CT UK High Income (CHI) has announced its annual results for the year ended 31 March 2024, during which it provided NAV and share price total returns of 11.8% and 10.2% for its ordinary shares respectively, which are both ahead of the return of its All-Share Index benchmark, which it says returned 8.4%. Its chairman, Andrew Watkins, says that he is “particularly pleased” with this outcome “against a backdrop during the year of high interest rates and inflation in the UK and an escalation of global tensions”. He also highlights that it is the 11th consecutive year of dividend/capital repayment increases, making CHI an AIC next generation dividend hero, and at 31 March 2024 the Ordinary shares and B shares had yields of 6.7%.
Over the last few years, the board has employed the company’s revenue reserve to maintain and grow distributions and this year is no exception. However, Watkins says that the portfolio manager is delivering upon the board’s stated objective to rebuild revenue reserves and the principal reason for drawing on reserves again this year was the timing of dividend payments from investee companies that occurred after CHI’s year end.
Watkins says that the portfolio has been “fine-tuned” since the appointment of David Moss in July 2023 to take account of changing market conditions and sentiment. The board says that it concurred with Moss that CHI should remain geared throughout the period and, while this proved painful as interest rates rose, it was tactically correct to acquire positions in quality companies at reasonable prices. Watkins adds that altering gearing levels on a play-by-play basis seldom proves beneficial and whilst the company has a flexible revolving credit facility, maintaining full exposure was a unanimous decision.
Discount to NAV
At CHI’s financial year end, its ordinary share and B share prices stood at discounts to the net asset value of 10.6% and 11.6% respectively, which were both wider than the board would prefer, but these may have been affected, temporarily, by adjustments in the market as the company’s Units were cancelled at the very end of its financial year. Watkins notes that the average discount levels at which the company’s Ordinary shares and B shares traded relative to net asset value in the financial year were 6.9% and 5.2% respectively, which is consistent with the board’s preference for the discounts to be in single figures.
Dividends and capital repayments
CHI has utilised its revenue reserve to maintain and increase dividend payments to ordinary shareholders in recent years. Total distributions to shareholders this year increased by 2% to 5.62p per share compared to the previous year. In the year to 31 March 2024 the revenue earnings per share increased by 10.8% but, due to the timing of some dividend receipts, CHI has drawn £105,000 from its revenue reserve to fund the dividend. Watkins says that this is a very short-term situation as those companies that were due to pay in March duly paid in April 2024. After payment of the fourth interim dividend on 3 May 2024, the revenue reserve is £2.3m, representing 2.77p per ordinary share.
The total dividend/capital repayment for the year to 31 March 2024 represented a yield of 6.7% based on the ordinary share price and B share price of 84.5p and 83.5p respectively at 31 March 2024.
AIC next generation dividend hero
CHI has now increased its distributions to shareholders in each financial year since 2013 and has been recognised by the AIC as being part of the next generation of “Dividend Heroes” for increasing dividends to shareholders in ten or more consecutive years.
Investment manager’s review
“The last financial year has been different from recent ones in that Covid has not been a subject of discussion nor the key driver of share prices. We have, though, arguably been dealing with the consequences of the pandemic – namely the huge increases in Government borrowing and the money supply together with the breakdown of supply chains exacerbated by the conflict in Ukraine. The result has been that two directly related topics have been the only real driver of equity markets in the last twelve months – inflation and interest rates. When we started our financial year on 1 April 2023, we had already seen the fastest pace of UK base rate rises ever and we saw a further 100 basis points before the end of August. While sentiment on inflation has waxed and waned since then and the Bank of England has kept rates flat, there is clear evidence of inflation falling and we look forward to the Company’s new financial year with a focus on when the first rate cut will be, rather than if it will happen.
“What has perhaps been surprising is that while the UK economy has clearly slowed as a result of these interest rate increases, we have seen neither the collapse in consumer spending nor rise in unemployment predicted by some. While the UK experienced a very brief technical recession, the impact was minimal. The biggest liability for UK consumers is their mortgage and the nature of the majority of UK mortgages, where the rates are fixed typically for two to five years, has meant that together with the sheer number of UK homeowners that don’t have a mortgage, many households have yet to be negatively impacted by higher rates. While inflation has clearly had an effect on household consumption habits, we have also seen rising nominal wages helping to offset the impact. With employment numbers remaining strong, inflation now falling and lower long-term rates feeding into lower mortgage rates, the outlook for the UK consumer is, in our opinion, improving. While we expect to see interest rates fall this year we do not see them falling to anywhere near the levels prevailing pre-and during the pandemic. Contrary to many, we see this as a positive and an environment that we consider ‘normal’ where money is not free and accordingly capital should be allocated more efficiently and one where savers are rewarded rather than punished.
“After the turbulence in politics last year, we have had a relatively stable political backdrop in the last twelve months. We can expect a lot more political noise at least during the rest of this calendar year as we move through the general election and see the emergence of actual policy thereafter. Despite the economy holding up, a better outlook ahead and cuts to National Insurance contributions, it appears clear that this election will see a change in Government. Whilst the likelihood of a Labour administration often causes concern for investors and volatility in markets, for now at least the messaging from Labour and in particular the Shadow Chancellor has been benign. We will see the reality in due course but for now we see nothing to disturb our positive view of the year ahead.”
Investment manager’s comments on performance
“While UK equities were volatile at times, falling 10% from the initial high point in April 2023 and then rising and falling over 6% twice more during the Company’s financial year, better economic news, in particular on inflation, led the UK stock market, as measured by the FTSE All-Share Index, to rise fairly consistently from the October 2023 low to produce a total return of 8.4% over our financial year.
“The net asset value (“NAV”) total return of the Company was 11.8% over the financial year out-performing the benchmark index by 3.4 percentage points, representing a welcome return to out-performance. This represents an acceleration in performance from the first part of the financial year helped by the judicious use of gearing, the Company’s portfolio was ahead of a rising market, with the biggest driver of performance being strong stock selection.
“Pleasingly, we have had positive contributions from stocks we have held for some time, as well as stocks newly purchased this year. It has taken over a decade, but legal finance group Burford Capital finally received a positive opinion from the Judge in its case against the Argentinian Government for the forced nationalisation of YPF. There are still appeals to come but the market recognised the potential for value generation and the shares responded very strongly. Two other long-held investments were also amongst the leading positive contributors with Cairn Homes producing strong results with rising dividends and share buybacks as they benefit from being the largest housebuilder in an Irish market with a shortage of housing. The biggest individual contributor was private markets investor Intermediate Capital Group where asset raising and investment returns have been robust. The demand from investors for access to private assets looks set to remain strong for years to come. Recent purchase SAP was amongst the top positive contributors as results were consistently good, the company increased guidance and was seen as a beneficiary of Artificial Intelligence.”
Investment manager’s comments on portfolio changes
“There has been an increase in turnover in the financial year as we looked to position the portfolio for what we felt were the opportunities ahead. This focused overwhelmingly on increasing the level of sustainable income generated by the portfolio and investing in companies where we could expect this to grow into the future. We approached this in two ways; we sold out of companies where dividends were zero or very low and where there was little prospect of any meaningful income soon and re-invested the proceeds in companies that have high current dividend yields and/or have the ability to grow distributions to shareholders. The latter is, we believe, the most important element as our strategy is to provide shareholders with a high and growing level of income. In terms of the companies that we sold, this included THG, ASOS, Wizz Air and Delivery Hero, all companies that we felt would struggle to fulfil expectations and where we saw no prospect of dividends on any sensible time horizon. We also sold a number of stocks with very low dividend yields and limited growth prospects including Experian, Deutsche Boerse, ASML and Hiscox.
“We have made new investments in several areas but activity within the financials sector stands out. As stated above, we believe we are now in an era in which money is no longer free, i.e. interest rates will be positive even if lower than now. This is a significant change for banks in particular which have struggled to generate acceptable returns for some time. After many years of limited demand for credit and strict regulation, UK banks are very well capitalised, highly liquid and, having been ignored by investors for years, are now very attractively valued. In this new era, they are able to generate low-mid teens returns on equity and can deliver significant returns to shareholders including very attractive and growing dividends and we have, therefore, bought a position in NatWest Group. All the previous points apply to NatWest but in addition, at the time of purchase, the resolution of well-publicised internal issues and the change of CEO gave us even greater comfort.
“We also added to our position in specialist buy-to-let lender OSB Group and bought UK asset manager and insurance company M&G.
“Two of our purchases this year have been the largest stocks in the UK market – AstraZeneca and Shell. While we believe we can add a lot of value at the smaller end of the market we will not be dogmatic about what makes a good business whether that be size or type. AstraZeneca under CEO Pascal Soriot’s tenure has proven to be one of the UK’s most dynamic and high growth companies and one of the world’s foremost pharmaceutical companies. Shell in common with most of its peers, has had a radical transformation in its approach to capital allocation. The oil companies have experienced high oil prices many times in the past but this boon normally results in big increases in capital expenditure on increasingly marginal projects and ultimately weaker returns for shareholders. In this cycle, Shell has been very disciplined on investment and the result has been high and growing returns to shareholders.”
Outlook
“What is most important for us is the quality of companies we invest in and the price we pay, not any particular economic view. That said, few of our investee companies operate in isolation and we are positive for the year ahead as the combination of an improving economic outlook, falling inflation and lower interest rates should be a very positive backdrop for equities. We can look at other equity markets and question whether this is priced in, but we are firmly of the view that this is not the case in the UK and especially in the more domestically exposed areas of the market. We and others have written extensively about the low valuation of UK equities but for our Company this provides fantastic opportunities. We can invest in companies that have the levels of dividends we need to meet our ambitions for our shareholders but the reason for these high dividends is not because they are weak or low returning businesses, but because they are in an out-of-favour market – the UK – and often in out-of-favour sectors. The result is that not only do these companies pay high dividends now, but we strongly believe they can grow these dividends into the future. Dividends grew 7.7% last year in the UK and we would expect more growth this coming year, together with a continuation of share buybacks if low valuations persist.”