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‘Good value’ Montanaro eyes wide discount after divi hike

8 July 2019

Rocky stock markets frustrate bid by Montanaro UK Smaller Companies to re-rate its shares after hiking dividends last year.

Rocky stock markets have frustrated a bid by Montanaro UK Smaller Companies (MTU) to re-rate its shares by hiking dividends last year, with outgoing chairman Roger Cuming describing them as ‘good value’ when they ended its financial year in March on an 18% discount.

Since then the gap between MTU’s share price and net asset value (NAV) has narrowed to its one-year average of 14%. Still this is wider than the 9% average of UK smaller companies trusts and is a far cry from what the trust hoped from last July when it replaced its annual dividend with a pledge to pay 1% of assets each quarter.

The move to ramp up the dividend policy more than doubled its yield to around 5% and initially had the desired effect, drawing in investors with the discount on the £188 million trust narrowing from around 20% to 6% in 2018.

The higher yield also shielded investors from some of the stock market in the fourth quarter of last year. On a total return basis, including dividends, MTU shareholders saw their stakes fall 8% while the underlying portfolio dropped nearly 18%, according to Morningstar data.

However, this year the discount has widened again as the shares have not kept up with the rebound in markets or the recovery in its NAV. Shareholders made a total return of 9.5% in the first six months of the year behind a 15% increase in the underlying portfolio managed by Charles Montanaro, according to Morningstar.

The widening discount may partly reflect investor recognition at what is now a higher but more volatile dividend. The first three quarterly payments under the new policy have been 1.43p in November, 1.17p in February and 1.29p in May, reflecting the rise and fall in NAV.

Last month’s annual results showed dividends jumped 77% to 3.9p per share from 2.2p in the previous 12 months. Revenue per share was flat at 2.5p which meant the distributions were uncovered with the remainder coming from the trust’s capital reserves.

The trust also narrowly outperformed its benchmark with NAV total returns of 0.5%, while its share price saw a loss of 1.1%, versus a 1.2% fall in the Numis Smaller Companies index.

Citywire A-rated manager Montanaro has succeeded in improving performance since his return to day-to-day management in 2017 with a second consecutive financial year of outperformance.

Nevertheless over five years the trust sits in the bottom half of the AIC UK Smaller Companies sector with a 38.2% total shareholder return below the peer group average of 70.4%. 

The recent improvement in performance and the relatively wide discount - which so far have not prompted any share buybacks by the board - have attracted wealth manager Rathbones, which this month emerged with a 7% stake. Its arrival follows discount hunter 1607 Capital Partners cutting its holding from 10% to 4.7% last month, stock exchange announcements show.

Montanaro said the full-year performance was influenced by the ‘see-saw ride’ in markets, as Brexit uncertainty and market panic at the end of 2019 weighed down ‘small-cap’ shares.

A 12% revival in NAV in the first quarter of this year was helped, said Montanaro, by a tactical increase in borrowing, or gearing, which he lifted from 0.5% to 6.2%. ‘Fortunately, this proved to be well-timed as equity markets have performed strongly since the New Year,’ he said.

Montanaro looks for high quality companies with strong growth prospects and sound balance sheets. At the end of March, his top holding with a 3% weighting was Marshalls (MSLH), the paving specialist; followed by Entertainment One (ETO), the TV production company behind children’s character Peppa Pig.

The fund manager said UK small-cap shares were trading well below their long-term average on 12.6 times earnings or profits, which was 5% less than FTSE 100 companies and 20% cheaper than European smaller companies.

‘History suggests that now might not be a bad time for sterling investors to address significant underweighting to the UK,’ he said.

‘We would not be surprised to see an increase in mergers and acquisition activity as overseas trade buyers take advantage of attractively valued UK companies made even more enticing by a weak pound,’ added Montanaro.

Cuming, who has been on the board since 2009 and chairman since 2016, will be replaced by Arthur Copple, who joined the board in 2017, in July.

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