Aberforth Smaller Companies Trust Plc Regulatory News (ASL)

Aberforth Smaller Companies Trust Plc - Half-year Report

PR Newswire

London, July 24

Aberforth Smaller Companies Trust plc 

Half Yearly ReportFor the six months to 30 June 2018

The investment objective of ASCoT is to achieve a net asset value total return (with dividends reinvested) greater than on the Numis Smaller Companies Index (excluding Investment Companies) over the long term.

Aberforth Smaller Companies Trust plc (ASCoT) invests only in small UK quoted companies and is managed by Aberforth Partners LLP. All data throughout this Half Yearly Report is to, or as at, 30 June 2018 as applicable, unless otherwise stated.

FINANCIAL HIGHLIGHTS

Chairman’s Statement

Review of performance

For the six months to 30 June 2018, Aberforth Smaller Companies Trust plc (ASCoT) achieved a net asset value total return of +2.6%, which compares with a total return of -1.2% from the Company’s investment benchmark, the Numis Smaller Companies Index excluding Investment Companies (NSCI (XIC)). The FTSE All-Share Index, which is dominated by larger companies, generated a return of +1.7% over the same period. 

The Company’s share price total return was +8.3%, for the six months to 30 June 2018. At the end of June, the Company’s share price was at a 9.6% discount to its net asset value (31 December 2017 - 14.1%). More broadly, discounts within the AIC’s UK Smaller Companies subsector narrowed during the period, taking the average discount from 12.2% to 8.4% at 30 June 2018. 

As is usual, the Managers’ report provides greater insight into the factors that influenced the Company’s NAV performance during the first half of 2018.

Dividends

Shareholders in small UK quoted companies have enjoyed a golden period since the recovery in dividends began in 2010. The first half of 2018 saw a continuation of the dividend friendly environment. The Board is pleased to announce an interim dividend of 9.5p per share for the six months to 30 June 2018 (2017-9.05p). This represents an increase of 5.0% compared with last year’s interim dividend. The Board, in implementing its progressive dividend policy, continues to be mindful of the fact that at some point in the future the dividend climate will turn more hostile. In this regard, the increase in the interim dividend should be viewed alongside the Company’s retained reserves, which stand at 60.6p per share, 2.1 times the total of the 2017 final and 2018 interim dividends. The interim dividend will be paid on 31 August 2018 to Shareholders on the register as at close of business on 10 August 2018. The ex dividend date is 9 August 2018.

The Company operates a Dividend Reinvestment Plan. Details of the plan, including the Form of Election, are available from Aberforth Partners LLP or on its website, www.aberforth.co.uk.

Board changes

The Board was pleased to announce the appointment of Martin Warner as a non-executive director with effect from 1 March 2018, upon conclusion of the Annual General Meeting. Martin co-founded Michelmersh Brick Holdings plc in 1997 and served as chief executive and subsequently non-executive chairman from May 2017. Martin is a Fellow of the Royal Institute of Chartered Surveyors and is Chairman of the Brick Development Association. 

With effect from 1 March 2018, Julia Le Blan has been appointed Chair of the Audit Committee and Paula Hay-Plumb has also been appointed as a member of the Audit Committee. 

Gearing

It remains the Company’s policy to use gearing in a tactical manner and the Company has available a £125m loan facility until June 2020, provided by The Royal Bank of Scotland International. Gearing levels are reviewed on a regular basis by the Board and Managers. As at 30 June 2018 ASCoT was ungeared, with a small net cash position. The Board remains comfortable that the Company has access to sufficient liquidity for investment purposes and for share buy-backs, as and when appropriate. 

Share buy-in

The Company’s share buy-in authority is renewed annually at the Annual General Meeting.

During the six months to 30 June 2018, 1,638,886 shares (1.8% of the issued share capital) were purchased for a total consideration of £22,249,000. Any shares purchased are automatically cancelled, rather than being held in treasury, thereby reducing the Company’s issued share capital. 

The Board continues to believe that at the margin, buy-ins provide an increase in liquidity for those Shareholders wishing to crystallise their investment and at the same time deliver an economic uplift for those Shareholders wishing to remain invested with the Company.

Conclusion

The Brexit journey continues. Politicians from all sides contribute to the uncertainty, the public trade opinions, large companies lobby and meanwhile small businesses appear to be just getting on with it. Some businesses see opportunities while others see risk: the currency lens undoubtedly influencing their perspective. Against a healthy global economic backdrop, the divergence between domestic and overseas businesses is most stark. Brexit, be it hard or soft, will run its course. Currency flexibility and an improving fiscal position may enhance the prospects for the UK economy once some of the Brexit hysteria fades. 

Globally, the world continues to tack away from deflation and it is perhaps that journey which will prove of more significance to ASCoT shareholders over the medium term. A normalisation of interest rates, and the end of “free money” has the potential to alter the investment landscape in a radical fashion. 

Akin to the small businesses in which it invests, ASCoT has been just getting on with it. It is pleasing to report on a half year where we have outperformed by 376bps, delivered a 5.0% increase in the interim dividend and returned £22m to shareholders via buy backs. 

Paul Trickett

Chairman

25 July 2018

paul.trickett@aberforth.co.uk

Managers’ Report

Introduction

After the very good stockmarket returns enjoyed in 2017, this year has begun more modestly. The FTSE All-Share’s total return in the six months to 30 June 2018 was +1.7%, while small companies – in the form of the NSCI (XIC) – experienced a total return of -1.2%. For reasons set out in the Investment Performance section of this report, ASCoT’s performance was more resilient: its NAV total return was +2.6%.

The lacklustre share price performance of UK companies, both large and small, in the opening months of 2018 was influenced by heightened concerns about macro economic and geopolitical risks. In this Donald Trump has played a central role, with his transactional approach to foreign relations in which confusion and unpredictability may indeed be by design. His threatened withdrawal from the Iranian nuclear deal has contributed to a higher oil price, which in itself acts as a drag on economic activity around the globe. Moreover, his trade initiatives threaten to exacerbate the protectionist instincts of politicians in other countries to the detriment of economic activity around the world.

Trump’s domestic strategy, based on fiscal stimulus, has succeeded in supporting economic growth but brings further inflationary pressure and concern about the pace at which interest rates need to rise. The ten year US government bond has responded, with the yield rising to 3% for the first time since 2013. This is a significant move for arguably the world’s most important financial instrument, which is the basis for the valuation of other assets around the world. Among these are equities and the specific implications for the value investment style are described later in this report.

To the extent that the higher ten year US yield reflects higher nominal economic growth, it is to be welcomed. However, the message is complicated by an accompanying increase in shorter term government bond yields with the effect that the yield curve has flattened. Historically, an inverted yield curve – when shorter term yields exceed longer term yields – has been a useful indicator of recession. While inversion has not come to pass, the risk inevitably tempers the enthusiasm that might otherwise accompany a return to 3% yields and a tentative normalisation of monetary conditions.

Meanwhile, in Europe, there are indications that 2017’s robust recovery in economic activity has lost momentum, with various indicators suggesting that while activity continues to improve it is doing so at a more modest rate. This comes against the backdrop of renewed concern about the politics of the euro zone. Angela Merkel is confronted by domestic concerns about immigration and by Emmanuel Macron’s integrationist agenda, while Italy’s general election in March was followed by the eventual assumption of power by populist parties who retain a sceptical stance on the European Union.

Turning to the UK, the paradigm for such sceptics, progress with the divorce negotiations remains frustratingly slow: fundamental details about relations with the EU after March 2019 are yet to be decided. Consequently, the economy remains beset by uncertainty and gloom about UK equities is pervasive, typified by a recent survey by Bank of America Merrill Lynch suggesting that the asset class is the least popular among fund managers around the globe. Within the UK market, the closer one gets to companies exposed to the domestic economy, and thus further away from businesses whose overseas profits have been boosted by sterling weakness, the worse sentiment becomes. To an extent this is understandable: consumer behaviour continues to be hampered by wages that are struggling to grow in real terms. However, such is the negativity that many companies are being written off as “Brexit victims”, when deeper scrutiny reveals a more nuanced picture. For those with a contrarian inclination, value among businesses reliant on the domestic economy continues to emerge. The Managers, while cognisant of the risk of a badly handled exit from the EU, have taken advantage of this situation by redirecting capital from overseas facing businesses to domestics as bottom-up opportunities emerge, a process described in the following section.

Investment performance

To recap, ASCoT’s NAV total return in the six months to 30 June 2018 was 2.6%, which may be compared with the -1.2% return from the NSCI (XIC). The difference between the two numbers is analysed in the following table. The subsequent paragraphs provide additional detail about the influences on performance.

Style

Despite a good year of economic progress in 2017, the performance of the value stocks in the NSCI (XIC) was frustratingly subdued, to the extent that it was the style’s ninth worst year since 1955. The first two months of 2018 followed a similar pattern, but, as US government bond yields rose, the value style recovered such that style had no meaningful impact on ASCoT’s performance over the six months to 30 June 2018. It is tempting to compare this recent episode with the events of 2013, when ten year bond yields in the US last reached 3% and the value stocks performed strongly. Experience would thus appear to back up the theory of a relationship between the cost of money and investment style.

There are two aspects to the theory. First, today’s population of value stocks is biased to companies sensitive to the economic cycle: a pick-up in economic activity, signalled by higher bond yields, thus ought to favour the value style. Second, higher bond yields imply the use of higher discount rates in valuing financial assets. Longer duration assets – i.e. those whose cash flows are weighted to more distant periods – are more affected to changes in discount rates. In stockmarket terms, growth stocks may be thought of as long duration equities, while value stocks are relative beneficiaries of a return to a normal cost of money.

Size

The portfolio retains its bias towards the NSCI (XIC)’s “smaller small” constituents: companies with market capitalisations of more than £750m account for 58% of the NSCI (XIC) but for just 28% of the portfolio. This is due to the lower ratings that persist for such companies and the premium that investors at large are still willing to pay for greater size and liquidity: at the end of June 2018, NSCI (XIC) companies with market capitalisations above £750m are on average 47% more expensive, using 2018 EV/EBITA ratios, than those of £100m or less. In the six months to 30 June 2018, the larger stocks within the NSCI (XIC) – specifically, those also in the FTSE 250 – under-performed the smaller stocks, which implies that the size effect had a beneficial effect on portfolio returns.

Sector

At the sector level, the main issue since the EU referendum and the subsequent devaluation of sterling has been the contrast in fortunes between those sectors exposed to the domestic economy and those earning their profits outside the UK. From the end of May 2016 to the end of December 2017, the latter out-performed the former by 20% in total return terms, and the gap widened by a further 16% in the first half of 2018. This suited the positioning of ASCoT’s portfolio, whose relatively high exposure to overseas companies going into the EU referendum was still in place at the start of the current year. 

However, the extreme bearishness about the outlook for the UK economy, which was noted in the opening section of this report, has resulted in more attractively valued opportunities among the domestic sectors. Accordingly, and consistent with the indication given in the annual report, the drift of capital within the portfolio has been from overseas sectors to domestic sectors. The transition has been gradual, driven by individual opportunities, such that the portfolio retained an overseas bias through the first half. This would have helped ASCoT’s performance relative to the NSCI (XIC). Entering the second half, 41% of the aggregate sales of the portfolio’s holdings are generated outside the UK. This is down from 46% six months earlier and in line with the NSCI (XIC)’s overseas exposure.

Results

Of the companies that the Managers follow closely within the NSCI (XIC), many have December year ends and report results in the first calendar quarter. This year, with those involved in the mining and oil industries excluded, there were 124 such businesses. The aggregated sales and profits of the 124 rose by 9% and 2%. It was therefore a year of progress, albeit one with a squeeze on margins, particularly for those companies paying more in sterling terms for goods and services sourced from outside the UK. While domestic facing businesses experienced greater pressure on profits, it is noteworthy that most of the domestics within the analysis were still able to grow their profits.

Investment by the 124 companies was encouraging: the ratio of aggregated capital expenditure to depreciation was 1.4x. For several years now, the ratio has been well above 1x, which suggests that small and medium sized companies have been investing for future growth. This bodes well and paints a different picture from that of the overall UK economy, which is inevitably influenced by the actions of large companies. The healthy rate of investment by small companies comes alongside evidence that boards of directors are willing to deploy the balance sheet strength that was built up in the years following the financial crisis. This is consistent with a broader recovery in confidence, which is also manifest in growing dividends and gives reason for optimism about an economy that seldom seems short of bad news.

Corporate activity

The last annual report noted a relatively quiet year for M&A activity in 2017. This was surprising since valuations for small UK quoted companies were low and sterling’s decline following the EU referendum rendered UK assets in general more affordable to overseas buyers. That reasoning has seen some vindication so far in 2018, with six deals announced up to the end of June, of which ASCoT owned two. The renewed enthusiasm for British businesses on the part of other corporates and private equity contrasts sharply with the Bank of America Merrill Lynch survey noted previously. Additionally, the incidence of shareholder activism within the NSCI (XIC) is notably higher so far in 2018. While the Managers choose to engage with company boards directly and discreetly, the proclamations of the public activists draw attention to opportunities within the small cap universe.

Income

The table below categorises the portfolio’s holdings depending on each company’s most recent dividend action. With numerous dividend increases and few cuts, it suggests a continuation of the strong growth trend that has been a feature of the portfolio and indeed the wider small company universe for the last eight years or so. The “Other” category contains companies that have returned to the dividend register or that have paid dividends for the first time and that therefore do not have a meaningful comparative payment in the previous year.

Perhaps the most worrisome aspect about small company dividends at present is that the growth has been so strong for so long. At some point, it is probable that something will happen to bring the rate of progress back closer to the long term average of 2.7% per annum in inflation adjusted terms. However, such a setback would not appear imminent: dividend cover for the portfolio of 2.6x is in line with the average since 1990 and, while trading is difficult for some, a year of profit growth for the majority of companies in the NSCI (XIC) looks likely.

Valuations

The table below shows a small rise in the historical PE of the NSCI (XIC) over the past twelve months, which is consistent with the capital only return from the index and some modest growth in earnings per share. The portfolio remains cheaper than the opportunity base, consistent with the Managers’ value investment style. The major development in PE terms within the UK stockmarket has come from large companies, with the FTSE All-Share’s historical PE, according to the London Business School, dropping from 21.6x at the end of December to 13.0x at the end of June. A fall was to be expected as large companies reported their 2017 results, which benefited from higher commodity prices and the boost to overseas profits from sterling weakness. However, there was an additional factor at work: through its purchase of Reynolds, British American Tobacco earned a one-off profit that brought its historical PE down to 2x reported earnings. Given the size of the company, this distorts the PE of the FTSE All-Share, which will persist for a year. With British American Tobacco excluded, the large cap PE would be just under 17x, which is a more representative gauge of large company valuation. This would represent a premium of 20% over the small cap PE, higher than the average since 1990 of 10%.

The table below focuses on the Managers’ favoured valuation metric: the ratio of enterprise value to earnings before interest, tax and amortisation. EV/EBITA is shown for the portfolio, for the Tracked Universe – a set of 280 stocks that are followed closely by the Managers – and for certain subsets of the Tracked Universe. The analysis confirms the valuation advantage enjoyed by the portfolio in relation to the Tracked Universe and to the constituency of growth stocks in particular. The table also compares the valuations of all the Tracked Universe’s domestic and overseas companies, an approach that excludes the resources sectors and those businesses with no particular geographical skew. This highlights the valuation gap between domestic and overseas companies, with the latter on a 17% premium to the former for 2018. It is noteworthy that the overseas companies are on a higher multiple of profits that have themselves, in many cases, never been higher. In contrast, the domestics are valued on lower multiples of profits that, in several instances, have already declined meaningfully.

Conclusion & outlook

It is now nine years since the last recession, a period in which total returns from the FTSE All-Share and the NSCI (XIC) have been 166% and 277% respectively. Given that length of time and the strength of those returns, a degree of nervousness about a less rewarding period is understandable. Early in the year, the markets appeared to have found good reason for concern as monetary tightening in the US combined with rising political risk around the world to cloud the outlook. And, of course, the situation in the UK is complicated by the threat of a divorce settlement that proves hostile to business.

In the event, the elevated volatility of the first quarter proved transient and many indices ended the half year at or close to historical highs. However, there is a different story in the bond markets, with the US ten year yield still around 3%. This would imply better prospects for economic activity in nominal terms but it remains to be seen whether the world economy can endure such a repricing of money. The experience of 2013 does not bode well, but today’s growth is more balanced among the major economies and inflationary pressures are more difficult to ignore, with employment markets tightening and populism encouraging looser fiscal policies. At the very least, 3% bond yields give financial markets pause for thought. Will the investment strategies and styles that have prospered in a decade of easy money prove so successful as circumstances change?

As these big picture issues play out and have their inevitable influence on ASCoT’s performance, it is important not to lose sight of the progress being made by the substantial majority of businesses within the portfolio and the NSCI (XIC). Notwithstanding the continuing negotiations with the EU, another year of higher sales and profits looks likely. A healthy level of investment and above average dividend growth suggest confidence on the part of company boards. However, in the context of broader equity markets, valuations of small UK quoted companies remain low, especially among the “smaller small” companies and domestic businesses to which the Managers are attracted through their value investment philosophy. The combination of factors should be supportive of future returns from ASCoT’s portfolio.

Aberforth Partners LLP

Managers

25 July 2018

INTERIM MANAGEMENT REPORT

A review of the half year and the outlook for the Company can be found in the Chairman’s Statement and the Managers’ Report.

Risks and Uncertainties

The Directors have established an ongoing process for identifying, evaluating and managing the principal risks faced by the Company. The Board believes that the Company has a relatively low risk profile in the context of the investment trust industry. This belief arises from the fact that the Company has a simple capital structure; invests only in small UK quoted companies; has never been exposed to derivatives and does not presently intend any such exposure; and outsources all the main operational activities to recognised, well established firms.

The principal risks faced by the Company relate to investment policy/performance, share price discount, gearing, reputational risk, and regulatory risk. An explanation of these risks and how they are managed can be found in the Strategic Report contained within the 2017 Annual Report. These principal risks and uncertainties have not changed from those disclosed in the 2017 Annual Report, albeit the political environment remains volatile.

Going Concern

The Directors are satisfied that the Company has sufficient resources to continue in operation for the foreseeable future, a period of not less than 12 months from the date of this report. Accordingly, they continue to adopt the going concern basis in preparing the financial statements.

DIRECTORS’ RESPONSIBILITY STATEMENT

The Directors confirm that, to the best of their knowledge:

(i) the condensed set of financial statements has been prepared in accordance with the Statement “Half-yearly financial reports” issued by the Financial Reporting Council; and

(ii) the Half Yearly Report includes a fair review of information required by:

(a) DTR 4.2.7R of the Disclosure and Transparency Rules, being an indication of important events during the first six months of the year and their impact on the financial statements together with a description of the principal risks and uncertainties for the remaining six months of the year; and

(b) DTR 4.2.8R of the Disclosure and Transparency Rules, being disclosure of related party transactions and changes therein.

(iii) the Half Yearly Report, taken as a whole, is fair, balanced and understandable and provides information necessary for Shareholders to assess the Company’s performance, objective and strategy.

On behalf of the Board

Paul Trickett

Chairman

25 July 2018

The Income Statement, Reconciliation of Movements in Shareholders’ Funds, Balance Sheet and the Cash Flow Statement are set out below:-

INCOME STATEMENT  (unaudited)

For the six months ended 30 June 2018

Dividends

On 25 July 2018, the Board declared an interim dividend for the year ending 31 December 2018 of 9.50p per Ordinary Share (2017 – 9.05p) which will be paid on 31 August 2018.

INCOME STATEMENT  (unaudited)

For the six months ended 30 June 2017

INCOME STATEMENT  (unaudited)

For the year ended 31 December 2017

RECONCILIATION OF MOVEMENTS IN SHAREHOLDERS’ FUNDS

 (unaudited)

For the six months ended 30 June 2018

For the year ended 31 December 2017

For the six months ended 30 June 2017

BALANCE SHEET

(unaudited)

As at 30 June 2018

CASH FLOW STATEMENT

(unaudited)

For the six months ended 30 June 2018

NOTES TO THE FINANCIAL STATEMENTS

1. ACCOUNTING STANDARDS

The financial statements have been prepared on a going concern basis and in accordance with the Financial Reporting Standard 104 and the AIC's Statement of Recommended Practice "Financial Statements of Investment Trust Companies and Venture Capital Trusts" issued in 2014 and updated in 2018. The total column of the Income Statement is the profit and loss account of the Company. All revenue and capital items in the Income Statement are derived from continuing operations. No operations were acquired or discontinued in the period. The same accounting policies used for the year ended 31 December 2017 have been applied.

2. INVESTMENT MANAGEMENT FEE

The Managers, Aberforth Partners LLP, receive an annual management fee, payable quarterly in advance, equal to 0.75% of net assets up to £1 billion, and 0.65% thereafter.

The investment management fee has been allocated 62.5% to capital reserve and 37.5% to revenue reserve, in line with the Board’s expected long term split of returns, in the form of capital gains and income respectively, from the investment portfolio of the Company.

3. DIVIDENDS

The interim dividend for the year ending 31 December 2018 of 9.50p (2017 – 9.05p) will be paid on 31 August 2018 to shareholders on the register on 10 August 2018. The ex dividend date is 9 August 2018. The interim dividend has not been included as a liability in these financial statements.

4. RETURNS PER ORDINARY SHARE

5. INVESTMENTS AT FAIR VALUE

In accordance with FRS 102 and FRS 104, fair value measurements have been classified using the fair value hierarchy:

Level 1 - using unadjusted quoted prices for identical instruments in an active market;

Level 2 - using inputs, other than quoted prices included within Level 1, that are directly or indirectly observable (based on market data); and

Level 3 - using inputs that are unobservable (for which market data is unavailable).

Investments held at fair value through profit or loss:

6. NET ASSET VALUE PER ORDINARY SHARE

The net assets and the net asset value per share attributable to the Ordinary Shares at each period end are calculated in accordance with their entitlements in the Articles of Association and were as follows:

7. SHARE CAPITAL

During the period, the Company bought in and cancelled 1,638,886 shares (2017: 361,800) at a total cost of £22,249,000 (2017: £4,507,000). 209,000 shares have been bought in for cancellation between 1 July 2018 and 25 July 2018 at a total cost of £2,895,000.

8. RELATED PARTY TRANSACTIONS

There were no matters during the six months ended 30 June 2018 requiring disclosure under section 412 of the Companies Act 2006.

9. FURTHER INFORMATION

The foregoing do not constitute statutory accounts (as defined in section 434(4) of the Companies Act 2006) of the Company. The financial information for the year ended 31 December 2017 has been extracted from the statutory accounts, which have been filed with the Registrar of Companies. The Auditor issued an unqualified opinion on those accounts and did not make any statements under section 498(2) or (3) of the Companies Act 2006. All information shown for the six months ended 30 June 2018 is unaudited. 

Certain statements in this announcement are forward looking. By their nature, forward looking statements involve a number of risks, uncertainties or assumptions that could cause actual results or events to differ materially from those expressed or implied by those statements. Forward looking statements regarding past trends or activities should not be taken as representation that such trends or activities will continue in the future. Accordingly, undue reliance should not be placed on forward looking statements.

The Half Yearly Report is expected to be posted to shareholders on or before 1 August 2018. Members of the public may obtain copies from Aberforth Partners LLP, 14 Melville Street, Edinburgh EH3 7NS or from its website at www.aberforth.co.uk.

CONTACT:

Alistair Whyte/Euan Macdonald (Telephone: 0131 220 0733)

Aberforth Partners LLP, Secretaries

25 July 2018