Dividend Crisis: Mangled Merchants insists payout will rise, but Troy set for cut

Merchants, the high-yielding portfolio of UK value stocks, reiterates determination to grow its dividend after painful half-year of declines, while rival Troy Income & Growth flags up near certainty of a cut.

Merchants (MRCH ), the high-yielding portfolio of UK value stocks, has reiterated its determination to keep growing its dividend after a painful half-year saw its shares drop by a third, while rival Troy Income & Growth (TIGT ) has flagged up the near certainty of a dividend cut next year as it seeks to curb losses from the pandemic.  

Merchants fund manager Simon Gergel acknowledged ‘some of the most volatile and challenging investment conditions’ of his career as interim results for the £403m UK equity income trust showed shareholders experiencing losses almost twice as severe as the wider UK market during the coronavirus pandemic’s first wave.

The trust also faces questions over the sustainability of its record as a leading ‘dividend hero’, with a lofty 8% yield to maintain if it is to extend its 38-year record of consecutively rising payouts.    

In the six months to the end of July covered by the results, shareholder total returns fell 34.3% compared to the 17.8% decline for the FTSE All-Share index, as lockdown upended the high-yielding strategy.

Gergel identified the trust’s gearing, or borrowing, as a major factor in the outsized losses.

Merchants entered the period with gearing, which amplifies both positive and negative returns, standing at 15%. That had actually been cut by its board from just under 20% six months prior, preventing an even worse result.

Without gearing, the portfolio would have fallen 25.5% over the six months, the company said.

By the end of July, gearing was back around 19%, with Gergel (pictured) reiterating its potential to enhance long-term total returns.  

Otherwise, the Allianz Global Investors fund manager said his positions in economically exposed ‘cyclical’ stocks drove the underperformance, with industries like travel, leisure and aerospace almost shutting down, along with ‘value’ stocks becoming even more unloved.

Housebuilder Vistry (VTY), Aerospace company Meggitt (MGGT) and bus firm National Express (NEX), where the stake has been reduced, were the worst-performing holdings over the half year. 

Compared to the index, however, not owning the strongly-performing AstraZeneca (AZN) took the most away from relative performance. While competitor GlaxoSmithKline (GSK) is Merchants’ top holding, Gergel said shunning Astra was partly due its high valuation.

The best performing holdings over the six months were spread betting firm IG Group (IGG) and Stock Spirits (STCK). Some profits have been taken on the latter, a leader in vodka in eastern Europe.

With buys and additions, Gergel said he had tried to reduce the portfolio’s sensitivity to economic conditions amid the downturn, as well as boost the income potential.

Tobacco companies have risen back to the top of the holdings list behind Glaxo. British American Tobacco (BATS) and Imperial Brands (IMB) were 4.9% and 4.7% positions respectively at the end of July, after Gergel added to the stocks.

The manager also bought into BT (BT.A) and Vodafone (VOD), with valuations depressed though the telecoms sector should be resilient during the recession.

After reducing the stake in Shell (RDSB) following its landmark dividend cut, they bought high-yielding Diversified Gas and Oil (DGOC). Vistry was also jettisioned in favour of fellow housebuilder Bellway (BWY), which has lower debt.

Gergel picked out several companies in the portfolio they had taken advantage of market volatility to add to, including DFS (DFS) and WPP (WPP). Next (NXT) was a new buy, with the manager noting its successful transition to online retail and track record of repositioning itself.

Complete sales included insurer Prudential (PRU) and German property specialist Sirius Real Estate (SRE) due to their economic sensitivity, and events company Informa (INF) with the pandemic fundamentally impacting its business. 

Some profits have been taken on other stocks which have done relatively well, including copper miner Antofagasta (ANTO) and PZ Cussons (PZC), the maker of Imperial Leather soap.

Income challenge

Gergel said it had been ‘particularly challenging’ to deliver a high income stream this year as dividend cuts had swept the FTSE, adding the trust had been writing more call options to generate extra income.

Earnings over the six months were 8.9p per share, a decrease of 45% from 16.1p per share in the same period last year.

While the manager mulled a ‘new normal’ level of dividends for certain companies, Merchants’ board reiterated its commitment to a ‘high and growing yield’ – a goal which looks under increasing pressure – backed up by revenue reserves. 

While reserves covered more than one year’s total dividend at the end of the last financial year, analysts have questioned previously whether those reserves are as strong as the accounts make out, once the timing of the trust’s dividend payments is factored into the equation. By the end of July, reserves had fallen to 22.6p per share, from 28.8p a year prior, meaning they no longer cover a full year’s dividend payment. 

Troy’s ‘almost certain’ cut

Separately, Troy Income and Growth (TIGT ) took another opportunity to remind investors it was ‘almost certain’ to cut its dividend next year, as the board declared an unchanged fourth interim dividend of 0.695p per share in respect of the its financial year just-ended . 

Co-manager Hugo Ure told Investment Trust Insider previously that the constitution of the UK market’s dividend would change post-pandemic, with the trust responding early to a lower overall yield on the FTSE.

The 3.9%-yielding £250m investment trust shares a spot with Merchants in the Association of Investment Companies’ UK Equity Income sector, but represents a very different proposition, with more of a tilt to lower-yielding ‘quality’ stocks like Reckitt Benckiser (RB).

Over one year, Troy has been better served by its approach, with shareholders total returns of -11.6% versus -26.6% for Merchants and -16.6% for the FTSE All-Share. Over half a decade, those returns stand at 23% for Troy, 6% for Merchants and 19% for the index.

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