UK ‘dislocation’: Schroder Income Growth makes first buyback in 16 years

UK equity income trust’s one share transaction is not much but, seen in the context of £100bn of company share buybacks and a surge in bids, it shouts the extreme value in domestic stocks.

Schroder Income Growth (SCF ) made its first share buyback in 16 years last month as the board of the UK equity income fund and ‘dividend hero’ sought to demonstrate its conviction in the portfolio run by Sue Noffke amid a sector-wide weakening in share prices.

The sole transaction involving 38,000 shares – now held in treasury for possible reissuance – is not much for an investment trust with nearly 69.5 million shares remaining, but it is significant in being the trust’s first purchase of its stock since 2008.

The board made its move on 16 April, buying the shares at 265.7p when they traded 12% below net asset value, wider than the trust’s average one-year discount of 7%.

Since then, they have rallied nearly 7% to 284p today, as the 13.6% geared fund has outpaced the 4% rally in the FTSE All-Share.

Fundamental value

‘This demonstrates your board’s confidence in the fundamental value of your company’s investments,’ said Ewen Cameron Watt, the trust’s chair, ‘and we will continue to buy back shares where such action materially enhances asset value per share.’

His statement came in half-year results showing the £219m listed trust lagged the All-Share, with a 1.9% investment return in the six months to 29 February compared with the benchmark’s 3.9%. Weak sales at luxury fashion retailer Burberry (BRBY) and an absence of turbo-recovery stock Rolls-Royce (RR) weighed on performance.

However, Watt said that Noffke, who runs the portfolio with Matt Bennison, had beaten the FTSE All-Share by 0.8% a year since taking on the trust in July 2011 and had consistently grown dividends, which are on track for their 28th consecutive annual rise.

The 4.8%-yielding trust has 11.4p per share in revenue reserves, equivalent to 86% of the annual payout, which Watt said the board would use to fund future dividend increases, even if these did not keep up with inflation in the short term. A slump in special dividends from mining companies means the total payout from UK companies is expected to fall this year.

Buybacks and bids

However, this decline should be seen in the context of a stunning increase in the amount of capital UK companies are returning to shareholders through share buybacks. Noffke (pictured above) said companies’ purchases of their shares had surged to a record £55bn in each of the past two years, up from a previous high of £34bn in 2018.

This was a logical response to the low valuations of UK stocks following years of disinvestment by domestic investors, with the average trading 25% below US counterparts.

‘Companies who feel their share price does not reflect the true value of the company are especially keen on share buybacks to enhance earnings per share, which should, all other things equal, boost the share price,’ she said.

This level of buybacks implied a 2.5% annual contraction in the £2tn UK stock market, she said.

The manager said this ‘dislocation’ was also evident in a spike in takeovers from overseas and private equity buyers. Last year saw 40 successful bids for UK companies over £100m at prices that were more than 50% higher than their pre-offer levels.

Noffke implied she could increase her holdings in smaller and mid-cap stocks, where about a quarter of the trust’s assets are held, saying valuations were particularly attractive after a three-year period in which FTSE 100 blue chips had outperformed small caps and mid-caps (SMIDs) by 25% and 31% respectively.

‘Historical trends indicate that periods of underperformance have often been followed by strong returns for SMIDs. The FTSE 250 Mid Cap index, in particular, has outperformed the S&P 500 index in local currency terms since 2000,’ she said in reference to the US stock market, where so many UK investors are now invested.

Tesco out, Diageo in

Among changes to the portfolio, Noffke and Bennison sold a longstanding position in Tesco (TSCO), which they said had done well through the pandemic and the subsequent inflationary period but remained in a ‘challenging’ and competitive sector.

The managers added four new positions, including a ‘modest’ holding in drinks giant Diageo (DGE) after a profits warning due to falling sales in Latin America that left the shares trading at their lowest valuation multiple in almost a decade.

Inchcape (INCH) was brought in as the car dealer continued to take market share from ‘independents struggling with debt and increasingly onerous demands from automotive manufacturers’.

Shares in artificial joints maker Smith & Nephew (SN) and British Land (BLND) were also bought as they looked good value, with the latter trading at a ‘material discount’ to asset value despite the ‘good prospects for occupancy and rental growth’.

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