Despite the persistent uncertainty hanging over UK companies, balance sheets look robust and lessons have been learned since the last financial crisis, says Neil Hermon, Fund Manager of Henderson Smaller Companies Investment Trust.
Q: What can you tell us about your activity regarding The Henderson Smaller Companies Investment Trust portfolio over the summer months and your take on the Trust’s performance in that time frame?
A: So in terms of performance and activity over the summer months it's been a challenging period for equity markets. Clearly not helped by the Brexit situation and also the current Trade War between the US and China and slowing global economic conditions. So tough, tough markets overall. In terms of Trust performance we had a good June, a poor July and August, and a good start to September. So overall for that three and a half month period we're down about 2% in total return about 1% behind our benchmark; so not disastrous but could be better.
Activity wise we found some good new ideas to add to the portfolio. Some additions would include companies like Volution an air conditioning specialist, Mitchells & Butlers (a pub company) and Frontier Developments - a gaming software company.
Q: We’re all well aware of the political uncertainty surrounding the UK, but less so regarding the affect this is having on UK smaller company prices.
What effect, if any, have you seen on the valuations of the UK small cap sector over the course of 2019; and what is your assessment as to the strength of their underlying balance sheets?
A: I suppose Brexit has been a big influence on UK equity markets really since the referendum in June 2016. Over the last two and half years Small Cap markets are pretty flat overall. Valuations have compressed; UK markets are out of favour. In terms of small company valuations the average multiple this year about 11-times earnings, which I think, in the context of history, is very cheap. [Valuations] haven’t changed a lot, but I think the UK equities are cheap from an international and an historic basis.
I think that you could look at the UK company or UK corporate position currently, and see it's actually pretty strong; balance sheets are actually very robust. I think the lessons were really learned from the 2008/2009 crisis when leverage was far too high going into the downturn. Management teams have responded to that and actually leverage is much lower than it has been historically. So actually the corporate health of the UK is actually pretty good. If you look at our portfolio, for example, 40% of the companies we own actually have net cash. So there is a lot of strength in balance sheets currently. It’s clearly a difficult economic environment to operate in but quite a lot of resilience from a financials perspective.
Q: The board of the Trust confirmed an increase in the annual dividend from 21p in 2018 to 23p in 2019; continuing a run of 10 years of consecutive annual dividend increases. Has that been a target for you and to what extent has the Trust’s dividend reserve been built up?
A: So the year just reported year to May 2019 we increased the dividend by 9.5% to 23p per share. That cements a very long running growth in the dividend; that has been 16 years of consecutive dividend increases. Over that period there has been a 27% compound growth in dividend.
So very strong dividend growth history from the Trust that essentially reflects the underlying growth of dividends in my portfolio companies.
We are kind of GARP style, we want the company to be growing, profitable, cash generative and paying dividends. So if they're paying high dividends, we'll pay high dividends to our underlying investors. 27% compound growth is pretty spectacular when it's about to continue into the future. But if our companies are growing then our dividend should grow too; so that story should continue. We've got a strong balance sheet with about 1.5 years of revenue reserves which means we've got a lot of stability in case things were to turn down.