North American Regulatory News (NAIT)

Legal Entity Identifier (LEI): 5493007GCUW7G2BKY360

5 October 2023

 

 

THE NORTH AMERICAN INCOME TRUST PLC

 

HALF-YEARLY FINANCIAL REPORT

FOR THE SIX MONTHS TO 31 JULY 2023

 

 

The investment objective of The North American Income Trust plc is to provide investors with above average dividend income and long term capital growth through active management of a portfolio consisting predominantly of S&P 500 US equities.

 

 

Performance Highlights

Performance (Total return)

Financial Calendar, Dividends and Highlights

Financial Highlights

Chair's Statement

Overview

In the six months ended 31 July 2023, The North American Income Trust plc (the "Company") navigated high macroeconomic uncertainty amid monetary tightening, banking sector issues and fears of a looming recession. Against this backdrop, the Company's net asset value ("NAV") total return per share declined 3.2% in sterling terms compared with a 1.0% decline in the total return of its reference index, the Russell 1000 Value Index. Meanwhile, the Company's share price total return fell 7.8% in sterling terms over the period, with the discount to NAV widening from 9.3% to 11.3%. Despite this, I am pleased to note that the Company continues to deliver a dividend yield that is almost double that of the reference index and among the highest dividend yields within its peer group. This highlights your Manager's focus on investing in high quality companies with a strong dividend track record. However, such a focus on income generation can sometimes be at the expense of capital growth in the portfolio. While the Company's revenue return per Ordinary share was unchanged at 6.10 pence over the six months to 31 July 2023, this reflects the increase in US dollar income being offset by 4.5% appreciation of sterling against the US dollar during the period.

Inflation, and the efforts of the Federal Reserve (the "Fed") to control it, was one of the key themes of the period. We have witnessed ten consecutive rate hikes which led to the target range of the Fed Funds rate reaching 5.25% -5.50% in July 2023. Despite the Fed's somewhat hawkish stance, your Manager expects limited further rate increases over the rest of the year. The other theme that affected markets was the collapse of Silicon Valley Bank and a small number of regional banks in March 2023, which acted as a brake on market sentiment. While these events raised the risk of a credit crunch and the possibility of a recession, investors were reassured by the regulators' timely actions to stabilise the financial sector.

During the period, the Company's equity portfolio generated £8.8 million in revenue, down 3.8% from £9.1 million in the same period in 2022. This decline was partly as a result of sterling strengthening to the US dollar, from $1.23 to $1.28 during the period, continuing a trend that began in October 2022. The Company maintained a low exposure to corporate bonds, which represented 2.2% of income in the period, slightly more than last year. Total income was less than 1% lower than for the same period last year. Meanwhile, the Company's revenue return per Ordinary share was unchanged at 6.10 pence, with the lower interest and tax charges offsetting most of the small decline in income.

Dividend

The Board is declaring a second quarterly dividend for the year to 31 January 2024 of 2.6 pence per share (2023- 2.5 pence), taking total dividends for the first half of the year to 5.2 pence per share (2022 - 5.0 pence). The second quarterly dividend is payable on 27 October 2023 to shareholders on the register on 13 October 2023. It is expected that the third interim dividend, which will be paid in February 2024, will be 2.6 pence per share and the fourth interim dividend will continue to act as a balancing figure once the income for the full year has been determined.

Management of Premium and Discount

The Company's share price fell 7.8% to 298.0 pence and ended the half year at an 11.3% discount to total NAV, compared with a 9.3% discount at the financial year end, 31 January 2023. Over the period, the Company's shares traded at discounts between around -8% and -12%, on a cumulative income basis. 197,574 Ordinary shares were bought back and cancelled at a weighted average price of 283.4 pence and a weighted average discount of 9.4%. The total cost was £565,000. Since 31 July 2023, the Company has bought back a further 659,338 Ordinary shares, at a weighted average discount of 11.8%.

Gearing

The Board believes that sensible use of gearing should enhance returns to shareholders over the longer term. In December 2020, the Company entered into a long-term financing agreement for US$50 million with MetLife for two loans of US$25 million with terms of 10 and 15 years. As a result, net gearing at 31 July 2023 stood at 5.5% (31 January 2023 - 2.9%).

Promotional Activity

The Board continues to update shareholders and promote the Company through the Manager's marketing programme by means of articles and videos from the fund manager, webinars, shareholder meetings and an online presentation prior to the Annual General Meeting ("AGM"). You can register for updates on the Company's website northamericanincome.co.uk which has been updated and refreshed over the last couple of months. The website is also the best source for up-to-date information about the Company, including monthly factsheets, interviews with the Manager and the latest NAV and price of the Ordinary shares.

Environmental, Social and Governance

On the environmental, social and governance ("ESG") front, your Manager continues to engage with companies in the portfolio based on a range of criteria, including strong governance practices and efficient resource management. The Investment Manager uses ESG tools, with a particular focus on climate-related criteria, to assess the carbon footprint of the portfolio. The Manager also published the first Taskforce on Climate-related Financial Disclosures ("TCFD") report on the Company's carbon footprint data, which can be found at invtrusts.co.uk/en-gb/prices-and-literature/company-literature. This report is produced to support investors in appopriately assessing and pricing a specific set of risks related to climate change.

Board

The Board continues to review its succession planning. In March 2024, I will have served nine years as a Director of the Company and, in accordance with the UK Corporate Governance Code, I intend to retire from the Board at the conclusion of the AGM in June 2024. 

As part of its succession planning, the Board has carefully considered my successor and I am delighted to report that Charles Park will be appointed as Chair with effect from the conclusion of the 2024 AGM. Charlie joined the Board in June 2017. He has extensive experience of investing in the US including through his valued experience as a Director of the Company.

In May 2023, the Board visited your Manager in the US, an excellent opportunity to meet the team face to face. The visit allowed the Board to develop a deeper knowledge of the Manager's investment process and culture, as well as broaden their understanding on how specific market developments in the US are impacting the companies in the portfolio. We also appreciated the opportunity to spend some time meeting directly with management of one of the companies and hearing from experts on the political and economic backdrop.

Outlook

Macroeconomic uncertainty persists given elevated inflation, tight monetary policies and geopolitical tensions. At the same time, the US is starting the extended run-in to the next presidential election in November 2024 and we are alert to the prospects of vote-garnering announcements by prospective candidates from both sides over the coming months.

While investor sentiment now favours an end to the Fed's interest-rate hiking cycle, some further rate increases cannot be ruled out due to still-high core inflation and the Fed's commitment to achieving its 2% target. Meanwhile, inflation could increase further due to the recent rise in oil prices. In addition to price increases, more restrictive lending policies as a result of the banking sector collapses in March and the restarting of student loan repayments could hinder consumer spending. However, the US economy has remained resilient during the review period, with a notably strong labour market which is an improvement on forecasts at the start of the year.

Against this backdrop, the Board believes a mild recession is still likely to begin at some point by the end of the year or in early 2024. Your Manager has positioned the Company's portfolio to focus on high quality companies with good corporate governance, strong balance sheets and a solid dividend growth history, with a view to protecting the portfolio from the worst impacts of such an economic backdrop. This strategy has enabled the Company to pay a progressive annual dividend over the past eleven years. The Board is convinced that a focus on quality and income generation is the best approach to navigate uncertain times and weather a potential recession. 

 

Dame Susan RiceChair4 October 2023

Investment Manager's Review

 Market Overview

The Company's reference index, the Russell 1000 Value Index, delivered a total return of -1.0% in sterling terms over the six month period ended 31 July 2023. The strength of sterling in the period more than offset the 3.5% local currency total return of the index.

A combination of higher interest rates and inflation - due in part to a robust employment market - led to continued volatility in US share prices over the period. This is evidenced by the banking sector turmoil in March 2023 when two regional banks, Silicon Valley Bank and Signature Bank, both collapsed. There were several reasons for the failures; however, a key determinant was higher interest rates forcing both banks to lower the value of their investment portfolios.

Faced with a US economy that has maintained positive momentum despite a succession of rate rises since March last year, the Federal Reserve (Fed) continued to tighten policy over the remainder of 2022. This included four successive rate hikes of 75 basis points (bps) between June and November 2022. However, with inflationary pressures moderating, the Fed then eased the pace of rate increases from 50 bps in December 2022 to 25 bps from its February 2023 meeting onwards. In fact, the Fed refrained from tightening policy altogether at the June 2023 meeting; however, the rise of 25 bps in July 2023 took the targeted Fed funds rate to 5.25-5.50%, its highest level since 2001.

US stock markets rose steadily during June and July 2023. This was after investor sentiment was helped at the end of May 2023 by the long-awaited news of an agreement over temporarily suspending the US debt ceiling until January 2025, thereby reducing the risk of a US debt default.

The communication services, information technology and industrials sectors were the strongest performers within the Russell 1000 Value Index, while the real estate, healthcare and utilities sectors were the primary market laggards for the period.

The technology sector performed strongly amid rising investor demand for artificial intelligence ("AI")-related stocks and the prospect of less monetary tightening in the future. The communication services and industrial sectors were also leading performers within the Russell 1000 Value Index. Conversely, the real estate, healthcare, and utilities sectors were the primary laggards for the period.

Revenue Account

The currency effect flows through the balance sheet and the revenue account, muting the sterling value growth as compared to the local currency performance.

This year the trend of year-on-year growth in dividend income has checked slightly as investee companies have reacted to the tightening fiscal environment. Dividend income in the first six months of the year was £8.8m, or 3.8% lower than the £9.2m earned in the six months to July 2022. The marginal reduction in dividend income was offset by an increase in deposit interest as cash is now generating a more meaningful return than has been the case for many years. Option income was also down 5.6%. Dividend income is still almost 15% higher than the pre-pandemic income in July 2019 and our forecast for the second half of the financial year is that income will be close to the level earned last year.

Total costs for the period have increased by 5.8%, with a reduction in the management fee, due to the decline in the underlying asset values, being outweighed by a rise in administrative expenses.

Investment Performance

The Company generated a NAV total return of -3.2% for the six months ended 31 July 2023, underperforming the -1.0% total return of the reference index, the Russell 1000 Value Index. 

At a sector level, the main detractor from the Company's performance was industrials due to stock selection and, to a lesser extent, having an underweight exposure to the sector. The second-largest detractor was stock selection in the materials sector.

Looking at individual stock contributions, the largest individual detractor was a lack of exposure to the social media and technology conglomerate, Meta Platforms ("Meta"). Shares in the Facebook owner surged as the company reported better-than-expected earnings in the second quarter and issued optimistic guidance as the company is investing heavily in AI, a move which has been well received by investors. Non-dividend paying technology companies, like Meta, do not fall into our stock selection criteria as they do not return money to shareholders via dividend payments.

Looking at stocks held in the portfolio, agricultural sciences company FMC Corporation underperformed, after the company reported disappointing second quarter earnings and lowered its full-year guidance, given lower-than-expected volumes due to inventory destocking fromits customers.

Diversified healthcare provider CVS Health was another weak performer as it faced a challenging macroeconomic environment and above-trend claims from its Aetna insurance segment.

In terms of positive contributors, at a sector level, the largest contributors to the Company's performance were energy and information technology, both due to stock selection.

Semiconductor manufacturer Broadcom was among the top positive contributors, performing strongly, alongside NVIDIA and other companies with AI exposure, after reports indicated a significant increase in demand for AI solutions. Broadcom subsequently reported earnings that confirmed these improving demand trends.

Oilfield services provider Baker Hughes also fared well after it was awarded a major subsea equipment contract off the Ivory Coast. The company will supply several technologies to Africa's first net-zero emissions development project. You can read more about Broadcom and Baker Hughes, and our rationale for holding them in the portfolio, on pages 15 and 16 of the 2023 Half-Yearly Report.

Real estate investment trust Omega Healthcare Investors reported better-than-expected earnings thanks to higher occupancy rates at its customer facilities, along with fewer staffing issues. At the same time, the company's management continues to make progress on restructuring certain customer contracts, a process which should conclude over the coming quarters.

Portfolio Activity

Our investment process focuses on identifying and investing in high quality, cash-generative businesses. Market volatility created opportunities to add quality companies into the portfolio at compelling prices.

During the six month period, we initiated positions in three new companies.

Beverage firm Keurig Dr Pepper has products in both the cold drinks segment (led by the flagship Dr Pepper brand) and the coffee segment, following the merger with Keurig which is a leading brand in the single-serve coffee segment. Historically, the cold drinks business has grown in line with, or above, the market, benefiting from the company's strength in non-cola flavours and its status as a preferred distributor and acquiror of niche brands. The single-serve coffee business has recently been under pressure due to the impact of higher inflation but has excellent long-term trends and pricing in both segments (especially coffee) has now normalised, while demand strength and market share gains have continued.

We also introduced Essential Utilities, a diversified utility with two-thirds of its earnings from the water business and one-third from the gas business. In the short run, the gas business should grow faster given the infrastructure upgrades needed. However, the water business should grow at a comparable pace over the intermediate term due to several small acquisition opportunities given that around 85% of the country is served by small, privately run municipal operations. Furthermore, environmental regulations continue to be more stringent and these incremental costs - some of which can be quite sizeable - are a common catalyst for acquisition opportunities.

Another new holding is energy infrastructure company Enbridge. It is a premier midstream company that operates one of the most advantaged oil pipeline networks in North America, a strong collection of natural gas infrastructure and utility assets, and a growing renewable energy platform. The company's diversified asset portfolio generates predictable cash flows thanks to its regulated and long-term contracts with customers. The strategy is to harvest this substantial cash generation to complete Enbridge's large backlog of low-risk projects. Over time, project completion should drive earnings higher while also supporting the company's shareholder-friendly distribution policy.

Meanwhile, we sold clothing company VF Corporation. Despite having a portfolio of well-admired brands like Vans and The North Face, the company has faced multiple setbacks due to its continued poor execution. While many of these issues appear to be temporary, with most of them stemming from the pandemic's effects on both supply chains and demand, they have impacted VF Corporation's balance sheet. Moreover, any improvement in operating performance has likely been delayed while a new CEO attempts to reposition the company at a time when consumer sentiment is already weak.

We also sold our position in energy infrastructure firm TC Energy, using the proceeds to fund our investment in competitor Enbridge. While both are still high quality energy infrastructure companies, we believe the fundamental backdrop favours Enbridge. TC Energy is in the process of completing several large projects that will create longer-term growth opportunities. However, factors primarily outside the company's control have created delays and put upward pressure on costs, negatively affecting project-level returns. Furthermore, because of these pressures, TC Energy has set ambitious divestiture goals to fund these projects and now risks balance sheet degradation if these sales are not completed at fair prices in a reasonable time frame.

A list of investments in the portfolio can be found on pages 12 to 13 of the 2023 Half-Yearly Report.

Within the Company's corporate bond portfolio, we initiated several positions over the review period to take advantage of more attractive valuations. This was after these bonds' yields became more attractive due to further monetary tightening as well as worries about what an economic slowdown could mean for the instruments' credit quality. In contrast, we exited some other positions as the valuation of these bonds traded through what we deemed to be their fair value. We continue to work closely with the Manager's fixed income specialists to monitor credits and market conditions.

Outlook

The US economy continues to surprise to the upside. After the latest interest rate increase in July 2023, consensus is shaping up that the Fed may be at the end of its interest-rate hiking cycle. However, this view may be premature as core inflation data continue to be slow to contract and the Fed has been clear that it is committed to hitting its 2% target. Moreover, gasoline prices have been rising recently, which will negatively affect future inflation data. Up to now, the consumer has held up remarkedly well; however, higher gasoline prices, tighter lending conditions post the averted bank crisis and restarting student loan repayments are likely to constrain spending. That being said, the abrdn 'house' view remains that a mild recession is still likely. We now expect it to begin in the first quarter of 2024 and we are not forecasting a recovery until the tail end of the year.

 

 

Fran Radanoabrdn Inc.4 October 2023

 

Other Matters

Principal Risks and Uncertainties

There are a number of risks that, if realised, could have a material adverse effect on the Company and its financial condition, performance and prospects. The Board has considered the principal risks and uncertainties facing the Company together with a description of the mitigating actions it has taken. They can be summarised under the following headings:

-      Market Risk

-      Major Market Event or Geopolitical Risk

-      Income and Dividend Risk

-      Operational Risk

-      Regulatory Risk

-      Gearing Risk

-      Discount Volatility

-      Derivatives

-      Potential Impact of ESG Investment Principles

Details of these risks are provided on pages 14 to 16 of the Annual Report for the year ended 31 January 2023.  

The Board monitors these principal risks closely and has a process to identify and assess emerging risks such as climate change and geopolitical developments.

The increasing political and economic uncertainty which could affect markets, particularly in reaction to higher interest rates and recent banking failures, received particular focus in the reporting period.

The Board is also aware of the elevated threat posed by climate change and continues to monitor, through the Investment Manager, the potential risk that the companies in the portfolio may fail to adapt to changes in policy and regulation.

In all other respects, the Company's principal risks and uncertainties have not changed nor are they expected to change in the second half of the financial year ending 31 January 2024.

Going Concern

In accordance with the Financial Reporting Council's Guidance on Risk Management, Internal Control and Related Financial and Business, the Directors have undertaken a rigorous review and consider both that there are no material uncertainties and that the adoption of the going concern basis of accounting is appropriate. The Company's assets consist substantially of equity shares in companies listed on recognised stock exchanges and, in most circumstances, are realisable within a short timescale. 

In December 2020, the Company entered into a long-term financing agreement for US$50 million with MetLife, comprising two loans of US$25 million with terms of 10 and 15 years.

The Directors have a reasonable expectation that the Company has adequate financial resources to continue in operational existence for the foreseeable future and the ability to meet all its liabilities and ongoing expenses from its assets. Given that the Company's portfolio comprises primarily "Level One" assets (listed on a recognisable exchange and realisable within a short timescale), and the Company's relatively low level of gearing, the Directors believe that adopting a going concern basis of accounting remains appropriate.

Accordingly, they continue to adopt the going concern basis in preparing the financial statements.

Directors' Responsibility Statement

The Directors are responsible for preparing the Half-Yearly Financial Report in accordance with applicable law and regulations. The Directors confirm that to the best of their knowledge:

-      the condensed set of financial statements has been prepared in accordance with Financial Reporting Standard 104 (Interim Financial Reporting);

-      the Half-Yearly Board Report, comprising the Chair's Statement, Other Matters and Portfolio Information, includes a fair review of the information required by rule 4.2.7R of the Disclosure Guidance and Transparency Rules (being an indication of important events that have occurred during the first six months of the financial year and their impact on the condensed set of Financial Statements and a description of the principal risks and uncertainties for the remaining six months of the financial year); and

-      the financial statements include a fair review of the information required by 4.2.8R of the Disclosure Guidance and Transparency Rules (being related party transactions that have taken place during the first six months of the financial year and that have materially affected the financial position of the Company during that period; and any changes in the related party transactions described in the last Annual Report that could do so).

The Half-Yearly Financial Report for the six months ended 31 July 2023 comprises the Half-Yearly Board Report, the Directors' Responsibility Statement and a condensed set of Financial Statements which has not been reviewed or audited by the Company's auditor.

For and on behalf of the Boardof The North American Income Trust plc

Dame Susan Rice,Chair4 October 2023

Ten Largest Investments

As at 31 July 2023

 

List of Investments

 

Geographical Analysis

Investment Case Studies

Broadcom

Starting out as a sub-division of Hewlett-Packard in the 1960s, Broadcom (formerly Avago Technologies) has grown into a leading developer and supplier of semiconductor and software solutions. Its broad product range covers the wireless, networking, server storage, broadband and industrial markets.

With CEO and president Hock Tan guiding a strong management team, the firm has built its reputation as a global technology powerhouse through an aggressive, yet smart, merger and acquisition strategy. The anticipated acquisition of cloud computing business VMware is evidence of this strategy at work. The deal has already been approved by the European Commission and provisionally approved by the UK's Competitions and Markets Authority, so now only needs clearance from the US Federal Trade Commission.

The explosion in AI is boosting the company's performance. Exposure to AI comes through custom silicon chips (believed to be used by Google in its Tensor Processing Unit AI accelerators), and AI ethernet switches. AI is expected to make up more than 20% of semiconductor sales in fiscal year 2024 (up from 10% in fiscal year 2022), worth around $6-8 billion.

The holding is maintained by the Investment Manager because Broadcom is an excellent allocator of capital and has the ability to compound earnings per share over the long-term. The company's management is committed to returning around 50% of free cash flow to shareholders, with an attractive dividend yield. Meanwhile, its valuation appears reasonable compared with its peer group.

Broadcom has made great strides in terms of ESG performance in recent years (evidenced by its 'A' rating from MSCI). Its products often focus on minimising power consumption compared with rivals. The company has also committed to the ethical sourcing of raw materials (as semiconductor manufacturing can involve the use of conflict minerals, which are linked to human rights abuses). More than 90% of its suppliers comply with the stringent Responsible Minerals Initiative standards. Given Broadcom's role as an industry consolidator, the Investment Manager has also engaged with the management team on human capital development. This has evidenced a more positive impression of Broadcom's ability to integrate people into the company when it makes acquisitions.

Baker Hughes

Baker Hughes is a unique oilfield services company with a diverse portfolio that includes traditional energy products, liquified natural gas ("LNG") equipment and 'new energy' solutions.

The mix of traditional oilfield services, LNG technology and new energy solutions, including carbon capture, utilisation and storage and hydrogen, presents an intriguing combination of near, medium, and long-term opportunities from an investment perspective. The company could benefit from greater spending by upstream customers, multiple years of strong demand for LNG technologies and secular tailwinds for energy solutions tied in with a greener, more sustainable future.

In the Investment Manager's opinion, investors do not fully appreciate the value of Baker Hughes' strong position within LNG equipment and new energy technologies. From an income perspective, the company's strong balance sheet and shareholder returns strategy allow it to maintain dividend payments to shareholders through economic cycles. Holding Baker Hughes gives the Company exposure to relatively more attractive parts of the energy value chain and that longer-term opportunity.

From an ESG point of view, Baker Hughes is highly rated (with an 'AA' score from MSCI). Despite its exposure to traditional oil and gas, the company is closely linked with the energy transition. It was one of the first energy companies to establish a net zero emission target for 2050, supported by interim targets. The Investment Manager views Baker Hughes' performance and disclosures in this area to be ahead of its peers.

Despite the company's above-average exposure to climate change risk, the Investment Manager is confident in its ability to mitigate these concerns following our engagement on the issue. For example, Baker Hughes uses robust internal models to run various scenarios and to better plan, or avoid, physical asset risk.

Condensed Statement of Comprehensive Income (unaudited)

Condensed Statement of Financial Position (unaudited)

Condensed Statement of Changes in Equity (unaudited)

Condensed Statement of Cash Flows (unaudited)

Notes to the Financial Statements (unaudited)

For the year ended 31 July 2023

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

17.         The Half-Yearly Financial Report is available on the Company's website, northamericanincome.co.uk. The Half-Yearly Report will be posted to shareholders in October 2023 and copies will be available from the Company Secretary.

Please note that past performance is not necessarily a guide to the future and that the value of investments and the income from them may fall as well as rise and may be affected by exchange rate movements. Investors may not get back the amount they originally invested.

 

For The North American Income Trust plcabrdn Holdings Limited, Company Secretary

For further information, please contact:-Company Secretary, abrdnTel: 0131 372 2200

Alternative Performance Measures ("APMs")