Schroder UK Mid Cap results for the 12 months ended 30 September 2024 came in behind its benchmark. The NAV total return for the period was 17.3% versus 21.4% from the FTSE Mid 250 ex Investment Trusts Index. The share price total return was +17.5%. The discount widened marginally, from 12.0% at the beginning of the year to 12.3%.
Net revenue per share for the year was 20.54p, down from 22.68p for the prior year. The board is dipping into revenue reserves to finance an increased dividend of 21.5p for the year.
The board has made a minor change to the investment policy to clarify that the 20% of the portfolio that can be invested in stocks that are not in the benchmark index may be used to hold shares in companies listed outside of the UK. It says that such overseas holdings could, for example, arise following corporate actions such as mergers or spin outs from existing holdings.
Extracts from the manager’s report
An underweight to the real estate sector and to more highly indebted companies in the benchmark more generally, was the main reason for the portfolio’s underperformance.
Turning to individual holdings, shares in both specialty chemicals company Victrex and scientific and industrial instrumentation company Spectris performed poorly. In the case of Victrex, a weak industrial backdrop and lower than expected demand in the higher margin medical division meant that earnings were lower than expected. However, the company is very well invested at this point, so any recovery in end markets should be seen quickly and, in the meantime, we expect to see a strong improvement in cash generated by the business.
Spectris also saw a slowdown in demand in some of its end markets from electric vehicles to pharmaceuticals and disruption from the implementation of a new enterprise resource planning system which should over time be earnings accretive. As well as its ongoing share buyback, the company has made three interesting earnings enhancing acquisitions this year. Two of these complement its existing Spectris Scientific division, by adding a hand-held instrument offer. Both Spectris and Victrex are more than 40% below their five-year share price high, and, given the cyclical aspects of both, it is logical to expect a turning point before too long, in our view.
Specialty pharmaceuticals business Indivior also detracted. A competitor is making more ground than expected in the opioid use disorder treatment market, which meant that top line growth was less than expected. In addition, re-enrolments into Medicare/Medicaid have proven to be an obstacle. However, the market remains vast and, unfortunately for those needing the drugs, growing. Indivior’s share price is underpinned by rolling buy-backs. We continue to see Indivior as another example of a unique investment opportunity in the UK market.
IT services business Computacenter disappointed as profit from certain US contracts moved into the second half of its financial year and expected acquisitions did not materialise. The company maintains a strong balance sheet, supporting an ongoing share buy-back, and good visibility over its H2. It is exposed to structural growth, for example, in data centres and the Cloud, has solid enterprise customers, and management are proven as excellent allocators of capital (the shares have beaten the total return of the S&P 500 over both 10 and 20 years for example), and we have retained the bulk of our holding.
An underweight holding in UK housebuilder Vistry was also unhelpful for performance over the period. The position was sold too soon, only halfway into what turned out to be an energetic rally, though some of the proceeds were reinvested into increasing the holding size in house builder Redrow. Vistry has since had a substantial profit warning and 20% downgrade to this year’s profit expectations, as such the shares have fallen considerably and the Company was right to sell the holding. Redrow then became the subject of an offer from larger housebuilder Barratt Developments at a 27.2% premium to the undisturbed price.
Our top performer was a new holding, Zegona Communications, which outperformed the Benchmark by 137%. The Company participated in fundraising by the Zegona management team, which has previous successes in the telecoms sector. The business model is one of buying telecoms assets, restructuring them, and then selling them. Management has been active as anticipated: during the year, Zegona acquired the Spanish assets of Vodafone. The company is now in negotiations for two potential fibre broadband joint ventures with competitors Telefonica and MasOrange (which could help to free up a possible c.€2 billion of cash), has received an investment grade credit rating and has agreed a positive new fibre wholesale agreement with Telefonica.
Other top performing holdings included bulk annuities insurer Just Group. The shares performed well after management revealed the company would “substantially exceed” its previous goal set in 2021 of doubling profits over five years, by achieving this and more in 2024. UK specialist lender Paragon Banking Group announced better-than-expected final results and a new £50 million share buy-back to follow on from the £100 million announced in the 2023 financial year.
Shares in another one of our long-term holdings, specialty groundworks contractor Keller, outpaced the benchmark return by more than 100%, thanks mostly to strength in the US market. Finally, drinks company Britvic, a company in which we had recently increased our stake, was in receipt of a bid during the period from Danish drinks company Carlsberg, at a 35.6% premium to the undisturbed price.
Not holding shares in Dowlais, an automotive engineering group, was positive for performance, as they underperformed the benchmark by 63.9% over the period. The company suffered a significant write-down in its powder metallurgy division as well as softer than expected trading.
Not holding UK merchant bank Close Brothers also aided returns over the period, as the shares tumbled following the FCA’s announcement of a review into the motor finance market, a factor outside the company’s control. Of the UK banks, Close Brothers has the biggest relative exposure to car finance loans and the news led the company to cancel any 2024 dividend “given the significant uncertainty regarding the outcome of the FCA’s review of historical motor finance commissions arrangements and any potential financial impact as a result”. (Source: Dividends/Close Brothers Group.)
Other stocks which it was right to avoid during the period included Wizz Air, Dr Martens, and Aston Martin, which have all serially disappointed the market.
The Company did not own shares in housebuilder Persimmon. This was the main single stock detractor in this category. More positive sentiment towards the housebuilders, as expectations of rate cuts took hold, most notably in early November 2023, drove the shares up. This assisted its promotion back into the FTSE 100 following the delisting of Dechra (which, as a reminder, was acquired by private equity). Shares in Ascential, which we had sold during the previous year, performed well as a complex break up was executed during the year. Not owning St. James’s Place detracted, although our financial sector exposure overall was a strong contributor. Having been relegated from the FTSE 100 in the previous quarter, the wealth manager enjoyed something of a share price recovery. A change of finance director in a time of regulatory change was another factor in our decision not to hold St James’s Place. Not holding shares in trading platform provider Plus500 also detracted. Our preferred long-term exposure to financials, however, includes companies such as Just Group, retail CFD and derivatives broker IG and other specialists including emerging market fund manager Ashmore (see below).
Finally, not owning enough highly interest rate sensitive stocks in the real estate sector, such as British Land, also detracted from performance.
SCP : Focus on strong balance sheets holds back relative returns for Schroder UK Mid Cap
