Today sees the release of Temple Bar’s half-year report for the six months ended 30 June 2022. You can read the chairman’s statement and investment manager’s report below, and you can download the full report here.
The UK market fell in the first half of the year, however it performed relatively well in comparison to other global indices. The total return of the FTSE All-Share Index was -4.57%. The Company’s net asset value total return was marginally better at -4.03% and the share price return was more pleasing at +0.21%.
The discount to Net Asset Value (“NAV”) during the period narrowed from 7.80% to 3.84%. The Board and Investment Manager have continued their efforts to generate more buying interest in the Company. The website has been refreshed and rebranded, targeted marketing has been undertaken, both in mainstream and social media, and we have maintained our commitment to public relations. In addition, the Board has been active in pursuing its buy back policy. During the period nearly 2m shares were bought back. This has the effects of accreting to the remaining shares’ net asset value and reducing the supply versus demand imbalance in the market.
The Board is pleased to have welcomed Charles Cade to the Board as an independent non-executive Director. He brings a wealth of experience in the investment trust sector.
As previously announced, I will step down as Chairman at the next Annual General Meeting (“AGM”). The Board has decided that Richard Wyatt should replace me as Chairman, subject to his re-election at the AGM.
On 13 May 2022, the Company completed the sub-division of each Ordinary Share of 25p into 5 Ordinary Shares of 5p each (the “Share Split”), which was approved by shareholders at the Annual General Meeting held on Tuesday, 10 May 2022. Following the Share Split, the values reported with effect from close of business on 13 May 2022 are calculated in accordance with the new Ordinary Shares of 5p each. The comparative figures in the Financial Statements and Notes have been restated where indicated to reflect the Share Split.
The Board declared a first interim dividend of 10.25 pence along with a commitment to pay at least 41 pence for the full year (equivalent to 2.05 pence and 8.2 pence respectively on a post-share split basis). However, the Company’s revenue account has been much more buoyant than expected and our revenue projections support a more generous distribution. Accordingly, the second interim dividend will be 2.30 pence and the total for the year will be 9.0 pence. It is anticipated that this level of dividend will be fully covered by earnings. Going forward our revenue projections imply that in the coming years further rises in the dividend will be warranted by the portfolio generating more dividend growth.
Rarely has it been so difficult to predict the future. Inflation in the UK gets ever higher and recession may be just around the corner. The terrible events in Ukraine and the pressure that, inter alia, has put on energy and commodity prices all add to the uncertainty. The domestic political situation is unclear. Nevertheless, as outlined in their report the Investment Manager believes the portfolio remains attractively priced and can still perform well.
Investment manager’s report
The FTSE All-Share Index delivered a negative return of -4.57% in the first six months of the year. Equity markets generally have been weak, with the UK market having fared better than most, as investors worry that the tighter monetary conditions that are needed to bring inflation under control will tip the global economy into recession.
Forecasting the macro-economic environment is notoriously hard as economic growth is ultimately driven by consumer and corporate confidence (and therefore a willingness to spend and invest) but we can say that rising interest rates and higher commodity prices act as a tax on consumption and thereby reduce levels of disposable income and corporate profits. Although we do not attempt to forecast if, or when, the UK economy might go into recession (we might already be in one), we can say that the outlook for corporate profits in the short term is particularly uncertain.
In the first six months of 2022, the Temple Bar NAV performed broadly in line with the FTSE All-Share Index, whilst the share price outperformed as the discount closed over the period. The three energy companies (Shell, BP and Total Energies), Standard Chartered, Vodafone and Pearson were positive contributors to return, whereas four domestically focussed names, Royal Mail, Marks & Spencer, ITV and Currys were detractors.
The three energy companies rose on the back of rising oil and gas prices caused by the war in Ukraine, coupled with a muted supply response caused by several years of under investment in bringing new resources to the market. We cannot predict where oil and gas prices might end up in the next few months, however we would point out that the share prices of all three companies already 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 8x to 9x assuming $60 Brent oil. Oil prices at the time of writing in late July are around $100 Brent per barrel, and we therefore take the view that there is a considerable margin of safety built into the share prices of all three companies.
Standard Chartered has been a beneficiary of rising dollar interest rates, which in turn should lead to higher income growth and thereby help the bank achieve its 2024 10% ROTE target. Although a large increase in interest rates 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 likely therefore that credit provisions will not need to be increased from current levels. Standard Chartered’s tangible net asset value per share was 960 pence at the end of 2021 and a 10% return would therefore equate to around 100 pence of earnings, a price earnings ratio of less than 6x at today’s share price. The company is priced at less than eight times this year’s expected earnings.
Vodafone’s shares have performed poorly for some time as the company has experienced ongoing price deflation in its main European markets and the management have come under pressure to demonstrate the value that exists within the business. In the last few months, both Etisalat and, the activist investor, Cevian have taken stakes in the company with a view to accelerating the pace of change. Vodafone has a €12bn holding in the separately quoted Vantage Towers (owner of mobile infrastructure) which contributes relatively little in the way of cash flow to the group. We believe that if the company were to monetise this asset and return at least a portion of the proceeds to shareholders, the remaining business would be valued on a price earnings ratio of around 8x. The company also has the potential to improve its below industry average margins through market consolidation, particularly in the UK and Spain.
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. Pearson’s share price jumped in March on the back of two separate bid approaches from the private equity firm, Apollo, and although both bids were rejected by the management team as undervaluing the company and therefore came to nothing, the approach serves to highlight the undervaluation in the company’s shares.
As fears of recession have mounted, the stock market has anticipated downgrades to profit expectations by pushing down the share prices of those companies likely to be most affected by a combination of lower demand and higher input costs.
Shares in RMG have suffered as the stock market worries that this year is going to be extremely challenging as parcel volumes normalise post the pandemic and costs inflate. As the company is a relatively low margin business in which wages make up around 50% of the cost base, RMG is more vulnerable than most to the inflationary wage pressures that we are now seeing. However, we believe this needs to be offset against the significant opportunity that the company has to improve productivity through higher levels of automation.
Although RMG’s UK business may lose money this year, the group has recently re-iterated its medium-term targets of 5% margins in its UK business and €500m of profits in its international operations. This 5% margin target in the UK is some way below the industry average of 7% to 8% and so should be achievable, although industrial relations will have to improve if RMG is to be successful in delivering its UK target. The company’s international operations do not face the same challenges in respect of the trade unions and are expected to generate £350m of profit in 2022 per the company’s guidance and sell side forecasts. At a relatively modest 10x EBIT, this suggests a valuation of around £3.5bn for the international business alone, suggesting that investors are placing a substantial negative valuation on RMG’s UK business. Accordingly, again we see that shareholders have a margin of safety against continuing problems in the UK.
Currys was a beneficiary of the COVID-19 pandemic and that coupled with a downturn in consumer spending will mean that the current year will be significantly more difficult than the last. Currys operates in a competitive market, although it is the number one by market share in all the geographies in which it operates, and it has been consistently growing that share for several years. Being the number one operator in its markets gives the company a buying advantage which, in turn, enables it to earn a higher profit margin. The company currently generates more than 50% of its profits from its high-quality overseas operations (primarily in the Nordics). Valuing the Nordic profits at even a modest multiple suggests that the company’s UK operations (with £5.5bn of revenues) are included in the group valuation for free. The company’s two-year target is to generate free cash flow of £150m per annum, and whilst there is much uncertainty around this number, if it is successful, it suggests very significant potential upside to today’s share price.
Likewise, ITV and Marks & Spencer fell on fears that a recession will lead to a fall in profits and whilst we think that this will indeed happen, our view is that this is more than factored into the companies’ share prices. ITV is valued below 6x this year’s expected profits and Marks & Spencer below 9x. ITV offers a dividend yield of over 7% in 2022. Again, visibility is low and there is much uncertainty surrounding these forecasts.
We believe that our ability to add value results from the fact that we focus on a company’s medium to long term profit potential (defined here as three or more years), whilst many other investors will typically focus on the outlook for profits in the next six to twelve months. We think that investors should not forget that the purchase of an equity entitles the shareholder to a long-term stream of cashflows and that a temporary reduction in those cash flows due to an economic downturn does relatively little to alter the long-run intrinsic value of the share. Despite this, investors tend to overreact to short-term news flow, often pushing share prices down by 50% or more on fears of recession.
When fears of recession increase, investors shun economic cyclicality and bid up the price of those companies which are perceived to be less exposed to a potential downturn. Whilst risk appetite is difficult to measure, the relative valuation of cyclical stocks versus the more defensive names can provide a useful guide. On some measures the discount applied to cyclical stocks today is near to record levels. Previous peaks in this valuation spread coincided with the COVID-19 crisis in 2020 and the financial crisis in 2008 and suggest that expectations baked into the share prices of the cyclical companies are at a very low ebb. On each of the previous occasions when valuation spreads have become as wide as they are today, it has paid to take a more pro-risk, cyclical stance although we cannot know of course when risk appetite might improve, and cyclicality will re-rate.
Despite the UK equity market holding up better than most overseas markets so far this year, UK equities continue to be valued at a significant discount to global equities generally. Accordingly, we believe that, notwithstanding the shorter-term uncertainties, UK equities are priced to offer relatively attractive returns into the future. There were no new holdings established in the portfolio during the six-month period, although early in February we reduced the level of gearing on the Company on concerns that even prior to the war in Ukraine, the deteriorating economic outlook was not being adequately reflected in share prices. Conversely, at the end of June, we reintroduced an element of gearing, increasing the Company’s holdings in the most undervalued stocks, in the belief that the valuations of those shares now fully discounted a likely recession.
The economic backdrop is highly uncertain and there is much for investors to worry about, however, we must not forget that the stock market is a discounting mechanism and much of this will already have been factored into share prices. From the starting point of today’s depressed valuations, for those who can extend their time horizons, the opportunities are compelling, with stocks in the portfolio offering the potential for significant upside to a reasonable view of intrinsic value.
Ian Lance and Nick Purves
 Standard Chartered’s Company Report and Accounts
 Currys Annual Report and Accounts
 Currys Management Team