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Temple Bar sets up share split after good 2021

Temple Bar beat its benchmark over 2021 – the first full calendar year under Redwheel’s management – delivering a return on NAV of 24.3% against 18.3% for the All-Share. The total dividend for the year was 39.5p, up from 38.5p for  2020. A small part of this has, once again, been paid from revenue reserves. However, revenue per share is climbing.

In common with its peers, the discount swung around a little over the year. Temple Bar’s discount was 7.8% at the end of 2021 but has narrowed since and is currently 4.0%.

Charles Cade has been appointed as a new non-executive director and member of the Audit and Risk, Management Engagement and Nomination Committees, with effect from 24 March 2022. Charles had a long career in the City, with over 25 years’ experience in the investment companies sector, most recently as head of research at Numis Securites.

Share split

The board is proposing that Temple Bar’s shares be split on a five for one basis to make it easier for investors to reinvest their dividends if they wish. If shareholders approve the split, dealing in the new shares will start on 3 May 2022.

Extract from the managers’ report

The Company’s portfolio performed well in 2021, continuing the sharp rebound that started at the end of 2020, when it was announced that vaccines would be largely successful in reducing severe illness from the virus. Top contributors to the Company’s portfolio return in the year included: Royal Mail (+3.3%), Marks & Spencer Group (+2.8%), Shell (+2.1%) and NatWest Group (+1.7%); from a total absolute return on net assets of +24.5%.

After several years of sluggish sales, declining productivity, and falling profits, Royal Mail looks to have turned a corner. The company was a beneficiary of the pandemic, seeing a meaningful increase in parcel volumes. This, coupled with improved labour relations, has resulted in a sharp rebound in earnings. We continue to see significant unrealised profit potential in the company’s UK business, which combined with continued growth in the company’s overseas operations should result in meaningful profit growth from here. Despite the strong recovery in the share price in 2021, the stock market still applies little or no value to the company’s UK operations.

At Marks & Spencer Group, there are signs that the recent overhaul of the business is really starting to bear fruit. In online food, the Ocado joint venture has been a significant success, whilst in store-based food the company is taking advantage of its niche to grow market share. Even in the troubled clothing business, performance has started to improve. In online clothing, the company is outgrowing its competitors and is now number two in the UK by market share. The company has a target that 40% of its clothing sales will be online within three years. The improved operating performance has led to significant upgrades to profit expectations and yet, despite the strong share price performance, the stock market continues to ascribe no value to the company’s clothing operations.

The Company holds three energy names: Shell, BP and TotalEnergies, which collectively added over 5% to the Company’s portfolio investment return in 2021. All benefitted from the sharp upward move in oil and gas prices, coupled with low starting valuations. Whilst we don’t attempt to predict oil or gas prices, we were not surprised by the upward move in 2021 given that demand for fossil fuels bounced back strongly after a period in which industry investment had been significantly curtailed. Some of this reduction in investment was no doubt an ongoing response to the weakness in energy prices in 2015/2016 and 2020, and some will have resulted from the sector’s desire to fund increased investment in green energy; however, the upshot is that when strong demand meets restricted supply, prices normally increase.

Again, despite the recent strength in share prices, sector valuations continue to be attractive. Shell is the world’s largest privately owned gas producer. Nevertheless, its enterprise value is around $250 billion at the end of 2021, the entirety of which can be accounted for by the company’s so-called transition assets (Gas Production, Marketing and Renewables), even though these assets currently account for less than 50% of group profits. Assigning even a modest valuation to the remaining assets (Upstream, Refining and Chemicals) suggests significant upside to the share price. Meanwhile, BP is valued at around 9x shareholder free cash flow (after all investment but before dividends) assuming Brent oil prices of just $60 per barrel, significantly below where oil prices sit today. All three companies have set out ambitious but credible plans to get to net zero carbon emissions by 2050 and, whilst it will no doubt be a challenge, we believe that these companies can therefore play a significant part in the forthcoming energy transition.

In the banking sector, the Company has exposure to four names: NatWest Group, Barclays, Citigroup and Standard Chartered. These companies collectively added over 4% to the portfolio’s return in 2021. We have for some time believed that the stock market is not giving enough credit to the banks for the very profound changes that the companies have made over the last few years. Their capital strength is much improved on where it was even a few years ago and lending standards are much better than they were. Whilst ultra-low interest rates have suppressed interest margins and have therefore been unhelpful, the banks have been using the benefits of technology to engineer cost out of their businesses. As a result, even assuming no pick up in interest rates, the companies are confident that they can deliver a 10% return on shareholder equity, as stated in their investor presentations. Nevertheless, the stock market has remained sceptical and many in the sector have continued to be valued at meaningful discounts to the value of that shareholder equity. Whilst the continued low level of loan losses and the spectre of rising interest rates were helpful for share prices in 2021, the companies continue to be valued at just mid-to-high single-digit multiples of earnings. In our view, therefore, the sector continues to be undervalued.

Pearson, easyJet and Capita all marginally detracted from portfolio returns in the year. easyJet has continued to be disrupted by COVID-19 induced lockdowns and has continued to burn through its cash reserves, albeit at a much-reduced rate. Pre-COVID-19, the company had no net financial debt on its balance sheet; however, its finances have since been undermined by cash losses that have accumulated over the last two years. Unsurprisingly therefore, last year the company took the decision to issue fresh equity and, whilst this restored the company’s balance sheet to health, it was dilutive to existing shareholder returns. Pearson has continued to struggle with the transition from physical print textbooks to a digital offering in its North American Higher Education business and although this journey is proving to be protracted and damaging to group profitability, we continue to believe that educational publishing is an attractive business offering the prospect of healthy returns. Accordingly, during the year, we used share price weakness to add to Temple Bar’s holding in the company. Likewise, the turnaround at Capita is proving more challenging than we had originally hoped. Nevertheless, we continue to believe that there is significant unrealised potential in the business, at a time when understandable scepticism in the stock market means that the shares are valued at a mid-single digit multiple of our conservative view of the company’s medium-term profit potential. Although Capita has been a poor investment for the Company, we think that ultimately patience will be rewarded in this instance.

We are long-term investors, who recognise the importance of keeping transaction costs to a minimum. At times of major stock market dislocation, such as that seen in 2020, we will rotate portfolios more aggressively to try and take advantage of other investors’ willingness to sell reasonable businesses at knock-down prices. More normally however, shareholders should expect that portfolio turnover will be low. This was the case in 2021, with just under £300 million of notional value trade. We established no new positions in the year although we did exit the Company’s positions in GlaxoSmithKline and Tesco in order to take advantage of what we believed were better opportunities elsewhere.

For some time now, UK equities have traded at a significant discount to other stock markets, and this resulted in high levels of corporate activity as overseas buyers sought to take advantage of this disconnect. Consequently, during the year the Company benefitted from the takeover of Royal & Sun Alliance Insurance (by an overseas competitor) and WM Morrison (by private equity), both at large premiums to the previously prevailing share price.

Our investment approach has always been to seek out fundamentally sound businesses which by virtue of their market positions can grow their profits over the long term, but where for one reason or another the shares are modestly valued. This may be because the company is underperforming its longer-term potential (Marks & Spencer Group) or because of a lack of interest or neglect (Shell). Either way, a low starting valuation looks to ensure that shareholders benefit fully from improved profit growth, whilst often in the meantime drawing an attractive income. Companies with low valuations also have a greater potential to re-rate as investor perceptions improve, further adding to investment returns. We believe investors should learn the lesson of stock market history which is that the starting valuation has proven to be the best predictor of investment return over time.”

TMPL : Temple Bar sets up share split after good 2021

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