Dunedin Income Growth has announced results for the year ended 31 January 2022. The NAV increased by 8.1% on a total return basis, underperforming the All-Share Index which produced a total return of 18.9%. The share price total return for the year was 12.5%.
The chairman notes that “Large capitalisation companies whose share prices were viewed as standing at a discount to their underlying valuations, sometimes referred to as value stocks, benefitted from an increase in share prices as economies bounced back from the receding impact of the pandemic and from increasing interest rate expectations. This type of rotation in markets, as companies with certain characteristics move into favour having previously languished, is not uncommon, but was particularly significant this year. The types of companies that benefitted from this recent style rotation were precisely the types of companies the Investment Manager has made a very deliberate decision to not invest in over recent years.”
The revenue return per share increased by 18.1%, taking it back to above the pre-pandemic level to an all-time high of 12.87p. From this, the board is proposing total dividends of 12.9p per share for the year, an increase of 0.8% on last year. This means dipping into reserves once again, but not by much. The trust will still have revenue reserves of 9.05p per share.
Extract from the managers’ report
It was a year where our style and strategy faced a number of headwinds and several of our holdings found themselves out of favour with investors. Our strategy of building a concentrated portfolio and being willing to be different to both the benchmark and peers does mean that there can be periods where our returns may differ markedly from either. Most of the time, we would expect that difference to express itself in a positive way but, unfortunately, for the year under review, that was not the case. Importantly, though, we consider the portfolio to be in good shape with our focus on higher quality companies, an emphasis on investments that can deliver both income and capital growth, as well as the application of sustainable and responsible investing principles, positioning us to be able to cope with what may be difficult market conditions ahead.
Total return performance notwithstanding, it was a year where there were a number of important strategic and financial developments. The implementation of the sustainable and responsible investment criteria was completed, positioning the Company uniquely amongst its peer group, while maintaining the cadence of dividend receipts. The portfolio continued to focus on delivering growth of both capital and income in a differentiated fashion with active share standing at 81% and more than half the portfolio invested outside the FTSE 100 Index. As a result, income generation came in ahead of our expectations hitting record levels and the discount to net asset value at which the Company’s shares have traded for many years moved to a modest premium.
Performance
Despite a challenging year for relative investment performance, the underlying profit and dividend generation from the companies we invest in has continued to be encouraging. This was reflected in the earnings per share more than recovering to the level achieved before the pandemic and indeed setting a new all-time high in the process. Whilst this outcome was somewhat flattered by the very substantial special dividend received from Rio Tinto, the underlying income generation was ahead of our expectations. It is worth noting that this rebound comes from a portfolio that had proven to be very resilient in the tough conditions of 2020/21 and therefore inherently offering less ‘rebound’ potential than others that took greater cuts to their income account. Indeed, the main performance challenge we faced for our holdings has been a reduction in the prices that the market is willing to pay for those businesses, as opposed to any aggregate impact on their cash flow, earnings and dividend generation capacity.
From a relative return perspective, this was very much a year of two halves. In the first half of the year we only slightly trailed what was a strongly rising market. But as the second half developed, particularly in the final quarter, the portfolio increasingly lagged the wider index. This was due to a combination of effects. Firstly, higher commodity prices saw oil and gas and mining stocks perform very strongly, areas to which we typically find it hard to gain direct exposure to given our focus on high quality businesses and the application of our sustainable investment criteria. Alongside this, the anticipation of rising interest rates was received very positively for the banking sector and in particular large UK and Asian retail banks with significant deposit funding bases. Once again, we have chosen to invest away from that area due to our preference for investments with a higher degree of visibility and stability and more dependable dividend distribution track records. Not owning the likes of large index constituents such as BP, Shell, HSBC, Lloyds, Barclays, Glencore and Anglo American all proved a significant relative headwind as those companies performed very strongly over the year. It is worth noting that all of these businesses suspended, cancelled or cut dividends in 2020.
The same effect of rising short term interest rates and longer term bond yields that supported the outperformance of the banks also provided a further headwind to our performance in that it catalysed a reduction in the valuation of a number of our holdings as investors shifted capital away from more expensive companies and allocated towards companies trading on lower valuations. This “rotation”, as it is termed, was particularly strong given the improving earnings dynamics for those cheaper businesses in areas like commodities and banking. Companies such as Aveva and Edenred, which have been tremendous long-term investments for the Company, all underperformed as investor attention moved elsewhere, despite solid operational and financial delivery. We estimate that around three quarters of the underperformance of the portfolio was driven by these stylistic and strategy related elements.
Alongside these impacts there were some stock specific elements where companies, for a variety of reasons, faced more difficult trading conditions. Ubisoft, the French computer game developer, reduced its profit guidance over the year as it faced a series of delays to the launch of its new releases and a generally less buoyant environment as economies opened up and demand for its products faced tougher comparatives. While this has been disappointing, the elements in the investment case that we have been backing over the last three years remain very much intact with a transition to more recurring revenues at higher margins as the company sells more digital content and better monetises its game franchises and back catalogue. The industry backdrop has also developed favourably, with content becoming ever more important, followed by a wave of consolidation which we think underpins the value of its intellectual property.
UK housebuilder Persimmon faced headwinds following the threat of government intervention over the cost of remediating defective cladding for apartment blocks. We still think the company is well positioned to manage this given a significant focus on house building as opposed to the construction of flats. From an earnings perspective, we expect that it can grow volumes steadily at reasonable margins in a market that remains constrained from a supply perspective. Remediation should be more than manageable financially given the company’s very strong balance sheet and we expect that it will continue to return excess cash flow to shareholders.
Emerging market credit fund manager Ashmore found itself under pressure as rising interest rates pressured bond valuations, emerging markets remained out of favour and the company’s own internal investment performance has been difficult. The business is anchored by a very strong balance sheet, an attractive dividend and a clear area of strategic expertise, but we do await signs of underlying operational improvement.
In a period of difficult performance, it is easy to overlook what were a number of very positive share price developments within the portfolio, rewarding companies for very strong operational delivery which will ultimately translate through into enhanced cash flows and dividends. Danish pharmaceutical company Novo-Nordisk performed extremely strongly as it benefitted from continued strong demand for its GLP1 diabetes products. The company also made a significant breakthrough in the treatment of obesity with its drug Wegovy, which for the first time gives the potential for major weight loss with a course of injections, avoiding the need for very expensive and intrusive surgical procedures and holding the hope of being able to make a real impact on the effects of co-morbidities such as heart disease and cancer. UK speciality chemicals business Croda performed well as it saw very fast uptake for its pharmaceutical products that form an integral part of the Pfizer Covid vaccine, providing a vital link in the provision of these critical medicines. The company also announced a sale of its more commoditised and lower margin industrial business which improves the business overall and provides capital for reinvestment into higher margin and faster growing areas. French energy giant TotalEnergies also performed well as it benefited from higher oil and gas prices, particularly from its leading LNG business, while continuing to grow its renewables portfolio and execute on cost and capital efficiency. These three strong share price performances were also accompanied with the delivery of dividend growth ahead of our expectations.
From a strategic perspective, it was pleasing to see a strong overall contribution to performance from our overseas holdings. It is also welcome that we saw strong returns from companies we deem to be sustainable solutions providers or sustainable leaders. Alongside Novo-Nordisk and Croda we also saw good outcomes from companies such as renewables and energy infrastructure developer and owner SSE, Dutch lithography machine manufacturer ASML and immunotherapy leader AstraZeneca. These examples show that positive allocation to companies with leadership in ESG risk management and those well aligned with the UN sustainable development goals can add value to investors prepared to back them.
DIG : Dunedin Income Growth struggles as value style comes back into fashion