Today sees the release of Temple Bar’s annual report and financial statements for the year ended 31 December 2022. You can read the Chairman’s statement and investment manager’s review below, and you can download the full report here.
“The Company’s managers are optimistic that further progress can be made and that the portfolio is well positioned. The Board shares this optimism.”
In the year under review, the Company’s NAV total return was (2.0%), which compares to the total return on the benchmark FTSE All-Share index of 0.3%. More pleasingly, the share price total return was 3.6% as the discount narrowed over the year to finish at 5.6%. Since Redwheel took over the management of the Company at the end of October 2020, the NAV total return to the end of 2022 has been 57.7% compared with 39.0% for the benchmark, a significant outperformance. Although annual metrics are important, the Board would always prefer to take a longer-term view of performance.
The Board continued with its active share buyback policy, purchasing 10,896,039 shares for a total consideration of £25.9m. These buybacks not only have the effect of stabilising the supply/demand balance but are also accretive to the NAV.
Portfolio turnover was again low this year at 7.2% (2021: 6.6%) with the managers being generally satisfied with the positioning of the portfolio. Further details can be found in the Manager’s Report on page 9.
As detailed in the interim report, the Company’s income account has been more robust than expected. As a result, the Board is recommending a total dividend of 9.35p per share, an increase of 18.4% over the 2021 level. The dividend is fully covered by earnings and the Board is confident that the dividend will increase from this level over time.
At the year end, the Company’s net gearing was 7.2% and the level has been relatively stable since more exposure was deployed by the Investment Manager in the Spring, having reduced the level at the outset of 2022 as market volatility increased.
Purpose and culture
The purpose of the Company is to deliver long-term returns for shareholders from a diversified portfolio of investments. These investments will primarily be UK listed.
As an investment trust, the Company has no employees, but the culture of the Board is to promote strong governance and a long-term investment outlook with an emphasis on investing in businesses that can deliver value to shareholders over an extended time horizon. Therefore, the Board asks the Company’s Investment Manager to invest in stocks that fulfil the traditional metrics of the value style and possess a business model that is resilient in the long term.
Environmental, Social & Governance (“ESG”) and Stewardship Issues
In September, the Board attended an Away Day at the offices of Redwheel, with a broad agenda covering ESG matters in relation to the management of the portfolio. The Board heard from representatives of Redwheel’s Investment, Sustainability, Compliance and Product Teams, with a particular focus on how stewardship is used by the Investment Manager to influence positively investee companies and how ESG-related factors are incorporated into investment research, stock selection, and portfolio management processes.
The Board continues to embrace the concept of active stewardship, asking the Investment Manager to monitor, evaluate and actively engage with investee companies with the aim of preserving or adding value to the portfolio. Further, with need for a collaborative approach becoming ever more pressing, if the situation warrants it, the Board encourages the Investment Manager to liaise with other investors when engaging with investee companies. The Investment Manager reports back to the Board regularly on these matters.
As mentioned in last year’s Statement, Charles Cade joined the Board in March. After the year end, the Board appointed Carolyn Sims as a Non-Executive Director and member of the Audit and Risk, Management Engagement and Nomination Committees. The Board is very pleased to welcome Carolyn, who brings a wealth of expertise and experience which will be invaluable. I will be standing down as Chairman at the upcoming AGM and Richard Wyatt will succeed me. The Company will be in good hands after my departure.
Annual General Meeting (“AGM”)
The AGM this year will be held at 25 Southampton Buildings, London WC2A 1AL on 9 May 2023 at 12:30pm. Like last year, shareholders are welcome to attend in person where you will be able to hear a presentation from the Portfolio Managers Nick Purves and Ian Lance and to meet the Board of Directors.
Shareholders unable to attend in person are invited to submit their form of proxy in advance by 12:30pm on 4 May at the latest.
Although the UK market performed better than many overseas markets, valuations still look reasonable. The Company’s managers are optimistic that further progress can be made and that the portfolio is well positioned. The Board shares this optimism.
Investment manager’s review
”All investors should remember the lesson of stock market history which is that starting valuation has proven to be the best predictor of investment return over time.”
Our investment approach has always been to seek out fundamentally sound businesses which by virtue of their market positions can grow their profits over the long term, but where for one reason or another the shares are modestly valued. This may be because the Company is underperforming its longer-term potential or because of a lack of interest or neglect. Either way, a low starting valuation looks to ensure that shareholders benefit fully from improved profit growth, whilst often in the meantime drawing an attractive income. Companies with low valuations also have a greater potential to re-rate as investor perceptions improve, further adding to investment returns. All investors should remember the lesson of stock market history which is that starting valuation has proven to be the best predictor of investment return over time.
We are long term investors, who recognise the importance of keeping transaction costs to a minimum. At times of major stock market dislocation, such as that which we saw when COVID first struck in 2020, we will rotate portfolios more aggressively to try and take advantage of other investors’ willingness to sell reasonable businesses at knock down prices. More normally however, shareholders should expect that portfolio turnover will be low. This was the case in 2022 and accordingly, we established no new positions in the year. We did, however, utilise the gearing available to the Trust to increase position sizes in a number of particularly undervalued holdings.
2022 was a difficult year for investors, as equity and bond markets had to contend with high inflation, rising interest rates and the added uncertainty caused by the invasion of Ukraine. Investors in the UK were also exposed to significant political instability with the arrival and departure of the Liz Truss Government in the Autumn.
It is worth reflecting on the speed with which interest rates have risen in 2022. At the beginning of the year, Central Banks were taking the view that inflation was a ‘transitory’ phenomenon. Accordingly, the Bank of England base rate and the US Federal Funds target rate were both set at just 0.25%. As we enter 2023, those rates are 3.5% and 4.5% respectively and the word ‘transitory’ has been dropped. The tighter monetary backdrop is likely to push many economies into recession (some are likely to already be in one) as defined by falling real economic output, although elevated inflation is likely to ensure that economies continue to grow in nominal terms. Given the size of the interest rate moves and the darkening economic outlook, it is not a surprise perhaps that equity markets struggled in 2022.
Within the markets, the companies that fared relatively well were the more defensive names whose profits will likely be less affected by an economic downturn, the Energy and Materials sectors and Banks. The Energy and Materials sectors have benefited from elevated commodity prices, brought about by continuing strong demand and the invasion of Ukraine, whilst Banks have benefited from rising interest rates which lead to higher margins on bank lending. The companies that particularly struggled were those where growth expectations are high as their profits are often far into the future and their valuations are therefore disproportionately impacted by a rise in interest rate assumptions, and those where operating leverage is high and revenues are most exposed to a consumer led economic downturn.
Given its high exposure to the Energy and Materials sectors and an under-weighting towards high growth technology sectors, the UK market fared relatively well in 2022, delivering a small positive total return. The Company portfolio delivered a small negative return over the period, although this masks a large disparity in the performance of some of the individual names. The Company’s holdings in the Energy sector (BP, Shell and Total Energies), Pearson, Centrica and Standard Chartered all delivered strong returns, with each stock adding between 1.5% and 3.0% to the portfolio return. Conversely, the portfolio’s holdings in International Distribution Services (formally Royal Mail Group), Marks & Spencer and Currys all declined markedly as investors attempted to factor in the deteriorating economic outlook. Each stock detracted between 2% and 4% from portfolio return.
The share prices of the three energy companies performed well on the back of rising oil and gas prices caused by the effects of the war in Ukraine coupled with a muted supply response; itself caused by several years of under investment in bringing new resources to the market. We cannot predict the path of future oil and gas prices, but would make the observation that demand for fossil fuels is strong today and is likely to remain so for many years at a time when many companies in the sector have severely curtailed investment. This provides the set up for continued strength in energy prices at a time when the share prices to levels of all three companies continue to discount commodity prices that are much below where we are today. By way of illustration, according to their own sensitivity analysis, BP, Shell and Total Energies are valued on price to earnings ratios of around 10x assuming a $60 Brent oil price. Oil prices at the time of writing are around $80 per barrel, and we therefore take the view that there is a considerable margin of safety built into the share prices of the companies. Centrica likewise delivered strong returns in the year, benefitting from high gas and electricity prices and significant consolidation in energy supply markets following the demise of a number of its competitors.
Pearson has struggled for some time with the transition from physical print textbooks to a digital offering in its North American Higher Education business and although this journey has proven to be protracted and damaging to group profitability, we continue to believe that educational publishing is an attractive business offering the prospect of healthy returns. The company’s share price performed well in the year prompted by two separate bid approaches from the private equity firm, Apollo, and evidence that the company has again returned to revenue growth. Although both Apollo bids were rejected by the management team as undervaluing the company and therefore came to nothing, the approach highlighted the potential undervaluation in the company’s shares.
Standard Chartered has been a beneficiary of rising interest rates, which in turn should lead to higher income growth and thereby help the bank achieve its 2024 10% Return on Equity target. Although the large increase in interest rates that we have seen could lead to credit stresses and increased loan loss provisions, the bank has been significantly de-risked over the last few years and lending standards are now much improved. It is possible and maybe even likely therefore that credit provisions will not need to be increased significantly from current levels. If the company is successful in hitting its financial targets for 2024, its shares would be valued by the stock market at less than seven times its annual profits. In January 2023, it was announced that First Abu Dhabi Bank had evaluated the idea of making a bid for the company and whilst again it came to nothing, it serves to highlight the strategic value of the company’s geographic footprint and its attractive valuation.
At International Distribution Services, a normalisation of parcel volumes post COVID, coupled with an inability to make productivity improvements in the UK (as a result of poor labour relations) has meant that its UK business, Royal Mail, is expected to lose money in the current financial year. The company continues to negotiate with the unions but has made it clear that any agreed pay deal needs to be accompanied by an improvement to outdated working practices. It has also said that it will not allow its international business, GLS, to destroy shareholder value by continuing to fund the UK business, and, if necessary, will separate the two companies to prevent value leakage. GLS is a parcel only business (no letters), with a non-unionised work-force, whose standalone value is greater than the stock market valuation of the entire group. The stock market has therefore placed a substantial negative valuation on Royal Mail, even though it is the leader in the UK parcels market and has significant surplus property that can be sold off over time. Any formal separation should throw a spotlight onto the very significant under valuation of the group’s shares.
Marks & Spencer fell on investor fears that the cost-of-living crisis will result in falling consumer spending and lower profitability. The food retailers generally (Marks & Spencer derives two thirds of its revenues from food) are going through a difficult period, with likely worse to come as they struggle to recover all their input cost increases without damaging sales volumes. However, our view is that this has already been more than factored into the Marks & Spencer share price. The shares are valued on a historic price earnings ratio of 7x at a time when we believe that there are many positive changes happening at the company. The company sells almost 40% of its clothing online (where it is number 2 in the UK by market share) and store-based clothing sales now account for just 20% of the group total, whilst in food the company continues to take market share. The company management target a level of operating performance in line with peers in the sector, which if they were able to achieve would result in further significant growth in earnings and a price earnings ratio of less than 6x at today’s share price.
Currys, the electrical retailer, is struggling with a difficult economic backdrop and as a low margin, operationally geared business is sensitive to relatively small declines in sales volumes. Accordingly, profit expectations have been significantly downgraded since the Summer. Although electrical retailing is a competitive business, the company is well managed and occupies the number one or two position in the UK and the Nordics. Although there is further downside risk to short term profit forecasts, the company is valued at less than 8x 2022/23 earnings, with the potential for a significant profit recovery as and when trading conditions improve.
For some time now, UK equities have traded at a meaningful discount to other stock markets. It is difficult to be sure as to why this is, although uncertainty surrounding Brexit and the recent political instability will have likely played a part. Whilst many are taking a dim view of UK economic prospects, it is important to remember that we buy companies and not economies and the companies in which the Company is invested are strong, conservatively run businesses with good balance sheets and capable management teams. In addition, many of them generate most of their profits overseas with the result that any fall in the value of the pound leads to higher sterling profits. In total we estimate that more than 50% of the Company’s portfolio profits are generated outside the UK.
The result of this negative sentiment towards the UK however is that UK listed stocks are valued at a significant discount to their overseas listed peers for no other reason than they happen to be listed in the UK. For example, Shell is valued at just 5x 2022 estimated earnings, whereas the US listed Exxon Mobil is valued at 8x. In banking, Barclays is valued at just 0.6x the value of its shareholder equity, whereas the US investment banks are valued at around 1x. As a result of what we see as an unjustified UK discount, the UK equity market offers an attractive dividend yield, and many UK listed companies are today priced to give their shareholders superior long term investment returns.
Ian Lance and Nick Purves