Schroder UK Mid Cap’s results for the 12 months ended 30 September 2022 reflect the headwinds facing the UK over that period. The NAV total return for the year was -30.0% compared to -26.8% from the benchmark (the FTSE 250 ex Investment Trusts Index). The share price total return over the same period was -32.5%.
Chairman Robert Talbut’s statement notes that within the UK equity market, small and mid caps were particularly affected by worsening investor sentiment. He suggests that valuations are now attractive and offer considerable potential for capital gains over the next few years as the current clouds affecting the outlook hopefully clear.
Dividends totalling 19.0p have been declared, 28.4% higher than the previous year. These were covered by earnings of 22.43p, with the excess going to the revenue reserve.
The discount widened from -7.8% to -11.4%. 485,000 shares were repurchased during the period between 27 April and 20 May 2022.
Extract from the manager’s report
Speciality chemicals business Synthomer was the lead detractor over the year. The company cut earnings forecasts largely as a result of ongoing destocking in medical nitrile rubber glove markets. Following the creation of a new division through the acquisition of US chemicals company Eastman Chemical Company’s specialist adhesives business in the US, Synthomer is better diversified, both geographically and from a product perspective. However, it has a weaker balance sheet than before. With an active divestment strategy now underway alongside a cash saving programme, suspension of the dividend, newly-announced financing from UK Export Finance, and relaxation of banking covenants, it is reasonable to expect to see an improvement in the shares’ performance.
Media company Future also underperformed despite small upgrades to earnings expectations this year. The shares suffered a de-rating alongside other growth stocks and amid fears around the outlook for the digital advertising market. Towards the end of the period, the announcement that the very successful CEO may retire at the end of 2023 after ten years at the helm, further impacted confidence. The group’s ability to deliver targeted audiences, both online and in print, to a wide range of advertisers in niche interest areas from pets to photography, PCs to pianos, remains a strength, as does a strong bench of talent around the CEO and, now, a very supportive valuation.
Online gaming group 888 was another detractor over the period as the UK regulatory uncertainty, which we had anticipated would be resolved this year, persisted. Although higher than expected cost synergies from the William Hill deal in the UK are helping to offset interest costs, the level of financial leverage in the business in a rising interest rate environment is discouraging the marginal investor (or new investors). We have performed a stress test analysis that has given us some comfort that 888 can pay down debt over the coming years even in a weaker economic environment. Importantly the debt is without a financial covenant, giving management breathing space. Gambling activity has been resilient in previous downturns and 888 have restructured their UK business to focus on lower value, recreational customers. The United States and Canada are structural growth opportunities that we believe are not priced into the shares.
IP Group, which invests in the commercialisation of IP with technology, cleantech and life sciences applications, underperformed over the period as falling technology company valuations affected sentiment towards the company’s shares. During the year, one of its portfolio companies, First Light Fusion, achieved nuclear fusion, underscoring the excitement which exists within the company’s holdings.
Having been an underperformer of note in the last financial year, it was pleasing to see our conviction in multi-utility provider Telecom Plus rewarded this year. Management upgraded earnings expectations as the company benefited from rising retail energy prices linked to the Russia Ukraine conflict, being able to offer a highly competitive energy deal to prospective customers. This is thanks to its long-term supply agreement with Eon (formerly npower), which essentially secures wholesale energy at an agreed (c.15%) discount, some of which Telecom Plus passes on to its customers. The group also benefitted from the collapse of a number of rival providers which went out of business as they were unable to manage a spike in wholesale gas prices.
Alternative investment manager Man Group bucked the decline in markets as robust net inflows followed strong performance from many of its products. Man announced a second tranche of share buybacks underlining the strength of the balance sheet and confidence in the valuation of its shares. Buybacks are now common amongst our holdings underscoring their attractive valuations and balance sheet strength. This is the second consecutive year that Man has appeared in our top five performers table.
A further positive contribution came from direct marketing specialist, 4imprint. The company published very strong interim results, citing “customer demand at record levels”, driven by a post Covid recovery in its key North American market. An increase in the effectiveness of its US TV advertising spend has markedly boosted profitability. The business model allows for growth together with strong cash returns which has allowed the company to retain a net cash balance sheet whilst growing the interim dividend by 167%.
Shares in gaming software group, Playtech, also performed very well as the company became the subject of a three-way bidding war. With the stock hitting five-year valuation highs, we disposed of our position.
SCP : Schroder UK Mid Cap says low valuations hint at brigher future