Welcome to the latest update for The Merchants Trust PLC from the Trust’s portfolio manager, Simon Gergel.
Side Thoughts from Simon Gergel…
April saw the first day since the industrial revolution that no coal was used to generate electricity for the UK’s national grid. The Financial Times reported that around 34% of power was generated from renewable sources, citing strong winds, with 18% from Nuclear and 47% from gas. The end of coal generation, if only for a day at this stage, is an important milepost in the energy transition from fossil fuels to renewables.
When investing in energy companies it is important to understand this issue. Although there is much debate about when we will reach peak oil demand, we are likely to see rising demand for gas for many years into the future. It was notable just how much gas was needed to replace coal completely in the system for one day.
We expect to see a similar story to unfold in the future around the globe. Although renewable generation is growing quickly, more gas generation will also be needed to displace “dirtier” coal power and meet the rising demand for electricity.
Prime minister Theresa May called a snap general election for June, despite her previous assurances that she would respect the spirit of the Fixed Term Parliament Act and see out a five-year term. She seems to be taking advantage of weaker opposition parties in an attempt to increase the Conservative majority, citing critical Brexit negotiations in the next few months. The pound reacted immediately to this announcement, with a strong rally, from a depressed level. A number of explanations were suggested by commentators, including speculative positioning against the pound. The most likely explanation for a stronger pound is that a bigger Conservative majority will allow the government to negotiate with the EU without having to constantly fear parliamentary rejection from either “hard-Brexit” or “pro-Remain” MPs
The stockmarket was little changed in the last month, with the FTSE All Share Index returning -0.4%, although the more domestic mid cap FTSE 250 index rose by 3.8%, on hopes that a stronger pound will boost consumer confidence and spending, by reducing the inflationary pressures from import prices. Among the larger sectors, the strongest performers included financial services, real estate and those which are heavily exposed to the domestic economy, such as retail and travel & leisure. The weakest sectors included pharmaceuticals, oil & gas, mining and telecommunications.
The Trust’s NAV returned 0.25%, ahead of the benchmark return of -0.4%. Investment performance was also ahead of the benchmark. Hostelworld shares rose significantly, and it was the biggest contributor to the portfolio’s outperformance, following encouraging results at the end of March. Equiniti and Standard Life also performed well. On the negative side, GlaxoSmithKline, UBM and Centrica underperformed. Centrica, owner of British Gas, was impacted by fears of government intervention in the energy pricing market.
We made new investments in the engineering sector. Meggitt is predominantly an aerospace and defence group, with a large proportion of highly profitable aftermarket revenues. The company stands to benefit from rising production levels of new aircraft models, where it has increasing content. The shares have de-rated in recent years, partly due to competition for aftermarket services which the company is now addressing more directly. Meggitt trades on a modest valuation, which does not reflect its improving growth prospects.
We have also made a small investment in Morgan Advanced Materials. This is a diversified engineering company which has particular expertise in the electrical and thermal properties of carbon and ceramic materials for specialist applications. Under new management, the business is being simplified and restructured to drive efficiencies which can be reinvested into research & development and sales capabilities to accelerate organic growth. The shares offer an average market yield but the potential for upwards revaluation as the strategy delivers. Elsewhere, we added to BHP Billiton and Kier as both these shares came back to cheaper levels.
We sold a large part of the investment in the online youth hostel booking company, Hostelworld. The shares have now risen approximately 70% since their float in late 2015 as well as paying significant dividends, and the valuation is less attractive. We took money out of a number of shares that have rallied significantly since we added to positions at depressed levels in the wake of the Brexit referendum, namely; Marks & Spencer, Lloyds and Balfour Beatty. We also took profits on CRH, Carnival, Aviva and Inmarsat, and reduced Centrica, where risks are rising in the energy supply market.
As we have said for some time, we find the best value within the stockmarket in selected mega cap companies like the oil majors and GlaxoSmithKline, as well as among recovery situations, where investors are not always willing to look through shorter-term trading issues at the intrinsic value of a business. In recent months we have increased exposure to industrial sectors, where we see scope for end market recovery, especially within aerospace, which stands to benefit from the roll out of new civil aerospace platforms and potentially higher defence spending.
Simon Gergel is portfolio manager for The Merchants Trust
For the latest portfolio breakdown, performance, dividend information, please visit www.merchantstrust.co.uk.
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