The Scottish American Investment Company P.L.C. (SAINTS)
Legal Entity Identifier: 549300NF03XVC5IFB447
Regulated Information Classification: Interim Financial Report.
The following is the unaudited Interim Financial Report for the six months to 30 June 2022 which was approved by the Board on 27 July 2022.
Results for the six months to 30 June 2022
- SAINTS' assets have shown marked resilience against an uncertain backdrop over the first six months of 2022, holding up better than equities generally: SAINTS' net asset value total return (borrowings at fair value) was -7.6% over the first six months of 2022, whilst global equities* returned -10.5% over the same period.
- Over the past five years the Company has outperformed both global equities and its sector, delivering a net asset value total return (borrowings at fair value) of 65.6% against the market's* total return of 53.4% and the sector's unweighted average net asset value total return of 38.2%.†
- The Company has declared a second interim dividend of 3.40p. The second interim dividend is 10.6% higher than the equivalent dividend last year, growing ahead of UK CPI inflation which in June reached 9.4%.
- SAINTS' revenues per share over the period were 7.78p compared to 6.74p for the equivalent period last year. The growth of the Company's revenues in another challenging period has been helped by the Manager's emphasis on dependability and growth, and the robust underlying dividend growth of the Company's holdings.
- The property portfolio delivered a 5.9% return, with a significant contribution from the realisation of a property above its most recent valuation.
- The Company's £80m debenture, which bore a coupon of 8%, was refinanced on previously agreed terms in April. The overall cost of the Company's borrowings is now just below 3% per annum.
- To satisfy market demand the Company issued £4m of shares over the period at a premium to Net Asset Value.
- The Board and the Managers are optimistic about SAINTS' long term prospects for resilient dividend growth.
* FTSE All-World Index (in sterling terms)
† Source: Morningstar/Baillie Gifford and relevant underlying service providers. See disclaimer at end of this announcement.
Interim Management Report
SAINTS' assets have shown marked resilience against an uncertain backdrop over the first six months of 2022, holding up better than equities generally in a period in which the invasion of Ukraine by Russia, combined with rising inflation and interest rates, has led to a rapid decline in share prices as investors' risk appetite sharply reduced. SAINTS' net asset value total return (with borrowings at fair value) for the first six months of 2022 was -7.6%. This was ahead of the total return on global equities (-10.5%) as measured by the FTSE All-World Index. The share price total return was -13.0%, as the Company's share price moved from a premium to a modest discount to net asset value towards the end of the period.
The world economy still faces a great deal of uncertainty. It is at times like this that it is helpful to look back at the longer-term performance of the Company's portfolio to put this in context, and to look forward with confidence in the future growth prospects of the Company's equity holdings. During the past five years, we have seen the sharpest recession in the history of the world economy, rising political uncertainty and extensive business and travel shutdowns. Despite those challenges, the equity holdings in the Company's portfolio have delivered average compound annual growth in earnings per share of 9% per annum, well ahead of inflation over the same five-year period. Dividends from these equity holdings have also grown ahead of inflation.
Russia's invasion of Ukraine has triggered a large and sudden increase in energy and food prices. Combined with persistent supply chain issues and a still elevated demand in developed markets, this has led inflation to accelerate further and hit levels not seen for a very long time. With persistent, and accelerating inflation, Central Banks around the world have moved into tightening mode and raised interest rates faster than investors expected just a few months ago.
Leading the charge is the US Federal Reserve, which raised its benchmark rate by 75bp in June and hinted at further increases later this year. This was the largest increase in interest rates since 1994 and further evidence of a new era in Central Banking. The credibility of Central Banks, so essential to keep inflation expectations in check, is at stake.
In turn, investors have started to anticipate a sharp slowdown in economic growth, if not a recession, in the coming months. This is not a supportive background for financial markets in general, and both global equity and bond markets fell in the period.
The Company's equity portfolio showed negative returns but outperformed global equity markets. In relative performance terms, the absence of oil and gas producers from the portfolio – companies whose long-term outlook we are convinced remains poor – was a headwind, but it was more than offset by the strong performance of individual holdings.
Danish pharmaceutical company Novo Nordisk was a strong contributor to performance as its obesity drug remains in high demand in the US. This led the company to raise its revenue guidance for the year after the publication of its first quarter results. To make matters better, trial results released recently showed positive trial data for a once-weekly insulin product. If confirmed by further studies, the convenience provided by this new product would be the first real innovation in this market for nearly two decades.
Deutsche Boerse was another strong contributor as it benefited from increased market volatility and the associated volume growth in derivatives trading, a core business for the company. With large cash reserves in their settlement operations, rising interest rates are also a tailwind for the company.
In falling equity markets, consumer staples companies tend to be more resilient and the first half of 2022 was no exception. Pepsico and Coca Cola are two holdings whose share prices rose in the period, on the back of strong results. Both are a good illustration of what is happening with many companies in the portfolio: input costs are rising but the companies are able to raise prices without affecting demand much. Often price increases are achieved by managing their portfolio of products rather than raising the price of every product. And this is where innovation comes into play: by promoting new and healthier snacks at higher prices, Pepsico can raise the average price of its portfolio of products. This has led to some strong revenue growth rates for staples companies, with Pepsico and Coca Cola publishing organic growth rates of, respectively, 7% and 15%. Demand for their products is relatively insensitive to the economic cycle, which is precisely what makes them resilient holdings.
Some of the more cyclical companies in the portfolio, however, had a difficult first half. The Swiss alternative asset manager Partners Group is a good example: with market volatility and interest rates rising, investors were quick to assume lower demand for less liquid asset classes like the private equity funds that the group manages. Partners is an outstanding company with a long-term investment horizon and a very impressive track-record. Volatility may reduce demand for their products, but it will also create good investment opportunities for managers like Partners who are willing to take the long view.
Shares in the UK drinks company Fevertree declined after the company announced half-year results showing continued pressure on its operating margins due to rising input costs. Swedish industrial company Atlas Copco was another detractor as investors paid more attention to the negative impact of supply chain issues than to the very strong order book. In both cases we remain confident in their long-term growth prospects.
Portfolio Activity
In terms of key transactions in the first half of the year, we purchased new holdings in the US-listed software company Intuit and the French-listed beauty products company L'Oréal. These new purchases were funded by the sale of Kimberly-Clark de M é xico and UK insurer Hiscox.
L'Oréal is a global leader in the beauty industry. We are longstanding admirers of its management, who have an impressive track record of continued innovation, and the company has an anchor shareholder who helps the management remain focused on long-term success. We expect the company to continue compounding its revenue and earnings for many years, underpinned by market growth, market share gains and steady margin improvement. The shares have recently fallen significantly on macro-economic concerns, which has provided us with an opportunity to invest in the shares at an attractive valuation.
The other new holding, the software company Intuit, has two well-established products in the US: QuickBooks, an online accounting service for small businesses, and TurboTax, an online tax service for consumers. Over the next decade, we expect Intuit's online services to add more functionality, and with more and more insight into their customers, to develop these services into a core financial platform for their customers. We expect this to lead to strong revenue and profit growth for several years to come. With strong prospects for a resilient dividend thanks to the healthy cashflows generated, we believe that the company is a good fit for the Company's portfolio.
These new purchases were funded by the sale of Kimberly-Clark of México and Hiscox.
Kimberly-Clark de México is the leading manufacturer of nappies, tissues and other sanitary products in Mexico. Our investment case was based on the assumption that rising household incomes in Mexico would drive growth in spending on the company's products, both in volume terms and through increased pricing power. In practice, however, the company has struggled to grow its earnings due to sustained pressure on its input costs, limited success in gaining market share and the depreciation of the Mexican currency. With little prospect that these headwinds will reverse and better opportunities elsewhere in the portfolio, we have sold out of the company.
More recently, we have sold out of UK insurer Hiscox, as we have come to the conclusion that it is no longer an ideal fit for the Company's portfolio. The most challenging aspect is the volatility of Hiscox's dividend, which tends to be correlated with periods of economic stress. By investing the proceeds into some of the more robust companies mentioned above, we have upgraded the overall dividend resilience of the Company's equity portfolio.
Beyond equities
One advantage of being an investment trust is the ability to add a prudent amount of long-dated borrowings at fixed rates. The Company uses these borrowings to invest in a diverse portfolio of commercial properties, infrastructure companies and fixed income securities, with the goal of generating returns above the cost of borrowing, to the benefit of shareholders.
This task has become considerably easier, as in April new long-term private placement debt of £80m replaced SAINTS previous debenture, which had borne a coupon of 8%. The overall cost of the Company's borrowings, including the further £15m of private placement debt which was added in April 2021, has now fallen to just below 3%. The opportunity set of potential investments which would yield more than the Company's cost of borrowings has therefore increased significantly.
During the first half of the year the property portfolio delivered a total return above 5%. One property was sold during the period, being the industrial warehouse in Basingstoke at a price more than 20% above the valuation at the end of 2021. Through the remainder of this year, the property manager is anticipating a difficult backdrop for commercial property valuations due to rising interest rates and slowing economic growth, and has been strengthening the portfolio accordingly. Inflation linkages in the portfolio's rental contracts remain strong, and the portfolio continues to have no voids.
The infrastructure companies delivered a total return above 6%. In a slowing economy with rising inflation, the value of infrastructure assets such as those managed by Terna, the Italian grid network, was increasingly evident to investors and this supported valuations. The dividend yield of the Company's infrastructure investments continues to exceed the Company's cost of borrowings.
The return from the fixed income portfolio was very slightly positive during the first half of 2022. The most notable contributions came from the early redemptions of two bond holdings, issued by Cogent Communications and First Quantum. Both redeemed at prices above par. We continue to look for opportunities to generate attractive returns from bonds where the risk is low because the underlying issuer is, in our view, well-managed and cash generative, much like these two companies.
Outlook
Since the start of 2022, we have seen a number of SAINTS' equity holdings announce quarterly results. So far we have seen little to suggest that SAINTS' holdings are being de-railed by the war in Ukraine, or the rise in inflation rates, or the increase in central bank rates, or the collapse of cryptocurrencies. The Company's holdings have been selected in part because we believe their resilience is unusually strong, for example with debt ratios far lower than the average company, cash flows that tend to be less volatile, and growth prospects that are significantly stronger than the average company.
We remain optimistic that over the long term the future of the Company's holdings, and the potential for inflation-beating growth in their earnings, remains strong. Underpinned by this earnings growth, the Board and the Managers remain confident in SAINTS' long term prospects for resilient dividend growth.