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The Merchants Trust The Merchants Trust Benefits from announced debt refinancing Investment trusts 3 November 2017 The Merchants Trust (MRCH) adopts a long-term approach to investing in UK equities, aiming to generate an above-average level of income along Price 490.0p with long-term capital and income growth. The trust has announced a Market cap £533m refinancing of its first tranche of high-cost debt, which will bring its AUM £692m effective cost of borrowing down from 8.5% to 6.1%, saving £2.8m in annual interest costs and locking in low-cost funding for the next 35 years. NAV* 507.6p Discount to NAV 3.5% The board adopts a progressive dividend policy; annual dividends have NAV** 517.6p increased for the last 35 consecutive years and the current 5.0% yield Discount to NAV 5.3% compares favourably with the average of MRCH’s peers in the AIC UK *Excluding income. **Including income. As at 1 November. Equity Income sector. Yield 5.0% Ordinary shares in issue 108.7m 12 months Share price NAV* Blended FTSE All-Share FTSE 100 Code MRCH ending (%) (%) benchmark** (%) (%) (%) Primary exchange LSE 31/10/13 45.2 36.0 20.7 22.8 20.7 AIC sector UK Equity Income 31/10/14 (3.1) (2.6) 0.7 1.0 0.7 Benchmark FTSE All-Share 31/10/15 (2.0) 2.6 0.8 3.0 0.8 31/10/16 1.1 9.3 13.7 12.2 13.7 Share price/discount performance 31/10/17 21.5 15.5 13.2 13.4 12.1 500 0 Source: Thomson Datastream. Note: All % on a total return basis in GBP. *NAV with debt at 475 -2 Discount (%)Discount market value. **Blended benchmark is FTSE 100 Index until 31 January 2017 and FTSE All- 450 -4 Share Index thereafter. 425 -6 Shareprice 400 -8 Investment strategy: Bottom-up stock selection 375 -10 350 -12 Manager Simon Gergel is able to draw on the broad resources of Allianz Global Jul-17 Apr-17 Oct-16 Oct-17 Jan-17 Jun-17 Feb-17 Mar-17 Nov-16 Dec-16 Aug-17 Sep-17 May-17 Investors (AllianzGI) to construct a relatively concentrated portfolio of c 40-60 UK MRCH Equity Discount equities. While benchmarked against the FTSE All-Share Index, he adopts an Three-year performance vs index unconstrained approach, selecting stocks primarily on a bottom-up basis with 140 strong/improving fundamentals, which are trading on reasonable valuations. The largest overweight sector exposure is industrials, while there is a meaningful 120 underweight exposure to consumer staples, as the manager thinks that in 100 aggregate the stocks are unattractively valued. The board’s policy is to maintain 80 gearing in a range of 10-25% of net assets, at the time of drawdown. Jul-15 Jul-16 Jul-17 Oct-14 Apr-15 Oct-15 Apr-16 Oct-16 Apr-17 Oct-17 Jan-15 Jan-16 Jan-17 MRCH Equity Blended benchmark Market outlook: Time to be more selective 52-week high/low 492.6p 411.5p UK equity indices have been hitting new highs. Economic data have been more NAV* high/low 522.4p 455.4p positive than expected since the result of the UK’s European referendum, and *Including income. investors have been focusing on the improvement in corporate earnings and Gearing dividend growth rather than any potential future economic slowdown. Given a Gross* 22.2% positive re-rating, investors seeking exposure to UK equities may be rewarded by a Net* 19.8% fund investing in attractively valued companies, including turnaround situations. *As at 30 September 2017. Valuation: Scope for discount to narrow Analysts Mel Jenner +44 (0)20 3077 5720 MRCH’s current 5.3% share price discount to cum-income NAV with debt at market Sarah Godfrey +44 (0)20 3681 2519 value is towards the low end of the 3.1% to 10.9% range of the last 12 months and [email protected] compares to the averages of the last one, three, five and 10 years (range of 2.3% Edison profile page to 5.7%). There is potential for the discount to narrow as a result of the debt restructuring or if investment performance continues to improve. MRCH has a The Merchants Trust is a research progressive dividend strategy; annual dividends have increased for the last 35 client of Edison Investment Research consecutive years, and the current yield is 5.0%. Limited Exhibit 1: Trust at a glance Investment objective and fund background Recent developments The Merchants Trust’s investment objective is to provide an above-average level 23 October 2017: Pricing of £35m fixed rate, 35-year, secured private of income and income growth, together with long-term growth of capital, through placement note at 2.96%, effective 18 December 2017. investing mainly in higher-yielding large-cap UK companies. Since 1 February 26 September 2017: Interim report to 31 July 2017. NAV TR +9.9% versus 2017, the benchmark is the FTSE All-Share Index. benchmark TR +7.1%. Share price TR +6.8%. Second interim dividend of 6.2p declared (+3.3% year-on-year). 4 July 2017: First interim dividend of 6.1p declared (+1.7% year-on-year). 27 March 2017: Annual report to 31 January 2017. NAV TR +14.9% versus benchmark TR +21.4%. Share price TR +15.1%. Forthcoming Capital structure Fund details AGM May 2018 Ongoing charges 0.63% Group Allianz Global Investors Final results March 2018 Net gearing 19.8% Manager Simon Gergel Year end 31 January Annual mgmt fee 0.35% Address 199 Bishopsgate, London, Dividend paid Quarterly Performance fee None EC2M 3TY, UK Launch date February 1889 Trust life Indefinite Phone + 44 (0)800 389 4696 Continuation vote None Loan facilities See page 7 Website www.merchantstrust.co.uk Dividend policy and history (financial years) Share buyback policy and history (financial years) Dividends are paid quarterly in August, November, February and May. The Renewed annually, the trust has authority to purchase up to 14.99% and allot up annual dividend has increased for 35 consecutive years. to 5% of issued share capital. 25 30 24 25 20 24 15 24.2 DPS(p) 23 24.0 23.8 23.6 10 23.2 23 23.0 Costs/proceeds(£m) 5 22 0 2012 2013 2014 2015 2016 2017 2012 2013 2014 2015 2016 2017 2018 Full year dividend payment Repurchases Allotments Shareholder base (as at 30 September 2017) Portfolio exposure by sector (excluding cash, as at 30 September 2017) Alliance Trust Savings (13.6%) Financials (28.5%) Hargreaves Lansdown (10.9%) Industrials (17.2%) Rathbones (3.4%) Consumer services (13.9%) Brewin Dolphin (3.3%) Oil & gas (13.6%) Charles Stanley (3.2%) Utilities (8.2%) HSDL (3.1%) Healthcare (6.7%) Barclays (2.9%) Consumer goods (5.1%) Redmayne Bentley (2.9%) Basic materials (4.8%) TD Direct (2.6%) Telecommunications (1.9%) Other (54.1%) Top 10 holdings (as at 31 October 2017) Company Sector Portfolio weight % 31 October 2017 31 October 2016* Royal Dutch Shell 'B' Shares Oil & gas 8.2 7.6 GlaxoSmithKline Healthcare 5.9 7.3 BP Oil & gas 5.8 5.9 HSBC Banks 4.7 5.8 Lloyds Banking Group Banks 3.9 3.5 Standard Life Aberdeen Insurance 3.4 N/A BHP Mining 3.3 N/A UBM Media 3.1 4.3 Prudential Insurance 2.9 N/A Legal & General Insurance 2.8 N/A Top 10 44.0 47.1 Source: The Merchants Trust, Edison Investment Research, Bloomberg, Morningstar. Note: *N/A where not in October 2016 top 10. The Merchants Trust | 3 November 2017 2 Recent developments On 23 October 2017, MRCH announced that it had priced a £35m fixed rate, 35-year secured private placement note at an interest rate of 2.96%. The effective funding date is expected to be 18 December, with semi-annual interest payments due on 18 December and 18 June. The new note will rank pari passu with MRCH’s other secured debt and will be used to repay £34m of high- cost (11.125%) borrowings maturing in early January 2018. Exhibit 2: Effects of debt refinancing Fiscal year end 31 January 2017 2018 pro forma Gross debt £111m £112m Effective interest rate (ex-perpetual debt) 8.5% 6.1% Average duration 7.2 years 15.3 years First maturity January 2018 May 2023 Source: The Merchants Trust, Edison Investment Research As shown in Exhibit 2, the debt refinancing brings down MRCH’s average cost of debt and locks in long-term refinancing. Gergel says that the ability to borrow at c 3% and invest in the UK stock market, which is yielding c 4%, is a good long-term proposition for shareholders, as they will be better off even if there is no capital or dividend growth. Interest is charged 65% to the capital account and 35% to the revenue account, so the lower interest rate will save £1.8m and £1.0m in annual interest payments to the respective accounts. The manager says that extending the life of MRCH’s debt profile from seven to 15 years is important, as it ensures the manager is able to invest with a long-term view, as befits an investment trust that is nearly 130 years old. Fund profile: Investing for long-term growth MRCH was launched in February 1889, making it one of the oldest investment trusts listed on the London Stock Exchange. It is managed by AllianzGI, which has assets under management approaching €500bn.
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