The Edinburgh Investment Trust, managed by Mark Barnett (pictured), has announced its annual results for the year ended 31 March 2016. During the year, the trust produced an NAV total return +4.6% (with dent at market value) versus a negative return of 3.9% for the trust’s benchmark, the FTSE All-Share Index. The company’s share price total return was +4.0%, which also beat the benchmark. The board say that income generation remained solid, especially when viewed against FTSE All-Share companies (a number of which reduced their dividends) and the Board is proposing a final dividend of 8.75p per share for the year which would result in a full year dividend of 24.35p per share, an increase of 2.1% year-on-year. The board comment that the trust’s overweight or underweight positions in various sectors continue to be material drivers of its relative investment performance.
The managers say that, against a highly volatile market backdrop, the key contributors to the trust’s outperformance were the holdings in the tobacco sector. They say that all four (Reynolds American, British American Tobacco, Imperial Brands and Altria) delivered strongly positive, with Reynolds’ shares rising by over 55%. Reynolds concluded the purchase of US tobacco company Lorillard in June 2015 and the managers say that it is beginning to see the benefits of this acquisition, with cost and revenue synergies emerging from the process of integration. In the manager’s view, dividend growth and profit margins remain healthy across all the tobacco majors, in spite of the continuing volume decline, driven by product innovation, tobacco quality improvements and cost rationalisation.
The managers say that certain investments in the financials sector also contributed strongly to performance. For example, in March 2016 the London Stock Exchange announced a merger with Deutsche Boerse and saw its shares rise to a record high as New York Stock Exchange owner ICE said it may make a counter offer for the company. Earlier in the period Amlin, a Lloyds insurance market investment vehicle, agreed to a takeover from Japanese company Mitsui, which the mangers say also resulted in a significant uplift to its share price. The share prices of Beazley and Hiscox, also in the non-life insurance sector, both rose on the back of positive results and amid growing takeover speculation. Meanwhile, the portfolio’s long term holding in Provident Financial gained entry to the FTSE 100 index during the period. The managers say that the company delivered a sixth consecutive year of double-digit percentage dividend increases and reassured investors of the positive long term outlook for its specialist lending business. Within the fixed line telecoms sector, the managers comment that BT announced its strongest revenue growth in over seven years and continued its expansion into mobile telephony, with its acquisition of EE gaining approval from the Competition & Markets Authority. They also say that shareholders received further good news as it was confirmed that the company would not have to demerge or sell the Openreach fixed line infrastructure, as had been feared. TalkTalk Telecom, however, announced that it had been the victim of a cyber-attack. The shares were marked down in the weeks following the news, but stabilised towards the end of the period as it was confirmed that the impact of the attack had been less than originally suspected. The managers say that they continue to avoid any exposure to banks, where dividend prospects are still uncertain, and mining companies, where the medium term outlook for metals prices is still problematic. This zero weighting in the banking sector impacted positively on performance, while the zero weighting in the mining sector, where share prices demonstrated exceptional swings, was a positive over the period as a whole, but a negative over the final quarter.
Among the less successful investments during the period were support services businesses Capita and G4S. The managers say that Capita’s results led to a lowering of forecasts for organic growth and a higher interest charge while G4S has faced headwinds in its emerging market businesses and from provisions for its ‘onerous’ (unprofitable) contracts in the UK and from balance sheet concerns. The managers think that the negative share price reactions have been unduly harsh, with the companies well positioned to deliver growth from their bid pipelines in a challenging macro-economic environment. Another detractor was GAME Digital. The managers say that it saw its shares fall sharply after an update on pre-Christmas trading, which confirmed that UK sales had fallen off sharply at the most critical time of year for the company. Reportedly sales in old format content have declined much faster than expected and, while sales of new generation content have remained strong, these were not enough to offset the fall. Rolls-Royce published a negative trading update in November, forecasting that 2015 profits would be at the lower end of expectations and that demand would weaken in 2016. With visibility of future earnings growth showing no signs of improvement, the managers took the decision to dispose of the remaining holding in the company was sold, having already reduced the position earlier in the year. The managers also say that holdings in the travel & leisure sector weighed on performance, where sentiment has been overshadowed by terrorist events. The managers say that Thomas Cook confirmed a challenging trading backdrop for 2016, although it has moved much of its summer capacity to the Western Mediterranean. EasyJet reported a reduction in revenue per seat – with the Paris bombing and the French air traffic control strikes having a short term impact.
In terms of portfolio activity, the Company’s holding in Amlin was disposed of on acceptance of the bid from Mitsui. Rolls-Royce was sold and holdings in GlaxoSmithKline, Serco and Workspace were also disposed of. New investments were made in BCA Marketplace, Circassia Pharmaceuticals, easyJet, Honeycomb, VPC Specialty Lending and Zegona Communications.
In terms of outlook, the managers say that the near term outlook for the UK stock market is likely to remain clouded by a muted macro-economic backdrop in the global economy and increased pressure on profitability in the corporate sector. In their view, the multiyear monetary policy of setting interest rates at close to zero has not stimulated capital investment. Instead, companies have contained costs, particularly wages, and have used low financing costs to buy back their own stock. The managers say that, whilst this is good for profit margins and shareholder returns in the short term, the result has been a level of economic growth in the developed world which is below historic averages. They say that another side effect has been to widen income inequality in many developed market economies, prompting incumbent governments, increasingly wary of more populist movements, to redress the balance – measures have included increasing minimum wages and tackling corporate tax arbitrage. Combined with some natural wage pressure from tighter labour markets in the US, this is beginning to threaten corporate profit margins. The managers are also of the view that the collapse in energy prices and the relentless drive of digital technology have entrenched low inflation expectations such that, combined with the factors outlined above; the global economy faces an ongoing lack of pricing power. In their view, this in turn has restrained the level of turnover growth in many industries, while any rebound in energy prices or pick up in employment costs may not easily be passed on. Reflecting this, the managers believe that the overall implications for the UK stock market, which they point out is highly global in its make-up, are that earnings growth in many sectors may disappoint. They say that, given that valuations are not obviously cheap, overall returns from equities may be expected to be subdued for the time being. Reflecting this, they think that the volatility witnessed since the start of 2016 is also likely to remain a feature of the investment landscape for the remainder of the year. As such, the managers say that the trust’s portfolio has changed relatively little in recent months as, in their view, the current investments continue to demonstrate the ability to grow earnings and dividends in what the managers see as a challenging environment.
Edinburgh Investment Trust sees strong benefits from its Tobacco holdings : EDIN