Share price boost for Schroder UK Mid Cap after refinements to strategy – Schroder UK Mid Cap (SCP) has announced its results for the six months to 31 March 2021, during which time its NAV was up 23.9% compared to a slightly higher 28.8% return from its FTSE 250 ex Investment Trusts index. However the board remains encouraged by the trust’s share price total return of 47.1%, reflecting in part a return of interest in the UK equity market and in particular to mid cap stocks.
Meanwhile, the discount to NAV narrowed significantly to 4.6% as at the end of March 2021. This reduction has been maintained since and was 3.9% as of 18 June 2021. In the 12 months to the end of March 2021 the NAV of the Company has delivered 15.8% outperformance of the Company’s Benchmark, building upon a good longer-term record.
There have been some recent refinements to SCP’s investment strategy including reducing the number of investments in the portfolio in favour of an approach with higher conviction and maintaining a specific focus on resilient companies with strong finances, which lead on sustainable business practices and have clear strategic direction. Chairman Robert Talbut said while this emphasis upon higher quality companies will not deliver outperformance in all periods, the historical equity market evidence supports the board’s belief that over the longer-term it should deliver superior returns to shareholders.
Review from the manager:
Portfolio performance
The NAV achieved a total return of 23.9%, but underperformed the Benchmark by 4.9% over the six month period. However the share price achieved a total return of 47.1%, having recovered from its March 2020 low of 288p to end the period at 664p, the discount having narrowed significantly to 4.6%. This in our view reflects the strong +15.8% 12-month NAV outperformance of the Benchmark.
The largest detractors over this period have been some of our best long-term (3 years plus) investments. Pet retailer and services provider Pets at Home underperformed as the market checked its exceptional performance during the first three quarters. We remain confident that there is further potential for strong sales growth in pet care and veterinary services in particular, driven by the recent boom in pet ownership: UK households have added an additional 3.2m pets since the onset of the pandemic (source: PFMA). Another of our holdings which gave back some previous stellar performance is fantasy games company Games Workshop. Despite enforced store closures, the market viewed the stock as a ‘Lockdown leader’ and with restrictions beginning to ease, performance unwound over the period. Whilst it is true that Games Workshop has had a “cracking” year (to quote its CEO), its best ever, we believe that there is further to go as stores reopen, the US expansion continues, and further licensing deals are done. Home furnishing retailer Dunelm, also viewed by the market, we believe rather one-dimensionally, as a lockdown winner, detracted from performance. A management share sale during the period added to the pressure, as did a period of pandemic related store closures, which resulted in weaker than expected sales in the January-March 2021 period. However, the company has since reported that since stores have re-opened, sales are +59% compared with 2019 (as one year ago stores were closed, therefore making comparison less relevant) and that it is winning market share, proof that the combination of stores and a strong online offer is key in the new retail battleground. Despite delivering consecutive upgrades during the period, Computacenter shares also underperformed, again tarred with the “lockdown winner” brush. This is another example of a company which can continue to benefit from a structural growth market (ongoing digitalisation) in addition to any lockdown boost. All of the companies discussed above now have stronger balance sheets than they did pre pandemic which we believe can only mean a strengthened competitive position from here; see our outlook commentary on the strong getting stronger as we exit the pandemic.
Positive contributors in the period included domestic housebuilders Crest Nicholson and Vistry. Housebuilders have seen a surge in demand for properties, particularly houses, with the onset of the working from home revolution, government support from the extension to the stamp duty holiday, and spend being directed away from travel and leisure (anything enjoyable, more generally) and into housing. Online gaming company Gamesys, a new holding in 2020, was bid for. Automotive distributor and retailer Inchcape posted a better-than-expected full-year profit and resumed its annual dividend, thanks to a strengthened, net cash, balance sheet. Being able to offer click and collect meant that it could continue delivering vehicles despite car showrooms being shut due to the pandemic. The company’s new CEO, who has a technology background, has launched a new strategy to harness the huge amount of data Inchcape gathers from each vehicle sold and serviced so that the company will capture more of a vehicle’s lifetime value (e.g. 3rd and 4th owners). Royal Mail shares continued to perform, as the pandemic further fuelled online sales and parcel deliveries. The company delivered 496 million parcels (+30% vs the prior year) in the final three months of 2020, a record performance. The pandemic has meant that, amazingly, this year’s revenues are three years ahead of where they were expected to be. Post the period end, the stock has been promoted to the FTSE 100, which is a satisfying result and a key element of our investment strategy of looking to invest in the FTSE 100 companies of the future.
Turning to stocks not held, our lack of exposure within the travel sector most notably weighed on returns. Not owning Easyjet and Tui, for example, whose shares rose dramatically on the news of the vaccine, detracted from performance. These types of shares continued to rise during the period as restrictions and the lockdown roadmap was announced. Both have since reported increasingly heavy losses and very high levels of net debt (£2bn and €6.8bn, respectively). Lack of exposure to media firm ITV and aerospace firm Meggitt, both seen as vaccine winners, also detracted from performance.
Portfolio activity
Attractively priced structural growth opportunities continued to influence our new additions to the portfolio. We added holdings in NCC and Chemring, both of which have significant operations in cyber security, a trend which is set to continue to grow in a post COVID-19 world. We believe both stocks represented good value versus other cyber security companies. We started a new position in industrial and electronics distributor Electrocomponents, which we believe is set to gain market share online in this space and which has a competitive and high margin own label offering. Continuing with the theme of online commerce, we participated in the IPO of Trustpilot. With online reviews becoming an essential part of winning new customers, this open review platform provides consumers with essential information about both products and services. We expect that a Trustpilot rating will become more and more of a “must have” for small and medium sized consumer facing businesses not only in the home markets of the UK and Denmark but also, potentially, in markets such as the US where the company is already making inroads.
Moving to the more notable complete sales for the period, within the travel and leisure sector, we sold our holding in JD Wetherspoon when, following their capital raise, which we supported, the shares went to a significant premium. Valuation remains a key element of our sales discipline as demonstrated by the disposal of airline Wizz Air. Finally, we disposed of our position in bookmaker William Hill following a bid from US partner Caesars. The deal seeks to consolidate the joint venture partnership between the two companies to take advantage of the fast growing and deregulating online sports gaming market in the US.
We currently hold 51 stocks in the portfolio, down from 54 at the financial year end. Gearing at the end of the period was 4.8% vs. 5.3% at the September year end.
Outlook
We’re increasingly optimistic on the outlook for the UK economy and many of the domestically-focused mid cap companies exposed to it. The building congestion on our roads is clear, everyday evidence of an economic recovery. Official statistics are also highly supportive of this view – higher than expected employment, lower than expected unemployment, very strong retail sales data and rising house prices to name a handful. The Bank of England is now forecasting GDP growth of 7.25% for the UK this year (upgraded from 5.0%), a level of growth last seen post-WWII, and helpful in the context of paying down national debt via the tax take.
Just over a year ago, when the implications of the pandemic were becoming clear, we kept faith in our homework. The crisis has meant that companies have had to accelerate fundamental changes to their businesses driven by customers’ changing needs. As usual, it has been the companies with genuine competitive advantages which have been most successful during the period in terms of market positions and balance sheets. As mentioned above, many have stronger balance sheets than they had before the crisis (the majority of the companies listed below, for example), without needing to raise any capital, other than for earnings accretive M&A purposes. This is an exciting position to be in, particularly given the backdrop of the chancellor’s super deduction, which could see management teams seeking to increase investment to grow companies. This demonstrates the importance of keeping some investment discipline in what feels like an increasingly short-term world.
With this in mind, as investors, we continue to primarily focus on seeking out the next mid cap disruptor, while looking to avoid the next industry to be disrupted.
SCP : Share price boost for Schroder UK Mid Cap after refinements to strategy