Investec upgrades Merchants as it cuts dividend no-shows

(Update) Merchants fund manager Simon Gergel cuts companies that have been sluggish in resuming dividends while Investec upgrades the UK equity income trust after its rebound in the value rally.

With dividends down during the pandemic, Merchants (MRCH ) fund manager Simon Gergel has been ruthless in repositioning defensively and cutting stocks that he thinks will take too long to resume distributions.

The 132-year-old trust has increased its dividend for 39 consecutive years with the most recent year being no exception despite the onslaught of the coronavirus outbreak that stung performance.

The board proposed a final quarterly distribution of 6.8p, making a full-year dividend of 27.2p, with a 0.1% increase ensuring it maintained its nearly four decade record of unbroken increases that have seen the UK equity income trust become an Association of Investment Companies ‘dividend hero’.

Gergel said last year was ‘tough for markets and especially for dividends’ with a 38% decline in corporate earnings being reflected in a fall in pay-outs at around the same level.

Dividends that were suspended or cancelled are slowly being reinstated and Gergel said balance sheets are ‘better than we thought they might be’, but that doesn’t mean all dividends have bounced back. Gergel has had to re-evaluate his positions and shed some stocks in the £634m trust where he believes a return to normal levels of payments will not happen anytime soon.

He said he ‘repositioned the portfolio more defensively’ and prioritised income.

‘The first thing we did in the pandemic shock is realise we had a pro-cyclical position,’ he said.

‘When we had the Conservatives win a majority [in 2019] and we had a stable government with the ability to push through legislation, we thought the economy would do well but clearly that was too aggressive going up to the pandemic and we tried to be more defensive and bolster income.’

This defensive about-turn included buying Vodafone (VOD) and ditching events group Informa (INF).

Other stocks have been replaced due to structural concerns caused by the pandemic.

‘We sold high leverage businesses and where we thought [pandemic] changes to the business had been material, like Informa,’ he said. ‘Everyone has got used to doing things via Zoom and there will be fewer people at trade shows, so we decided to move out of that company.’

In that spirit, Gergel (pictured) switched out of engineer Senior (SNR), which specialises in aerospace engineering, as he was concerned about the impact travel bans will have on its ability to restart its dividend.

The group has made no decision about the fate of its payout and slumped to a loss of £177m in 2020 from a £62m profit the year before.

‘I would not say the dividend will not come back, it will eventually but it will be a long time before travel is back and Senior is back. That will be a long recovery,’ he said.

He said that the share price was ‘too depressed’ to sell in the early months of the pandemic but it ‘recovered well and we exited at a sensible price’.

Gergel has instead switched into engineering peer Meggitt (MGT) despites its equally poor showing last year. It cancelled its 2020 dividend after swinging to a pre-tax loss of £334m.

While Gergel admitted the businesses were similar, he was more optimistic about Meggitt due to its defence division.

For similar reasons to Senior, he has sold National Express (NEX), which has given the vague indication that it will reinstate its dividend when the UK economy improves.

‘It is a very strong business and it will recover but it will be quite a while before the dividend comes back to the level where it was before,’ he said.

While the vaccine announcement was a boost to value stocks and those that will benefit from a reopening trade, value manager Gergel is still being cautious.

‘We have seen pause in the growth-to-value rotation. It can go further because the polarisation [between growth and value] is still there and the trajectory for interest rates is probably up rather than down. It will continue but not at same pace,’ he said.

Investec impressed

That has not discouraged Investec analyst Alan Brierley (pictured), a long-standing bear on Merchants, who reversed his previous ‘sell’ stance to update it to a ‘hold’ after the full-year results.

Brierley has been encouraged by Merchants replacing its expensive, long-term debts, giving it more income to support its high 5.4% dividend yield and flexibility to pick growthier stocks, even as the ‘value’-style portfolio enjoyed the rotation away from growth stocks since November.

In the past six months, the shares have shot up 45%, way ahead of the FTSE All-Share’s 25%, generating almost half of the less impressive 109% total return over 10 years, which reflects how the trust was previously held back by its investment style and high borrowing costs.

‘The big question now is what comes next?’ Brierley asked in a note to investors, before giving his answer.

‘While history doesn’t repeat, we highlight that Merchants experienced a similar
explosive period of outperformance as markets embarked on their recovery phase in March 2009, and this continued, albeit at a more modest rate, until the summer of 2013, when the relative performance peaked.’ 


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