Today sees the release of Temple Bar’s annual report and financial statements for the year ended 31 December 2023. You can read the Chairman’s statement and investment manager’s review below, and you can download the full report using the link above.
Chairman's statement
Review
In the year under review, I am pleased to report that the Trust’s Net Asset Value total return with debt at fair value was +12.3%, outperforming the total return on the FTSE All-Share Index of +7.9%. The share price total return was slightly better at +12.5%.
Since Redwheel took over the management of the Trust at the end of October 2020, the Net Asset Value total return to the end of 2023 has been 86.7% compared with 50.0% for the Benchmark, a significant outperformance. Although annual metrics are of course important, the Board continues to focus primarily on the Trust’s longer-term performance.
Capital
Challenging stock market conditions have continued to have a negative impact on share price discounts across the investment company sector, with the average level of discount standing at c. 12.3% for equity investment trusts (Source: Cavendish Securities), compared to the Trust’s discount of 10.1% as at 2 April 2024. The Board has continued with its active share buyback policy, purchasing 27,209,505 shares to be held in treasury for a total consideration of £63.5m during the year. These buybacks not only have the effect of stabilising the supply/ demand balance but are also accretive to the Trust’s Net Asset Value, adding 1.4p per share to our year-end Net Asset Value.
On 31 December 2023, there were 290,612,881 shares in issue (excluding the 43,750,944 shares held in treasury). Since this date to 2 April 2024, a further 3,771,869 shares have been bought back for treasury, at a cost of £8.9m.
Portfolio
Portfolio turnover increased in 2023 (see glossary on page 100 of the full report for definition), although remained comparatively low at 16.9% (2022: 7.2%) with our Portfolio Manager being generally satisfied with the positioning of the portfolio.
Further details of the Portfolio Manager’s investment approach, portfolio construction and significant contributors to and detractors from return in the year can be found in the Portfolio Manager’s Report beginning on page 14.
Dividend
Total dividends for the year amounted to 9.60p per share (2022: 9.35p per share), an increase of 2.7% and representing a current yield of 4.0%. This increase has been supported by a marginal contribution from the Trust’s distributable revenue reserves this year.
The Board closely monitors the Trust’s net revenue position and, based on the latest forecasts, expects future annual dividends to increase from this level over time.
Gearing
At the year-end, the Trust’s net gearing was 9.8% (2022: 8.4%).
Environmental, Social & Governance (“ESG”) Issues
ESG matters continue to be an important priority for the Board and our objective is to have full, transparent disclosure on the topic. The Board continues to advocate the concept of active stewardship, requesting that our Portfolio Manager monitors, evaluates and actively engages with investee companies with the aim of preserving or adding value to the portfolio. The Portfolio Manager reports back to the Board regularly on ESG related matters. Further details can be found in the Portfolio Manager’s Report beginning on page 14 and also on page 18.
The Board
Lesley Sherratt, the Company’s Senior Independent Director and the Chair of the Audit and Risk Committee, having served on the Board since 2015, will retire at the conclusion of the Company’s Annual General Meeting on Tuesday, 7 May 2024. Lesley’s leadership, and her financial and investment industry experience have been invaluable to the Board. Carolyn Sims, a Chartered Accountant, will take over from Lesley as the Chair of the Audit and Risk Committee and Charles Cade will take over as the Senior Independent Director.
Annual General Meeting (“AGM”)
Like last year, the AGM this year will be held at 25 Southampton Buildings, London WC2A 1AL. It will be held on Tuesday,7 May 2024 at 11.00am. Shareholders are welcome to attend in person where you will be able to hear a presentation from the portfolio management team Nick Purves and Ian Lance and also to meet the Board of Directors.
I encourage all shareholders to exercise their right to vote at the AGM and to register your votes in advance of the meeting. Registering your vote in advance will not restrict you from attending and voting at the meeting in person should you wish to do so.
Shareholders are invited to register their vote in advance by 11.00am on Thursday, 2 May 2024 at the latest (please see page 95 for further information).
Outlook
Against a backdrop of continued concerns regarding the level of inflation in the UK and uncertainty for the global economy and also rising geopolitical tensions, the valuation of UK equities looks compelling compared to their equivalents overseas.
Your Board shares the view of our Portfolio Manager that the Trust’s portfolio continues to be priced to offer shareholders further excess investment returns in the future.
The UK equity market continues to be valued at a significant discount to its international peers as many market participants in the UK have been allocating away from UK equities. This has resulted in large portions of the UK equity market being valued at a significant discount to intrinsic value. Unless this changes, it seems likely that we will continue to see overseas corporate buyers step in to take advantage of these depressed valuations, with ownership falling into foreign hands and the number of quoted UK businesses continuing to decline. Whilst this process is likely to be very rewarding for the Company’s shareholders, with takeover premiums often between 50% and 100% of the previously prevailing share price, your Board believes that a healthy equity market is beneficial to the functioning of the economy.
Richard Wyatt
Chairman
Portfolio manager's report
How do you describe your approach to investing?
We are value investors. This means that we invest the Trust’s assets in companies whose stock market value is at a significant discount to the fair or intrinsic value of the business. Investing in under valued companies provides two benefits. First, it provides investors with a margin of safety if events don’t unfold in a way that investors would have hoped and second, they can expect to receive an excess investment return as and when this under valuation is corrected by the stock market.
How does this work in practice?
A company’s shares will trade at a discount to its intrinsic value for one of two reasons: neglect or controversy. Where the cause is neglect, the stock market is not concerned that there is a particular problem with the business; it is just that the company is seen to offer relatively dull prospects in a world where many investors crave excitement. Where there is a controversy surrounding the company, investors are worried that a downturn in the economy or some secular change in the company’s industry will negatively impact profitability. This uncertainty is unsettling for many investors and can cause them to sell the shares. In a desire to avoid what are
sometimes seen as troubled businesses, investors often forget that the purchase of a share exposes them to a very long-term stream of corporate cash flows, the true value of which only changes by a relatively small amount even in the event of a severe recession. The result is that share prices will often overreact to short-term news flow.
Temple Bar seeks to take advantage of this excess volatility by investing in companies whose shares are significantly undervalued based on a conservative view of a business’s long-term profit potential.
What evidence is there supporting this style of investment?
Numerous academic studies1 have shown that systematically investing in lowly valued companies has seen investors enjoy an excess long-term investment return above the wider stock market, even though it is often these companies that are seen to operate in the most challenged industries. The reason for this outperformance comes down to psychological factors where investors systematically overpay for those companies whose prospects are seen to be the most attractive, whilst being too quick to overlook or dismiss companies where the outlook is more difficult. By investing the Trust’s assets in lowly valued companies, we aim to take advantage of these behavioural inconsistencies to the benefit of the Temple Bar ’s shareholders.
So, what is it that you look for in companies?
We seek to identify fundamentally sound but lowly valued companies whose shares are priced to offer higher investment returns in the future. A fundamentally sound business is one that can grow its profits over time (although not necessarily in each year), has strong finances and a capable and sensible management team who allocate capital in the best interests of their shareholders.
How would you describe the investment backdrop in the last year?
Most stock markets delivered attractive returns in 2023, despite having to contend with further interest rate rises, the ongoing war in Ukraine and instability in the US banking sector. In the US, the UK and Continental Europe, Central Banks have been raising rates to bring inflation back to the target level of around 2%. In the summer, there were concerns that Central Banks were losing this battle which led to fears that interest rates might have to take another step up, thereby increasing the risk of a hard landing in the economy. However, in the fourth quarter, the narrative changed considerably thanks to several downside surprises in inflation readings, which led to hopes that inflation would soon be back to around target levels. For stock markets, this led to optimism that an economic soft landing was coming into view, whereby inflation would be back at target levels without a recession taking place.
Turning to the financial year, how has the portfolio performed and what were the major winners and losers?
Despite the depressed starting valuation, the UK equity market was a laggard in 2023, delivering a total return of around 8% , however, the Trust’s portfolio performed well in the year, outpacing the rise in the FTSE All-Share. Temple Bar benefitted from significant rises in the share prices of Marks & Spencer, Centrica and International Distribution Services (the old Royal Mail Group). Each of these three companies added over a per cent to the Trust’s return, with Marks & Spencer more than doubling during the year. The Trust ’s portfolio was negatively impacted by a more than 30% fall in the share price of Anglo American.
In 2023, Marks & Spencer continued to perform well from an operational perspective, taking market share in both clothing and food and continuing to make good progress towards its longer-term profitability targets. Although it can’t be quantified, there is little doubt that the company is benefiting from the demise of several competitors during the COVID pandemic, and the company is able to invest capital at high returns in rightsizing and re-orientating its store estate. If achieved, the company’s profitability targets would simply bring the retailer’s profitability in line with its peers and would result in significant growth in shareholder earnings, thereby suggesting that the shares continue to be undervalued.
Centrica announced the results of a strategic review in the summer. The company has a unique place in the energy value chain and can add value as a producer of power, through the provision of energy infrastructure, system optimisation through its Marketing and Trading business and energy retail through British Gas. Having simplified and de-risked the business, management intend to invest in the energy transition and thereby create further value for shareholders. Nevertheless, the company’s profits will continue to be sensitive to the level of energy prices. Even assuming a ‘normalisation’ of commodity prices from today’s elevated levels to pre COVID levels, the company continues to be valued at around nine times it annual profits. The company also has significant portion of its market capitalisation as net cash on its balance sheet, and this needs to be factored into any consideration of value.
International Distribution Services performed well in 2023 as a new agreement with its unions bedded in well. A successful execution of the agreement will enable the company to release significant unrealised potential in the company’s UK business and thereby drive group profitability higher. Making just modest assumptions about the potential profitability in the company’s UK business, suggests that the company is valued at less than six times its earnings potential. For some time, we have believed that more than 100% of the company’s market capitalisation can be justified by its overseas (parcels only) business alone, suggesting that the stock market is placing a negative valuation on the more challenged UK business. This is even though more than half of the company’s UK revenues are derived from parcels (rather than letters) and it has around a 50% market share in the UK parcels market.
On the negative tack, Anglo American downgraded its production guidance for 2024 and 2025 and as a result 2024 earnings estimates were cut by 20% to 25%. These profit downgrades are unwelcome although the accompanying share price fall has left the shares looking very undervalued. To address balance sheet issues, the company went through a radical restructuring in 2015, halving the number of assets in its portfolio and consequently, the assets that remain are generally of good quality. Anglo American has significant investments in publicly quoted assets and stripping these out, the company’s Copper, Diamond, Metallurgical Coal and Nickel assets are valued at just five times earnings before interest and tax. We would therefore not be surprised to see some corporate activity if the operating performance of the company does not improve. This could take the form of asset disposals to demonstrate value or a bid for all or parts of the group.
How has the Trust’s portfolio changed over the year?
In 2023, the Trust purchased shares in Stellantis, a company formed by the merger of Fiat Chrysler and Peugeot in 2021. The rationale for the merger was to combine the European strength of the Peugeot business with the North American strength of Fiat Chrysler. Combining the entities has allowed for significant cost saving s and created a stronger and more diversified business. At the time of purchase, the company was valued at around three times its annual profits and the shares offered a dividend yield of around 8%. In the last two years, the auto industry has enjoyed high profitability as strong demand post COVID, coupled with muted supply drove price increases in most markets. Whilst profitability is likely to decline in future years as industry conditions normalise, in our view, the company would nevertheless continue to be very attractively valued. The company has significant net cash on its balance sheet, equating to around one third of its market capitalisation. Stellantis has performed well since its purchase and in 2023 added over 1% to the Trust’s return.
We also established a position in GlaxoSmithKline (“GSK”), a high-quality global franchise which has traditionally struggled with execution and whose shares have therefore significantly underperformed its peers over almost all-time frames. The company’s vaccines business is the global leader, with the widest product and technology portfolio, and is well insulated from threats, with more than 90% of revenues coming from vaccines with more than 90% efficacy. In combination with GSK’s pharmaceutical business, the company should be capable of delivering good levels of growth. The management targets annual sales and operating profit growth of more than 5% and 10% respectively over the five years to 2026.
A new position in the Dutch Insurer, NN Group, was also established which derives most of its profits from the Dutch pension market. The company targets moderate growth in profits in the coming years and its balance sheet is strong. At the time of purchase, the company was valued at a multiple of six-times profits and offered a dividend yield of around 9% and is expected to return another 3% of its market capitalisation in share buybacks in respect of 2023.
The UK stock market continues to be compared negatively with other major equity markets. Do you think this is justified and are you able to find appealing investment opportunities in the UK?
The UK stock market remains very out of favour with investors who continue to sell UK assets to channel money overseas. Here investment prospects are seen to be more exciting even though a large portion of the profits of companies listed in the UK are derived from 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. Today, your portfolio in aggregate is valued at a multiple of around eight times last year’s estimated earnings. In contrast, in the US, the S&P 500 is valued on a multiple of over twenty times, more than 2.5x the valuation of the Trust’s portfolio. In respect of the UK, you should take comfort from the fact that markets don’t de-rate forever and that this headwind will ultimately abate and maybe even become a tailwind. If the Trust’s portfolio simply re-rated back to a still conservative ten times earnings on an earnings base that was unchanged, the Trust would deliver a return of around 25% to its shareholders from this re-rating alone. Whilst many will no doubt continue to take a dim view of UK economic prospects; it is important to remember that the Trust buys companies and not economies. The companies in which the Trust is invested are sound, conservatively run businesses with strong finances and capable management teams.
How is the portfolio currently positioned and what is your outlook for the year ahead?
Whilst it is somewhat frustrating that UK listed shares continue to attract such miserly valuations, the attraction for the long-term investor is significant as stock market history has shown that the best predictor of long-term future investment return is starting valuation. Time and time again, those that have invested in highly valued assets have been rewarded with suboptimal returns, even though the underlying asset has continued to perform well from an operational perspective. Conversely, those that have invested in lowly valued, but fundamentally sound businesses, which did not happen to fit with the prevailing investment narrative at the time of purchase, have enjoyed outsized gains. We are often asked when UK equities will re-rate and whilst we can’t answer this question, we would point out that one doesn’t need the Trust’s portfolio to re-rate to enjoy an attractive investment return. A lowly valued company that converts a significant portion of its profits into cash can pay a generous dividend and undertake value enhancing share buybacks whilst holding debt at a constant level. As we enter 2024, the Trust’s portfolio continues to be priced to offer its shareholders further excess investment return in the future.
Could you provide your views on the post-period takeover bids that were received on holdings within the portfolio?
So far in 2024, there have been two bids for companies held in the Trust’s portfolio; first Currys and then Direct Line Group. Whilst takeover bids can come at any time, this is perhaps not a surprise as many of the companies in the portfolio carry a stock market valuation which is significantly below a reasonable view of their true value. The UK continues to be an attractive place to invest and given the rock bottom valuations that exist in some parts of the UK market, it is understandable that private equity and corporate buyers would want to take advantage of that.
We have mixed feelings about these takeover approaches. Takeover bids highlight the undervaluation that exists in the target companies and can result in a rapid crystallisation of the upside that we believed existed at the time of a stock’s purchase. However, we must also remember that private equity bidders especially are intent on paying a price which continues to undervalue the company and from which they themselves can make an attractive investment return. They will therefore rarely be prepared to pay what we think the target company is worth. Currys is a case in point. Our view of the company’s fair value was significantly higher than the 67p offered by hedge fund, Elliott who have since said that they are not prepared to bid any more.
In 2022, the private equity group, Apollo Capital, made three takeover offers for Pearson, the educational publisher, and last year, First Abu Dhabi Bank approached Standard Chartered. It is reasonable to expect that there will be more bids for companies in the Trust’s portfolio and shareholders should expect to benefit further from that.
Ian Lance and Nick Purves
Redwheel
1 One study from Professors Dimson, Marsh and Staunton used dividend yield as a measure of valuation and demonstrated that the highest yielding part of the US stock market between 1927 and 2022 generated a total return of 11.2% per annum versus 9.4% per annum for the lowest yielding part, meaning that $1 at the start of the period became $25,277 in the former but only $5,513 in the latter. The data for the UK market starts from 1900 with £1 invested producing £199,040 in high yielding stocks versus £9,717 for low yielding stocks. Source: © Elroy Dimson, Paul Marsh and Mike Staunton; US data is from Professor Kenneth French, Tuck School of Business, Dartmouth. UK data is from Elroy Dimson, Paul Marsh, and Mike Staunton, London Share Price Database. Further information can be found online here. Past performance is not a guide to future returns. The information shown above is for illustrative purposes.
How to Invest
The Company’s shares are traded openly on the London Stock Exchange and can be purchased through a stock broker or other financial intermediary.