Montanaro European Smaller Companies

The Board of Montanaro European Smaller Companies Trust plc (the "Company") announces the unaudited half-yearly results of the Company for the six months ended 30 September 2023.

Highlights

Performance

Sources: Morningstar Direct, Association of Investment Companies ('AIC'), Montanaro Asset Management Limited.

Chairman's Statement

Performance

The first six months of the financial year saw a weak period of absolute and relative performance for your Company. The Net Asset Value fell by 12.5% to 138.5p per share, underperforming the Benchmark (MSCI Europe ex-UK SmallCap index), which fell by 7.5%.

At the end of the period, the discount was 13.8% versus 13.1% at the start. As a result, the share price fell by 13.2% during the period, providing a total return of -12.7%. The Board recognises that while it is not out of line with the peer group, the level of discount is high. The Board will continue to monitor the discount closely and stands ready to act should it deemed to be in the interest of shareholders.

This is a disappointing performance but one which is not unexpected given the environment: "growth" companies have underperformed "value" and high quality companies have underperformed low quality. Montanaro seeks to invest exclusively in high quality, growing companies and so these style shifts acted as a significant headwind during the period.

Montanaro take a long-term approach to investing and despite this difficult period, over 5 and 10 years your Company has delivered NAV per share total returns of 35.0% and 171.5% respectively, outperforming the benchmark by 17.0% and 39.4%. Since Montanaro were appointed in September 2006, the NAV total return has been 380.0%, 123.1% ahead of the benchmark.

These returns have been delivered through consistent application of Montanaro's investment process, even in times when their quality growth style has been out of favour. The Board believes this approach provides the best possible foundation for your Company to deliver superior long-term returns in the future, as it has in the past. Montanaro have been able to successfully weather multiple economic cycles and take advantage of periods of high market volatility over the past 30 years. We believe this time will be no different.

Earnings and Dividends

Revenue earnings per share rose to 1.37p in the period (2022: 1.02p). The Board has declared an interim dividend of 0.225p per Ordinary Share (2022: 0.2p per share) payable on 26 January 2024 to shareholders on the register on 22 December 2023. This increase is being proposed both to reflect the timing of when revenues are received and to provide a better balance between the interim and final dividends.

Borrowings

At the end of the period, the Company had gearing, net of cash, of 2.2% compared to 3.3% at 31 March 2023. During the period, the Company's borrowings in the form of a €10 million fixed rate loan and a €15 million revolving credit facility matured. The Board has replaced these facilities with a new €10 million fixed rate loan and a new €15 million revolving credit facility, both of which are due to mature on 13 September 2026.

Outlook

Smaller companies have had a torrid time in recent years. In Continental Europe, they have underperformed their larger counterparts by more than 17% over both three- and five-year periods. Despite this, they have outperformed significantly over longer time periods.

The chart below shows the P/E ratio of small companies versus the P/E of the wider market in Continental Europe over the last two decades. For most of this period, small companies have traded at a higher P/E than the wider market, but they have recently moved to a discount. At the end of October 2023 they were trading at levels previously only seen in times of extreme stress. This suggests that small companies look cheap when compared to their larger counterparts.

MSCI Europe ex-UK Small Cap v. MSCI Europe ex-UK - 12 month forward P/E

Source: Montanaro Asset Management, MSCI, FactSet.

Note: Thick red line = average +2 standard deviations (dashed red line = average + 1 standard deviation). Thick green line = average -2 standard deviations (dashed green line = average -1 standard deviation). Black line = average.

Small companies also look cheap relative to their own history: at the end of October 2023, the MSCI

Europe ex-UK SmallCap Index was almost two standard deviations below its long-term average P/E.

MSCI Europe ex-UK Small Cap - 12 month forward P/E

Source: Montanaro Asset Management, MSCI, FactSet.

Note: Thick red line = average +2 standard deviations (dashed red line = average + 1 standard deviation). Thick green line = average -2 standard deviations (dashed green line = average -1 standard deviation). Black line = average.

It is historically unusual for quality growth companies to underperform during bear markets. Usually as recessionary fears rise and markets fall, investors seek the sanctuary of companies with high recurring revenues, defensive end markets and strong balance sheets. This time has been different because the drawdown in stock prices has been predominantly driven by a rapid rise in inflation and interest rates.

It remains to be seen what the future trajectory of interest rates will be but it is clear from listening to companies on the ground that the effects are now being felt in the "real" economy.  Companies with stretched balance sheets are finding it increasingly difficult to roll over their debts, which heightens the risk of corporate defaults. However, we believe that your companies are well insulated from the risk of balance sheet stress, as nearly half of the portfolio has net cash on the balance sheet and the average Net Debt / EBITDA ratio for 2023 is a mere 0.3x.

As the high quality, structurally growing companies in which your Company invests are well suited to more difficult economic environments, we would expect investors to start re-appraising the relative attractiveness of the Company's portfolio.  This, coupled with highly attractive valuations for the asset class, means that we can look forward to the future with confidence.

Portfolio Summary

Twenty Largest Holdings

As at 30 September 2023

Geographical Analysis

As at 30 September 2023

Source: Montanaro Asset Management Limited

Sector Analysis

As at 30 September 2023

Source: Montanaro Asset Management Limited

Interim Management Report

The important events that have occurred during the period under review and the key factors influencing the financial statements are set out in the Chairman's Statement above.

Statement of Principal Risks and Uncertainties:

Most of the principal risks that could threaten the Company's objective, strategy, future returns and solvency are market related and comparable to those of other investment trusts investing primarily in quoted securities. The principal risks faced by the Company are investment and strategic, gearing, financial, discount volatility, regulatory, operational, cyber security, ESG and manager risks. These risks and the way in which they are mitigated are described in more detail under the heading 'Principal and Emerging Risks and Uncertainties and Risk Mitigation' within the Business Model and Strategy section on pages 14 to 17 of the Company's Annual Report for the year ended 31 March 2023. The Company's principal risks and uncertainties have not changed materially since the date of that report and are not expected to change materially for the remaining six months of the Company's financial year.

Related Party Transactions:

Related party transactions are disclosed in note 13 below. There have been no material changes to the related party transactions described in the last Annual Report.

Going Concern:

The Directors are satisfied that the Company has sufficient resources to continue in operation for the foreseeable future and for a period of at least 12 months from the date of this report. Accordingly, they continue to adopt the going concern basis in preparing the condensed financial statements.

Directors' Responsibility Statement in respect of the Half-Yearly Report

We confirm that to the best of our knowledge:

·      the condensed set of financial statements have been prepared in accordance with IAS 34 'Interim Financial Reporting' and give a true and fair view of the assets, liabilities, financial position and profit or loss of the Company;

·      the Interim Management Report includes a fair review of the information required by the Disclosure Guidance and Transparency Rule ('DTR') 4.2.7R, being an indication of important events that have occurred during the first six months of the financial year and their impact on the financial statements;

·      the Statement of Principal Risks and Uncertainties shown above is a fair review of the information required by DTR 4.2.7R; and

·      the Chairman's Statement, together with the condensed set of financial statements, include a fair review of the information required by DTR 4.2.8R, being related party transactions that have taken place in the first six months of the financial year and that have materially affected the financial position or performance of the Company during the period, and any changes in the related party transactions described in the last Annual Report that could do so.

The Half-Yearly Report and Accounts were approved by the Board and the above responsibility statement was signed on its behalf by:

R M CURLING

Chairman

11 December 2023