whole, the Company produced a total return on net assets, with debt calculated at par value, of -6.1% against a total return of -5.1% for the benchmark which points to a significant rally from the lows of earlier in the year. The discount of the share price to NAV, with debt calculated at fair value, widened, from 1.4% to 3.8%, resulting in a total return to shareholders for the year of -8.4%. All returns include dividends paid.”
Managers Guy Anderson and Anthony Lynch on the drivers and detractors
MRC’s managers, Guy Anderson and Anthony Lynch, had this to say on the main drivers and detractors of performance: “Our longstanding and substantial holding in Nottingham-based Games Workshop was a significant performer through 2020. The company designs, manufactures and sells war-gaming figurines and was able to shrug off the financial impact of closing both warehouses and stores through the early stages of the pandemic. Growth in the online and trade channels was driven by huge demand for the latest release of its ‘Warhammer 40k’ franchise, which surpassed expectations.
In the Technology arena, our holding in Computacenter, a leading technology services provider to large corporate and public sector organisations, continued to deliver strong growth in profits as demand for both its technology sourcing and services remained robust throughout the year. In addition, our holding in Softcat, one of the UK’s leading value-added technology resellers, continued to perform well as they delivered their fifteenth consecutive year of growth.
Another significant contributor to performance was B&M European Value Retail, the limited assortment discount retailer that has grown from just 21 stores in 2004 to around 400 when we invested at its float in 2014 and to nearly 1,000 today, and which is now a member of the FTSE 100. The business has traded very well through the past year, undoubtedly aided by its categorisation as an essential retailer, but also as it has successfully focussed on its strategy of broadening its appeal to a wider customer demographic while continuing its store roll-out, and thus continued to expand its market share.
There was a common thread connecting some of the major detractors from performance this year: businesses that depend heavily upon travel to drive demand for their products or services. Examples include several longstanding investments, such as our holdings in bus operator National Express, food and beverage concession operator SSP Group, sandwich and ‘food-to-go’ manufacturer Greencore and travel retailer WH Smith. In each of these instances, demand was heavily impacted by what we view to be largely temporary impacts of the pandemic. We supported each of these companies – amongst a handful of others – with fresh capital to shore up their balance sheets, as we believe that their business models, competitive positioning and long-term prospects remain sound and that their share price falls presented compelling investment opportunities.
The other most notable detractor from performance was from our holding in Bellway, which over the last 70 years has grown from a local family business to one of the country’s largest house builders. Shares across the housebuilding sector fell sharply at the onset of the pandemic largely reflecting the cyclical nature of the industry and uncertainty over the impact to future demand and hence house prices. While accepting that the trajectory of house prices remains uncertain, particularly as the temporary support from furlough schemes eventually unwinds, so far demand for new homes and pricing have remained robust and the long-term prospects for continued growth remain strong.”
‘Inventory levels have generally been run down, which could precipitate a re-stocking cycle and thus a period of super-normal growth in revenue and rapid margin expansion’
The managers note that “The pandemic has inflicted tremendous economic damage across the globe and there are still question marks around what the shape of the recovery will be and whether there will be long lasting economic damage. However, the speed at which a number of alternative vaccines have been developed and the pace at which they are now being deployed – in particular across the UK – provides us with great confidence that the global economy is on the path to recovery.
On the domestic front, which represents over half of the portfolio’s end markets, we are particularly optimistic. The UK economy suffered the greatest fall in economic activity of the G7 last year and so arguably has the greatest upside potential. Furthermore, and rather unusually at the end of a recession, the UK consumer is in a financially robust position, with some estimates putting the ‘excess savings’ from 2020 as high as £170 billion, equivalent to 8% of GDP. While consumer confidence is currently at depressed levels, as life returns to normality it may improve and with it so might consumption, which would provide a further boost to the economy.
For more international exposure, an area of great importance to the portfolio is industrial activity and there is plenty of evidence that activity levels are improving across the majority of relevant end markets. Inventory levels have generally been run down, which could precipitate a re-stocking cycle and thus a period of super-normal growth in revenue and rapid margin expansion, although recent Sterling strength could provide a headwind to reported earnings growth.
The UK market has been one of the least favoured markets for the past five years, but with Brexit behind us and economic growth in front, as well as a relatively lowly valued market, this sentiment could finally start to improve.
The company can hold up to 10% in cash or utilise gearing of up to 20% of net assets where appropriate. While accepting that there remains a great deal of uncertainty, we are viewing the future with tremendous optimism and the portfolio is currently 12% geared, the highest level since 2012. There will be bumps in the road but many of our portfolio companies are reporting improving trading conditions and we are finding an increasing number of attractive investment opportunities.”
MRC: Mercantile reflects on a difficult 2020 and its optimism around the UK for 2021