CT UK Capital And Income Investment Trust Plc (CTUK) Earnings Call Transcript & Summary

Good morning, and welcome to the CT UK Capital and Income Investment Trust plc Full Year Results Investor Presentation. [Operator Instructions] Before we begin, I'd like to submit the following poll. And I'd now like to hand you over to Portfolio Manager, Julian Cane. Good morning to you, sir.

Hello. Good morning, and thank you for joining us on 29th of November, the day of our final results through to the end of September for CT UK Capital and Income Trust. So in the presentation this morning, I'll touch on a couple of topics. Most obviously, the results for today, then we'll look at some other issues may be affecting the U.K. market. We look at dividends and also come to the outlook as well, outlook for U.K. markets. So just to set the scene a little bit for those who haven't followed CT UK. closely over the years, I'm the manager, and I have been the manager since March '97. So a long run there of performance and results. Our objective as a fund is to grow our total return over time. We focus separately on capital growth and income growth. Our benchmark for the capital growth is All-Share index. We are primarily investing in U.K. shares. And over time, we aim to grow our dividend ahead of inflation. And that we have done each and every year since launch, now 31 years, and that makes us an AIC dividend hero, which we're very proud, and that's a record we want to try and continue. Those dividends in response to shareholders are paid quarterly. They're paid at quarter end as well, which shareholders like because it gives predictability for those wanting to receive that income. And for those, of course, familiar with investment trusts, it's also important to note that we have a long track record of keeping our share price and the net asset value relatively close together. And that means there's relatively little volatility in that, so that the NAV and the share price over long periods should track each other fairly closely. So results for the year through to September of '24, actually very encouraging. At the start of the year, I think there are a number of reasons to be cautious about U.K. equities and about equities generally. But actually, the market performed pretty well. The FTSE All-Share gained total return, 13.4%. And our performance was usually ahead of that. We'll look at some of the stocks behind that in a moment. We are also able to announce our 31st consecutive annual dividend increase, and that's an increase of 2.9% over the year compared to CPI of 1.7%. So again, getting back to that record of beating inflation with our dividend growth. Our share price return, almost the same as the NAV, a little bit of a gap. And that's because the shares ended the year at a discount to NAV of 2.9%, having averaged 3.8% over the year. This is a chart from the annual report. The annual report should be on our website, I think, from later on this afternoon for anyone who wants to dip into more detail. Well, that tracks performance over the year, showing a reasonable progression and with our NAV growing ahead of the performance of the all share. Over 3 years, the performance hasn't been quite so good, to be absolutely honest. And the reason for that is very clear in this chart where you can see that 2022 was not a good year for our performance. The All share was actually relatively flat, but our performance took a bit of a dive. In essence, of course, that was a year when interest rates started to rise. That was not good for our performance for the individual stock performance. And of course, having 4 chancellors in the year was pretty disruptive as well. So that was the year to have avoided our performance. But since then, our recovery has been in line and actually, of course, left ahead of the All-Share most recently. As I said at the start, I run CT UK for a very large number of years. And so I think it's fair to look at the longer-term performance numbers. And here, we've put 10 years and 25-year track record. And you can see that despite the fact we have had the occasional year when we've not matched that of the index, the longer-term track record shows useful gains ahead of that benchmark. Also, I've touched on the fact that income and dividend are very important for us and also for our shareholders. shareholders consistently say that they want income to grow. And there are a number of ways of tracking that, and this is one way that we think is useful for shareholders, and it shows the experience that a shareholder would have had if they put GBP 1,000 in writeback in the formation of the company in September [ 92 ]. And it tracks how the investors' experience would have been different if they had invested either in the FTSE All-Share index, just got the index return, the dividend from the index or put their money into a savings account. And you can see that the savings account would, in fact, have given you a better return for years at the start. But of course, we've been through a period when interest rates have been extraordinarily low, and hence, the return of that bank account would have been pretty small. So although the savings accounts left forward in early years, the returns from us, from CT UK have far outstripped in recent years. It's a little bit of an example, I think, of the power of compound interest. So we are able to compound by growing our capital through stock market investments, the capital grows. And then in time, that should lead to a flywheel effect where we're able to grow our dividend. And you can see our dividend is growing very easily ahead not just of that savings account, but also the All-Share Index. And it's just worthwhile thinking about why that might be, of course, the All-Share Index from time to time through various crises, whether it's the dot-com boom and bust or whether it's a global financial crisis or indeed through COVID, there have been periods when dividends from a market as a whole have been cut in response to severe measures. That's not true of us. As I said, we've had 31 consecutive years of dividend growth, and that really shows through compounding in these numbers. So that's one way of looking at our dividend and income growth. The other way is just having a look at how we've performed relative to inflation. And over 31 years, CPI has grown 106%, whereas our dividend growth now is 267%. So you can see we've far outstripped the rate of CPI growth over the long term. Unfortunately, we haven't been able to do it each and every year. We wouldn't commit to that. Certainly, there have been spikes even recently, CPI went up to 11% and we can't necessarily aim to grow that rapidly each year, but we do aim to have progressive growth. Perhaps tortoise and the hare might be the way of thinking about it over the long term, our growth has far outceeded the inflation. Here's a table. There are many more tables in the annual report to give you even more information, but this just gives a bit of a flavor for some of those stocks, which performed well. As I said, the outlook perhaps might not have been all that auspicious at the start of the year, yet as is nearly always the case, some shares have performed exceptionally well. Private equity still appears to be in the doldrums, but it's interesting to note that investors in private markets, such as Bridgepoint and Intermediate Capital were 2 of the strongest performers last year. So they have produced incredibly strong results despite the background for them still not being all that favorable. DS Smith has been a long-standing investment. That has been -- it is being taken over by International Paper, and that accounts for the strength of the share price there. Elsewhere, we had some building stocks performing well. So CRH, building material supplier and also Vistry, the housebuilder, they both performed well with the story there being that the interest rates, the expectation of interest rates coming down was positive for the sector as a whole. As is not unusual, of course, a number of stocks also struggled during the year. I'm sure most people on the call will be well aware of the troubles that Burberry had and has had. We have remained reasonably positive on the story that we certainly think that the appointment of a new Chief Executive and a slight relaunch of the business and repositioning should be positive for it. And likewise, the issues affecting Close Brothers have been pretty widely broadcast. I think it's fair to say that they caught nearly everybody from left field. It was not an expected outcome. We await further legal developments very closely. It's a holding that we have kept, but it's now very small, but it's one that clearly deserves a lot of close scrutiny. XP Power is an interesting business. It provides power supply to a number of different businesses, including the semiconductor world. So if you're wanting to build a large fabricator plant to make semiconductors, the chances are you may well have an XP Power supply. It's obviously vastly more sophisticated than a simple plug if you want to have a big kit like that. It has been subject to a number of takeover bids and despite that, the share price is languishing. So we think the underlying business is very, very attractive and the valuation there really does not reflect the long-term potential that, that business has. So that's the table of some of the absolute performance. The interim -- sorry, annual report also gives you a relative attribution report for those who want a bit more detail. Just turning to the makeup of the portfolio itself. We predominantly invest in U.K. companies, and that's represented by the [ entry rate ] of this data, and that shows you where the domicile is overwhelmingly U.K. listed. But the point that I wanted to get across to people was that the balance of these businesses where they actually operate, where they sell and where they make their profit is truly international. So the U.K. part is still the largest individual segment, but the majority of the underlying revenue is international with the North America being the largest part of that and then Europe and Asia Pacific also being sort of meaningful chunk. So yes, it's a U.K. listed portfolio, but international exposure is really a very big driver as well, arguably a bigger driver really than what's happening in the U.K. itself. So that's enough for results and looking at the portfolio for the moment. I just wanted to touch on valuations and why we strongly believe that valuations matter. And I think it's just worth touching on this topic in the month when I'm sure some of you will have noticed that a banana taped to a wall was sold for $6 million. And Bitcoin is rapidly approaching $100,000 per coin. We strongly believe that valuations do matter, and we are looking to invest in productive assets. We're looking to invest in assets which generate cash flow and ultimately pay dividends or grow their share price. And that benefits the share price of CT UK and in turn, allows us to pay increased dividends and generates a higher share price for our investors. So the theory is obviously pretty certain. If you imagine a bond, you can track the cash flows over time. You know exactly when those are going to arrive. So it's absolutely clear in theory that a higher starting valuation, the higher the price you pay for that investment on day 1, the lower the return you get. So that's the theory. In practice, and particularly for equities, it's not quite so clear because, of course, with an equity, one never knows what those returns are going to be over time. It's not a bond, future returns are uncertain. But in practice, there is a very strong link between higher valuations and lower returns. It's also less true for individual companies than for whole market. A market as a whole clearly is an average. It's a composite of all the equities within it, and therefore, it's likely to be closer to the mean. Whereas individual companies can and sometimes do provide truly exceptional returns, and so they break that rule a little bit. The chart on the following page, I think, helps to put it in a bit of perspective. And here, we can see both for the U.S. and the U.K. how returns have subsequently evolved relative to the starting price earnings ratio. So just to explain this in a little bit of detail, taking the U.S. chart on the left, if you look at the starting P/E axis, you can see there were 2 occasions when the market started with a P/E of 40. One of those subsequently gave you a 10-year return compound of 5% and the other somewhat less than that. And the purple line is the line of best fit. So you can see the higher the P/E, the lower return, that's exactly as the theory would have suggested. Of course, when the U.S. market is starting at such high multiples as it is at the moment, these charts would strongly suggest that your subsequent returns are going to be pretty low. And by contrast, in the U.K., when you're starting with a relatively low P/E, it rather suggests that your subsequent returns should be pretty high. What return you'll get from investing in bananas at $6 million a pop? I have no idea, but I know you can go and buy them for about 20, 25p in your local supermarket in the role of duct tape, not very much. I'd rather have the equity. So here, we look at the value opportunities as we see them in the U.K. market as a whole. And here, we've just sort of plotted a long-run average for the P/E ratio and for the dividend yield. And you can see in both cases, the market is trading more cheaply than it has done historically. Of course, there is no guarantees situations vary. And as I said earlier, they're not -- well the relatively recent past had an interest rate environment that is very different to where we are now. But nonetheless, it gives some prudence, I think, to the idea that valuations are pretty low for U.K. equities as a whole. The second main theme I thought would be worthy of a little bit of investigation and thought would be the course of dividends in the U.K. market. And it is pretty clear both from what companies are saying to us and what we observe that attitudes to paying dividends are changing. I think undoubtedly, it was partly brought on by COVID when a number of companies probably rightly suspended their dividends in order to preserve their financial flexibility and keep their balance sheets, keep their companies safe. So undoubtedly, there has been a ripple through of that, but that is evolving not to be just a one-off, but to be an increasing dynamic within the market. I think it also reflects how companies and investors see value opportunities. Companies, many of them are rightly perceiving that their share prices are pretty lowly valued. And actually, buying their own shares is a good value enhancement for their shareholders. It's also, I think, more of a tactical and a flexible response from company management because they undoubtedly perceive that once a dividend is paid, it sets an expectation for that dividend to be higher in subsequent years. So us as investors like to see progressive buyback -- like to see progressive dividend policies. There's no such expectations for a progressive buyback policy. So it is definitely a more flexible route to return cash to shareholders than dividends. It also mimics to an extent what happens in the States. In America, investors in general are not particularly keen on dividends. Dividend yields are very low for most companies, some barely of to pay dividend at all. Share buybacks are much more common. As investors, we ourselves are relatively agnostic the way that it comes back to shareholders. And we think that particularly given the starting point of share prices at the moment, share buybacks may be a pretty good route for companies to increase their total return. So for us, it does and these results show lead in a bit of a change to our own income account. We received our earnings per share did not grow as much as they would have done because we invested in companies who are buying back shares rather than giving us dividends. And that has led us to use our revenue reserve in order to pay out a growing dividend to our own shareholders. But nonetheless, we've got a revenue reserve of over GBP 11 million. And just to put that in context, that's the same level as we had in 2022. So previous years, we've added to this reserve when we've had a surplus of income, and it allows us to draw down on it in those years, which are a little bit more difficult. And the table here I've taken from AJ Bell. It's on their website. I think it's a very useful summary of just how the payment of ordinary dividends, special dividends and share buybacks has evolved in the U.K. market. So turning then finally to the outlook for the U.K. market. I think as ever, there are a number of positives and negatives to weigh up. And it was clearly good during the earlier part of this year that growth in the U.K. was starting to step up a bit. We were seeing better levels of growth. Indeed, U.K. growth was right at the top of the peer group of G7. But undoubtedly, that growth has been fading more recently. Interestingly, disposable income, despite the cost of living crisis, which people are constantly reminded of, disposable income has been rising at pretty good levels, allowing people to repay savings and actually, individual balance sheets are pretty robust. How much further we're going to see that disposable income improve, I think, is debatable. But nonetheless, it has grown at pretty reasonable levels. And I think inflation and the outlook for inflation is perhaps one of the big issues here. So there had been an expectation as we rolled through '24 that inflation was coming down. We got below the Bank of England's target of 2%. That clearly set a positive backdrop and an expectation that rates would decrease further. More recently, because partly of wage increases, that has come under pressure a little bit as a thesis. And so perhaps there's a bit of a concern that interest rates and inflation will be a bit higher for longer. And certainly, the Monetary Policy Committee will be looking very carefully at that. I think though, if one looks at the normal determinants for inflation, it's difficult to really think that there's going to be much of a firm pushback or that inflation will remain particularly extended. I think if you look at surplus labor or commodity costs, China obviously is still a hugely deflationary force. So there are, I think, a number of reasons to suspect that the inflation blip that we're seeing at the moment will be just that, that it will certainly steady and won't get out of control. So our longer expectation is for interest rates to come down. The budget and the rhetoric around the budget has definitely been one of those features, though, that has unsettled and has caused companies and individuals to lose a bit of confidence. And to that extent, politicians may have shot themselves in the foot a little bit. And I think it may serve as a warning to those politicians and the government as they find their feet in governing the country. About the law of unintended consequences that really, it's best to tread carefully that the economy is incredibly complex and difficult to predict. And in many ways, kind of defies simple mechanistic assumptions. And the killed market also, I think its response to recent measures also puts a bit of a dampener on any large spending increases that the government may have had. So I think in a small positive, I think the government may be slightly more constrained now in what it can do. And of course, we all hope that it is able to achieve the growth that it keeps claiming to want to achieve, and that would undoubtedly be good for equity markets generally. So there is a mixed outlook as ever, but I think the strongest point that I would come back to in terms of our outlook for the U.K. is the valuations are very attractive. Of course, it's not just us saying that. I think it's always interesting to compare words and actions. So companies, the companies that we invest in are the valuation of their shares. They're doing something about it. It's not just talk, but they are buying back their own shares. And certainly, we've seen in a number of instances that companies are being taken over either by their peer groups or occasionally by private equity. So again, that would be a reflection of the fact that the U.K. market is pretty attractively valued. So those are my comments. I think there are a number of questions that have come in, and I'll be very happy to answer those. So thank you very much for listening.

Perfect, Julian. Over to you, Peter.

Thank you very much. So my name is Peter Brown. I work in the Investment Trust sales team, and I'll be managing the questions that have been posed. A couple of questions on the portfolio. How many stocks are in the portfolio? What sectors are currently favored in the portfolio versus the benchmark? And why are you taking these positions on?

Yes, good. Thank you. So the annual report has a full list of all the stocks. There are currently 44, I think. There's no particular set number that we operate to. And certainly, over the time that I have managed the portfolio, we have, on occasion, had over 100. We're currently below 50. And my preference would be to have a smaller number at around 50. I don't mean smaller from this point. Having gone over 100, that was, I think, anomalous. We were over diversified. We had a separate allocation, numerous companies invested in Europe. So having a more concentrated portfolio of 40 to 50 companies, to me, seems right. It's concentrated. It means each individual company can and does have a real impact on performance, both on capital and dividends. In terms of the balance of the portfolio, so thinking of the big sectors primarily, we are underweight in the oil sector. The general thesis there would be that the oil companies, although Shell has performed very well over long time periods, are really price takers for the most part. They're clearly operating in commodity markets, and it's very little to distinguish their product from anyone else's. So it is inherently quite a tough area to operate in. It's also, of course, highly politically charged and very sensitive. And it just seems to us that over the next 5 or 10 years that those companies will find life probably increasingly difficult, whether it's because of rules around climate change or just their transition into other areas. So there's undoubted expertise that they have in managing oil molecules from out of the ground into producing energy. They undoubtedly are good at that. But it's less clear that their expertise lies in managing electrons as we increasingly electrify economies. So I think the future may be rather more difficult. Of course, they're quite volatile because of that commodity exposure. And so we do have some exposure, and we are certainly aware that the long-term dividend record of Shell, for example, and its total return, it's very active buying back its own shares, appears pretty attractive. But nonetheless, we feel that it's very difficult to forecast the oil price and we'd rather invest in other companies who are more in charge of their own destiny. In terms of other large sectors, so there's a notable underweight position in U.K. banking, primarily because we don't hold HSBC. We feel that the valuation there is really fully up with events. And we'd much rather hold our exposure to the financial sector in smaller companies where they are more in control of their own destiny, where they're able to generate good returns, better returns than HSBC does and with greater growth potential. In the pharmaceutical sector, they are the other large one, we are cautious a bit on the valuation of AstraZeneca. Clearly, it's been an exceptionally strong performer for a long period of time. And we sort of note with interest Glaxo, and that's one increasingly that I'm sort of looking at. I mean, we've had a long-standing position there. It has been extraordinarily disappointing. But having spoken to senior management of the company this week, they clearly are very positive about their ongoing pipeline. And that's a level of interest and recognition that perhaps the market just doesn't get. So Glaxo has been very disappointing. It's trading at a very low multiple. And that makes it interesting because if it really is going to turn itself around then that could be an opportunity to change those weightings. So that gives you a quick flavor of some of those exposures. We tend not to manage the portfolio too closely in terms of sector exposures. What we are really trying to do consistently is manage it from the bottom up. So we're looking at individual companies. We're looking at the returns those companies generate and the growth they can achieve relative to the price you pay. And sector exposures, we look at having chosen stocks. So it's not managed at a sector level first. It's managed at a stock level first.

Okay. And going on a little bit further, how is the portfolio positioned in terms of defensive versus growth assets? Do you have that analysis?

Well, it's an issue of definitions here that I personally find it very unhelpful. I can understand why people want to have an analysis of it. And we do run analysis through risk models to look at where our exposure is. But it is notable that over time, these quantitative risk models change their allocations for where companies stand. So I spent a little while explaining our exposure to the oil stocks. And the oil stocks, for example, despite the fact in many years, they struggle to generate returns above the cost of equity have at various stages in these quant models be described as quality. And that's not a concept that I or I suspect most investors would really recognize. So the point being that when you put a portfolio through a quantitative model, it will give you an answer to a lot of decimal places. But that doesn't mean to say that it's right. So one might have thought, for example, of some of the pharmaceutical companies has been defensive, classic defensive, but then you look at the share price of Glaxo and it just hasn't been. So it tells you something, but I'm not sure it tells you all that much. Undoubtedly, having given my warning preamble. Undoubtedly, we perform better when the economy and U.K. economy, world economy and stock markets, when they're doing well, we perform better. That undoubtedly is the case. And I think that one could argue perhaps sometimes we should go to be more defensive or more aggressive when we have a big macro view. The answer is we try not to have big macro views. It's very difficult to make forecasts events that move markets often are completely unexpected and inherently difficult to forecast. So we're not trying to move it around in response or in anticipation to big macro events. We just most obviously, over the last 12 months, longer, we've had obviously, the horror of what's happening in the Middle East. And it would have been a perfectly reasonable assumption that the oil price would have gone up, that oil companies would have performed well. It just hasn't happened. So it's remarkably difficult to make those forecasts right. But if the stock market performs well and on valuation terms, we see no reason why it shouldn't. That should help our portfolio. That's the message I would want to hand out.

Okay. That's fair enough. Question, could you comment more on the rate of growth of dividends versus buybacks from U.K. companies?

Yes. I mean it's an evolving situation. I think in truth, we can't -- we certainly can't influence in any great way that debate. Obviously, we do talk to companies that we invest in, and it is a topic of discussion, but we have one voice amongst many. While share prices are pretty low, we're certainly not against companies buying back their own shares because I think that does add value. Nonetheless, there is a discipline in companies paying dividends to their shareholders. And we think that, that can be a useful discipline. We wouldn't want to choke off companies investing in their own assets or maybe making acquisitions if that's attractive. How that situation evolves, we'll have to have a look at it. I suppose rolling forward, then how does that impact what we do? Well, we have a twin objective to grow capital and to grow income. And there is a logic to us. We receive dividends from companies that we invest in. And in turn, we are able to pass those through to shareholders. But we are also able to pay dividends out to the revenue reserve. As I touched on earlier, we've got over GBP 11 million in our revenue reserve. So that gives us a pretty substantial buffer in case companies divert more towards buybacks than dividends. And then even beyond that, we are able to pay dividends from our capital reserve. So as long as our investment portfolio has grown over time. We have capital reserves, and we can -- in future, we don't at the moment, but we could in future pay dividends from those. So there's lots of routes that would allow us to continue to pay a growing dividend. And we believe that's what shareholders want. If shareholders don't want that, then we would think again. But all the indications are that shareholders like to have a growing dividend.

Okay. And finally, you did touch on the MPC and the rate situation in the U.K. and also in Europe regarding future rates, but difficult to forecast, but what are your base rate forecasts for the next 12, 18 months and how that's affected any portfolio changes you're making?

Well, the short answer is I don't have any explicit forecasts for interest rates. As you are asking, I would expect interest rates to come down. I would expect them to come down rather more slowly than perhaps if you had asked me 4, 5 months ago. So the rate of decreases will be a bit lower. But it's a matter, I think, of weighing up what's happening to inflation and what's expected to happen to inflation relative to what's happening at a growth level. So you mentioned Europe. European growth, I think, in average is even slower than what's happening in the U.K. So clearly, at some stage, the monetary authorities will wake up to say, well, even if inflation is perhaps a touch above our targets, which remember, are entirely arbitrary. Isn't it a bit more important to have some more growth. And so I certainly wouldn't expect interest rates to come down to the level that they were following the GFC. But I think if we got rates 3.5%, 4%, that would definitely stimulate a bit of growth. It seems most unlikely to me that it would drive any meaningful increase in inflation. So yes, interest rates likely to come down, probably not all that much. But at the margin, it will be positive.

Some final comments about the trust.

Well, thank you very much for those who've listened. I hope you found that useful. Either Peter or myself are very happy to answer any other questions that people may have had. Hopefully, it's provided a bit of a background for CT UK and the results we've had over the last year. And I think, hopefully, we've also been able to outline despite the fact that there are numerous uncertainties in the world, there always are, that actually the valuation of the U.K. stock market is still pretty attractive. So thank you very much for listening in.

Julie and Peter, thank you both for updating investors today. Can I please ask investors not to close the session as you'll now be automatically redirected to provide your feedback in order that the management team can better understand your views and expectations. This will only take a few moments to complete, but I'm sure will be greatly valued by the company. On behalf of the management team of CT UK Capital and Income Investment Trust Plc, we'd like to thank you for attending today's presentation, and good morning to you all.