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Growth sell off hits BlackRock Smaller Companies

BlackRock Smaller Companies (BRSC) lagged its benchmark over the12 months ended 28 February 2022, returning 16.7% to the Numis Smaller Companies plus AIM excluding investment companies Index’s 24.9%. 35p of dividends were 5.1% higher than the previous year as revenue recovered from the effects of the pandemic – the revenue return for the year was 35.29 p. The trust has now increased its annual dividend every year since 2003. Expensive debt maturing in July 2022 looks set to be replaced with much lower cost funding, saving on the interest cost.

Extract from the managers’ report

Watches of Switzerland delivered further upgrades as demand for higher end jewellery and watches continued post the re-opening of their retail outlets. Their success as a distributor has been recognised by the major brands, resulting in further opportunities in the United States (US) and Europe. The recovery in corporate spending has been felt in several areas, from Next Fifteen Communications benefiting from the increased demand for digital content, to YouGov and their suite of data products. In an ever-changing world it is of paramount importance for businesses to know not just who their customers are, but also how best to access them, and whilst large technology companies do more to protect their customer data, the value of businesses that can provide other mechanisms to identify and target audiences will increase. Morgan Sindall delivered several upgrades through the course of the year as domestic infrastructure and regeneration markets recovered. The management of Morgan Sindall take great pride in the relationship they maintain with the supply chain, with prompt payment a key component. In an industry that has historically been characterised by confrontational relationships between clients and suppliers, this is a definite source of competitive advantage, and will likely help Morgan Sindall manage their business more effectively than others in today’s environment of component shortages.

Even before the recent dislocation in energy markets caused by events in Ukraine, oil and gas prices were rallying as the additional demand required by a post COVID-19 world met the supply side realities of an industry that hasn’t invested for growth for a number of years. Whilst high commodity prices will inevitably cause pressure for corporates and consumers, they are of course positive for the resources sector, with both Serica Energy and Gulf Keystone Petroleum appearing in the top performers this year.

No year is ever perfect, there are always companies that fail to deliver on expectations. When this happens, our role is to understand if changes are temporary, and ultimately have no impact on longer term fundamentals and value, or if they represent a more permanent shift in opportunity. Joules is an example of the twin pressures of a weakening consumer backdrop and the supply chain stresses that are impacting on the retail sector, with the shares weakening on the back of two downgrades. Sadly, we expect these difficult conditions for Joules to continue, and have sold the position. In contrast, Moonpig shares have also fallen substantially since their 2021 peak despite delivering on the earnings expectations set at the time of their Initial Public Offering (IPO). The supply chain for greetings cards is far less complicated than for fashion, less exposed to the logistics and inflationary pressures we are seeing elsewhere, whilst there is a structural shift to online cards and gifting that will continue to drive the top line. With this view in mind, we continue to hold a position.

In an environment of rising costs, it is paramount that businesses have pricing power. Unfortunately, International Greetings has shown what happens when customers are unwilling to accept price increases, no matter how justified they may be by raw material inflation, and the company finds itself in the vice like grip of the closing jaws of cost and price. With the outlook showing no signs of improvement, and no suggestion they will suddenly develop more pricing power, we have exited the position.

A combination of significant available liquidity and favourable valuations catalysed a resurgence in Mergers & Acquisitions (M&A) activity. The Company has been fortunate to benefit on a number of occasions this year, with bids for Sumo, Sanne, Stock Spirits and Vectura. It is worth noting how many of these deals have corporate buyers rather than private equity, highlighting the increased confidence from management teams, and value they see in the UK market. That confidence extends to our own investments too, as Auction Technology Group, Team17, and Learning Technologies took advantage of equity markets to raise capital for transactions, whilst a myriad of others utilised their own cash flow to carry out bolt on deals. However, the health of the M&A markets stood in stark contrast to the IPO markets, where the offerings this year were generally of lower quality or at unattractive valuations. As such, our participation in offerings this year has been minimal, with only Kitwave Group, In The Style Group, Big Technologies and Devolver Digital added to our holdings.

Whilst we have a fundamental bottom-up investment process, by default that stock selection aggregates up to produce sector exposures. This year we have reduced our overweight in consumer related stocks, moderating the position as the outlook for consumer spending becomes more opaque. Employment is still high, wage increases are coming through, but it is still unclear whether these increases will be enough to cover the rapid changes to the cost of living. Overlaying the macro dynamics are unknown shifts in consumer spending patterns. After two years of lockdowns, home shopping and house repairs, it is unclear where consumers will look to spend their tightening budgets in the coming twelve months. However, whilst consumer spending may be more challenged, it is clear that corporates have their cheque books out. Whilst some of this may be post COVID-19 catch up, most is a response to fundamental changes in global supply chains. Traditional patterns of trade are shifting, “just in time” is being replaced with “just in case”, and global supply chains are being localised or nearshored. As a result, our exposure to corporate expenditure, whether that be through Capital Goods or Media has been increasing. Finally, our exposure to the resources sector has increased. Typically, this is an area where we struggle to identify valuations that suitably compensate for the risk, but with resources prices hitting new highs all through the year, some of these businesses are now producing significant cash flow.

BRSC : Growth sell off hits BlackRock Smaller Companies

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