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Half-year Report

Released 17:22 24-Jul-2017

Half-year Report

HALF YEARLY REPORT

Performance

During the six month period to 30 June 2017 Temple Bar generated a total return on gross assets of 3.53%, underperforming the benchmark FTSE All-Share Index total return of 5.50%.

The portfolio benefitted from its holdings in builder’s merchant Grafton which performed well on the back of earnings upgrades driven by excellent operational performance in Ireland, and SIG which, following the appointment of new management, bounced back strongly. Notable holdings that detracted from performance were Signet Jewelers, hindered by weakness in malls across the US and concerns regarding its loan book, Barclays which announced results weaker than expected, and Tesco whose bid for food wholesaler Booker worried investors that a reasonably straightforward recovery story had been made unnecessarily complex.

Market background

In recent years, the success of different styles of equity investing has become a slave to bond yields with, in general, Value investors, including Temple Bar, finding progress hard when bond yields have been low and falling. We would therefore expect any significant increase in yields to reverse this trend swiftly; should it occur, many investors are poorly placed for such a reversal.

The language of central bankers modified in late June with hints of a reversal of Quantitative Easing (QE – the printing of money to purchase bonds) and the requirement for higher interest rates as advanced economies return to more normal conditions.

In briefings, the central bankers have raised a number of issues: 1] significant increases in asset values may have created false prices and driven mis-allocation of capital; 2] the effects such increases have had on wealth inequality; 3] the unknown long-term inflationary effects of loose monetary policy; 4] unemployment is falling, possibly to a level which would stimulate inflation; 5] interest rates need to be higher ahead of the next recession.

Markets shrugged off this change in tone, believing either the central bankers were all talk or that any weakness in markets following implementation of this strategy would quickly force its cessation (or even reversal).

While we would prefer to sideline banker/market noise, and focus on picking individual stocks from detailed bottom-up analysis, we cannot ignore the changing attitudes of central bankers.  Their previous decisions have driven bond and equity markets to very high valuation levels, and investors should be alert to the likely consequences of a change of tack.  We identify three scenarios.

Scenario 1: interest rates rise across the yield curve and QE is reversed, with no significant effect on economic growth.  We believe this would depress asset markets.  After all, if interest rates return to historical levels, equity ratings should also revert to long-term norms.  However, it is unclear whether the monetary authorities have the nerve to watch bonds and equities fall without acting.

Scenario 2: rising interest rates slow economic growth, dampening inflation expectations.  This would probably be good for government bonds and for asset classes with valuations most closely linked to bond yields.  Precious metals might also benefit if markets worry that central

banks would find difficulty in unwinding QE. This scenario implies a continuation of low interest rates, low inflation, sub-par economic growth and no significant increase in government spending.  However, around the western world politicians have recently been left in no doubt of voters' resentment of the status quo. As this scenario appears to be unsustainable, we should prepare for scenario 3.

Scenario 3: if central banks fail to increase rates and reverse QE while inflation falls and/or there is an equity market crisis, markets may price in the risks of further QE or, more likely, increased government spending.  Or governments may authorise the creation of helicopter money (ie money printed specifically to be used for increased government spending - a neat blend of monetary and fiscal policies). We assume this would be a very good outcome for precious metals, a bad outcome for bonds (as investors would suspect that governments are desperate to generate inflation) and a mixed outcome for equities.  We believe equities most closely correlated to bonds would struggle, relative to those less sensitive to interest rates.

The portfolio, although not purposely constructed for this outcome, is best placed for scenario 3.  We believe, broadly, that markets are approaching the end of an era.  The long-term trend of globalisation has had very deflationary effects and, combined with extreme monetary policy, has driven bond yields down to very low levels. The current mood among electors and politicians suggests that the globalisation trend of the last few decades could give way to trade barriers, tariffs, protectionist policies and restricted movement of labour, plus greater use of fiscal policy. The consequence of scenario 3 is likely to be a more inflationary future and one, with government debt so high, which the authorities would welcome. 

Portfolio changes

Our new era views are reflected across the portfolio and in the activity of the last six months. We sold out completely from our tobacco holdings BAT and Imperial Brands, the last of our ‘bond proxies’. Both companies have a number of attractive operational and financial characteristics but, we believe, they were more than adequately reflected in the share prices.

The weighting in the bank sector remains the portfolio’s largest. We believe the market underestimates the changes banks have made to their operating models over the last decade. The high growth and weak and aggressively financed balance sheet approach has been replaced by one focused on low growth and a strong and conservatively financed balance sheet. Although investors typically regard regulatory interference with caution, we believe the regulators’ actions since the Global Financial Crisis significantly reduce the downside risks for equity holders in banks. This downside resilience together with the low valuations of the banks continue to provide us with confidence that they remain undervalued.

We did, however, decide to sell our holding in Lloyds Banking Group. We believe the business has a number of challenges. It has a significant exposure to very profitable variable rate mortgages (vulnerable to both competition and regulation) and has grown quickly in personal and car loans at a time when the UK consumer is under increasing financial pressure. Although we are fairly sanguine about bank regulation overall, we believe Lloyds could be affected by further changes as its mortgage book is currently considered as very low risk. New regulation may demand more capital is held against this book and consequently reduce dividend expectations for the company.

The portfolio retains a significant weighting towards the UK consumer, mostly through holdings in banks, retailers, travel and leisure companies and builder’s merchants. Many UK consumer focused companies are finding trading conditions tough and as Brexit is negotiated there is a clear risk of further deterioration. However, valuations and performance of these stocks reflect a lot of bad news particularly when compared with other areas of the market. We retain some dry powder as absolute valuations remain rather high for our taste. Within the consumer sector

we increased our holding in US jewellery retailer Signet and clothing retailer Next although we did sell our holdings in Best Buy (it having recovered from some self-induced woes) and Sainsbury (our hypothesis of weakness in the discounter market did not play out as expected).

Dividend

A first quarterly dividend of 8.33p per share was paid on 30 June 2017 and the directors have declared a second interim dividend, also of 8.33p per share, an increase of 3%, to be paid on 29 September 2017 to those shareholders on the register of members as at 8 September 2017. The ex-dividend date for this payment is 7 September 2017.

Outlook

The changes underway in central bank attitudes and actions, after nearly a decade of ultra-accommodative policies, may well unsettle markets, leading to a re-appraisal of valuation criteria and enhanced volatility. In such an environment, where predictions become unreliable, strict adherence to our value investing approach becomes more important than ever. The general performance of the value investing style, compared with alternatives, hinges critically on an increase in interest rates towards more historical levels of normalcy.

By order of the Board

Investec Fund Managers Limited

24 July 2017

TWENTY LARGEST HOLDINGS AS AT 30 JUNE 2017

Company Industry Place of Primary Listing Valuation
£’000
% of Portfolio
UK Treasury 1.00% 2017 Fixed Interest UK 139,214 14.11%
HSBC Holdings Financials UK  81,451 8.25%
GlaxoSmithKline Healthcare UK  68,531 6.95%
Grafton Group Industrials UK  52,944 5.37%
Royal Dutch Shell Oil & Gas UK  51,884 5.26%
Barclays Financials UK  46,527 4.71%
BP Oil & Gas UK  44,560 4.52%
SIG Industrials UK  38,286 3.88%
Royal Bank of Scotland Financials UK  30,468 3.09%
WM Morrison Supermarkets Consumer Services UK  28,715 2.91%
Top Ten Investments  582,580 59.05%
CitiGroup Financials USA  24,838 2.52%
Marks & Spencer Consumer Services UK  22,400 2.27%
Tesco Consumer Services UK  21,808 2.21%
ETFS Physical Silver Physical Gold and Silver UK  20,257 2.05%
Travis Perkins Industrials UK  19,692 2.00%
Signet Jewelers Consumer Services USA  18,705 1.90%
Centrica Utilities UK  17,769 1.80%
CRH Industrials UK  17,491 1.77%
Global X Silver Miners ETF Basic Materials USA  17,383 1.76%
Direct Line Insurance Financials UK  16,586 1.68%
Top Twenty Investments  779,509 79.01%

STATEMENT OF COMPREHENSIVE INCOME FOR THE SIX MONTHS ENDED 30 JUNE 2017 (unaudited)

30 June 2017
(unaudited)
30 June 2016
 (unaudited)
31 December 2016
 (audited)

Revenue
£’000

Capital
£’000

Total
£’000

Revenue
£’000

Capital
£’000

Total
£’000

Revenue
£’000

Capital
£’000

Total
£’000
Investment income 18,985 - 18,985 18,969 - 18,969 34,069 - 34,069
Other operating income 4 - 4 4 - 4 5 - 5

Total Income
18,989 - 18,989 18,973 - 18,973 34,074 - 34,074
Gains on investments
Gains on investments held at fair value through profit or loss assets - 17,767 17,767 - 14,550 14,550 - 128,792 128,792
18,989 17,767 36,756 18,973 14,550 33,523 34,074 128,792 162,866
Expenses
Management fees (699) (1,048) (1,747) (596) (893) (1,489) (1,380) (1,990) (3,370)
Other expenses including dealing costs (353) (511) (864) (344) (609) (953) (633) (1,039) (1,672)
Profit before finance costs and tax
17,937

16,208

34,145

18,033

13,048

31,081
32,061 125,763 157,824
Finance costs (1,308) (1,980) (3,288) (1,311) (1,992) (3,303) (2,645) (4,012) (6,657)
Profit before tax 16,629 14,228 30,857 16,722 11,056 27,778 29,416 121,751 151,167
Tax (108) - (108) - - - (163) - (163)
Profit for the period 16,521 14,228 30,749 16,722 11,056 27,778 29,253 121,751 151,004

Earnings per share (basic and diluted)

24.71p

21.28p

45.99p

25.01p

16.53p

41.54p

43.74p

182.06p

225.80p

A first interim dividend of 8.33 pence per share in respect of the quarter ended 31 March 2017 was paid on 30 June 2017.

A second interim dividend of 8.33 pence per share in respect of the quarter ended 30 June 2017 was declared on 24 July 2017 and is payable on 29 September 2017. 

The total column of this statement represents the Statement of Comprehensive Income, prepared in accordance with IFRS. The supplementary revenue and capital columns are both prepared under guidance published by the Association of Investment Companies.

All items in the above statement derive from continuing operations.

STATEMENT OF CHANGES IN EQUITY FOR THE SIX MONTHS ENDED 30 JUNE 2017 (unaudited)

Ordinary
share
Share premium
Capital

Retained

Total
capital account reserves earnings equity
£’000 £’000 £’000 £’000 £’000

BALANCE AT 1 JANUARY 2017

16,719

96,040

735,178

32,003

879,940
Profit for the period - - 14,228 16,521 30,749
Unclaimed dividends - - - 11 11
Dividends paid to equity shareholders
-
-
-
(16,390) (16,390)
BALANCE AT 30 JUNE 2017 16,719 96,040 749,406 32,145 894,310

STATEMENT OF CHANGES IN EQUITY FOR THE SIX MONTHS ENDED 30 JUNE 2016 (unaudited)

Ordinary
share
Share premium
Capital

Retained

Total
capital account reserves earnings equity
£’000 £’000 £’000 £’000 £’000

BALANCE AT 1 JANUARY 2016

16,719

96,040

613,427

29,569

755,755
Profit for the period - - 11,056 16,722 27,778
Unclaimed dividends - - - 24 24
Dividends paid to equity shareholders
-
-
-
(16,023) (16,023)
BALANCE AT 30 JUNE 2016 16,719 96,040 624,483 30,292 767,534

STATEMENT OF FINANCIAL POSITION AS AT 30 JUNE 2017 (unaudited)

30 June 2017
(unaudited) £’000
30 June 2016
 (unaudited)
£’000
31 December 2016
 (audited)
£’000
NON-CURRENT ASSETS
Investments held at fair value through profit or loss* 986,691
868,130
973,353
CURRENT ASSETS
Receivables 4,557 12,610 4,266
Cash and cash equivalents 18,108 6,303 17,340
22,665 18,913 21,606
TOTAL ASSETS 1,009,356 887,043 994,959
CURRENT LIABILITIES
Interest bearing borrowings (25,000) - (25,000)
Payables (1,200) (5,713) (1,169)
TOTAL ASSETS LESS CURRENT LIABILITIES 983,156 881,330 968,790
NON-CURRENT LIABILITIES
Interest bearing borrowings (88,846) (113,796) (88,850)
NET ASSETS 894,310 767,534 879,940
EQUITY ATTRIBUTABLE TO EQUITY HOLDERS
Ordinary share capital 16,719 16,719 16,719
Share premium 96,040 96,040 96,040
Capital reserves  749,406 624,483 735,178
Retained earnings 32,145 30,292 32,003
TOTAL EQUITY 894,310 767,534 879,940
NET ASSET VALUE PER SHARE 1,337,33p 1,147.75p 1,315.84p

*Includes £139.2 million UK Treasury holding considered by the Board to be held in lieu of cash.

STATEMENT OF CASH FLOWS FOR THE SIX MONTHS ENDED 30 JUNE 2017 (unaudited)

30 June 2017 30 June 2016 31 December 2016
(unaudited) (unaudited) (audited)
£000 £000 £000
 Cash flows from operating activities 
 Profit before tax 30,857 27,778 151,167
 Adjustments for:
 Gains on investments (17,767) (14,550) (128,792)
 Finance costs 3,288 3,303 6,657
 Purchases of investments 1 (180,266) (168,101) (335,164)
 Sales of investments 1 184,694 170,145 346,228
 Dividend income (18,306) (18,373) (32,841)
 Interest income (683) (600) (1,233)
 Dividends received 16,525 16,452 32,078
 Interest received 701 917 1,683
 Decrease/(increase) in receivables 1,470 (8,284) (1,231)
 Increase in payables 30 4,639 95
 Overseas withholding tax suffered (108)                 -   (163)
(10,422) (14,452) (112,683)
 Net cash flows from operating activities  20,435 13,326 38,484
 Cash flows from financing activities
 Unclaimed dividends 11        25 24
 Interest paid on borrowings  (3,288) (3,287) (6,587)
 Equity dividends paid (16,390) (16,023) (26,843)
 Net cash used in financing activities  (19,667) (19,285) (33,406)
 Net increase/(decrease) in cash and cash equivalents 768 (5,959) 5,078
 Cash and cash equivalents at the start of the period 17,340 12,262 12,262
 Cash and cash equivalents at the end of the period  18,108 6,303 17,340

1. Purchases and sales of investments are considered to be operating activities of the Company, given its purpose, rather than investing activities.

RESPONSIBILITY STATEMENT

The Directors confirm to the best of their knowledge that:

The half-yearly financial report was approved by the Board on 24 July 2017 and the above responsibility statement was signed on its behalf by:

John Reeve
Chairman


Notes

1.         Comparative figures

            The financial information contained in this half-year report does not constitute statutory accounts as defined in section 434-436 of the Companies Act 2006.  The financial information for the six months ended 30 June 2017 and 30 June 2016 has not been audited.

            The information for the year ended 31 December 2016 does not constitute statutory accounts, but has been extracted from the latest published audited accounts, which have been filed with the Registrar of Companies.  The report of the auditors on those accounts contained no qualification or statement under section 498(2) or (3) of the Companies Act 2006.

2.         Publication

            This half-year report is being sent to shareholders and copies will be made available to the public at the Company’s registered office and on its website.

For further information please contact:
 

Alastair Mundy
Investec Fund Managers Limited             020 7597 2000


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Half-year Report - RNS