Fidelity Special Values PLC (LON:FSV) has announced its half-yearly results for the six months ended 28 February 2023 (unaudited)
Financial Highlights:
- The Board of Fidelity Special Values PLC recommends an interim dividend of 2.53 pence per share, an increase of 10% from last year’s interim dividend.
- The net asset value (“NAV”) of the Company increased by +10.4% for the six months ending 28 February 2023 outperforming the Benchmark Index (FTSE All-Share Index) which rose by +8.7%.
- The ordinary share price return was 13.1%.
- The Portfolio Manager continues to find good opportunities towards the smaller end of the market cap spectrum.
PORTFOLIO MANAGER’S HALF-YEARLY REVIEW
PERFORMANCE
In the six month reporting period to 28 February 2023, the net asset value (“NAV”) per ordinary share return of +10.4% and the share price return of +13.1% outperformed the FTSE All-Share Index (the Company’s Benchmark Index) return of +8.7% (all on a total return basis). This report seeks to summarise the reporting period, highlight the key drivers of performance, and set out the Portfolio Manager’s views looking ahead.
STOCK MARKET AND PORTFOLIO REVIEW
UK equities advanced during the period despite an uncertain economic outlook. The positive performance was mostly driven by blue chip stocks, with the FTSE 100 Index reaching an all-time high in February 2023, surpassing its previous record from May 2018. However, returns from medium and smaller companies were more subdued and they continued to lag their larger counterparts. At a sector level, returns were largely driven by holdings in energy, mining and financials, which have benefited from rising energy prices, higher inflation and interest rates. Consumer discretionary stocks were also bolstered by an improvement in sentiment from depressed levels, amid better than expected holiday spending and optimism around China’s broader reopening following a lifting of its COVID-related restrictions. Selected industrials, especially aerospace and defence companies, were also able to benefit from the current backdrop. For value investors, it was a particularly satisfying period, with value outperforming growth by seven percentage points.
Despite the positive headline returns, share prices proved to be particularly volatile. The period started with a sharp sell-off as investors were concerned about the Bank of England’s monetary policy tightening path and the poor economic outlook. An un-costed plan by Liz Truss’s newly formed government in its ‘mini-budget’, to increase spending and implement tax cuts in a bid to boost growth and counter slowing activity further spooked market participants. Shares recovered in October 2022, after Truss was replaced by Rishi Sunak as Prime Minister, and with the new Chancellor Jeremy Hunt reversing most of the unfunded tax-cutting proposals following weeks of market and political pressure. Tentative signs of moderating inflationary pressures in the US bolstered expectations of a slowdown in the US Federal Reserve’s monetary policy tightening cycle which also soothed investors’ concerns, as did an easing of the stringent COVID-19 control policy in China, which boosted hopes of a recovery in demand. However, markets turned somewhat cautious in December 2022 as global central banks reaffirmed their commitment to bringing inflation down, as it remained well above their target levels, and economic data showed clear signs of slowing growth.
2023 kicked off on a positive note, building on the markets’ resilient performance in 2022. Having started the year thinking that the end of interest rate rises was in sight, market participants became increasingly concerned that rates may have further to climb, after a string of economic reports and company results showed that many Western economies were performing better than expected. While inflation remained high, price pressures seemed to ease and the BoE was relatively dovish in its commentary as it announced a 0.5% rate hike in February 2023, the fourth time it has raised rates during the period, to the current level of 4.0%.
Over the period, the Company’s NAV outperformed the return of the FTSE All-Share Index. The outperformance was primarily driven by our long-standing overweight stance in financials. Irish lender AIB Group was the leading contributor as its shares benefited from an improved outlook for interest income in an environment of rising rates. The group reported strong annual profits and robust loan growth, while it also announced higher dividends. Also within financials, reinsurance underwriter Conduit Holdings was another strong performer. It posted an impressive start to 2023 with a significant rise in premiums, and stated that it expected this ‘exceptional pricing environment’ to continue, reflecting a fundamental re-pricing of risk and an imbalance in the supply and demand of capital. Conduit is one of the few operators in the industry with capital available to deploy, which should allow for strong growth and profitability.
Meanwhile, designer and manufacturer of gift packaging and stationery IG Design’s interim results highlighted a profit recovery and progress in the turnaround of its America’s business. Its outlook statement highlighted a strong order book for 2023, coupled with stable customer relationships. Our view is that the business has significant recovery potential following several issues over the last two years, many of which should prove to be temporary.
Mergers and acquisitions (“M&A”) activity also remained a strong theme within the Company’s portfolio, despite the economic uncertainty. Oilfield and engineering services group John Wood Group was a beneficiary, as it received four unsolicited buyout proposals from US private equity group Apollo Global Management, all of which the company rejected, citing undervaluation of its stock. A smaller holding, Wentworth Resources, also accepted a takeover bid from its operational partner in December.
Conversely, after a strong performance last year, government outsourcer Serco was a detractor from performance, despite reiterating its expectations for profits to be in line with previous forecasts. Over 2022, the business grew by 10%, excluding COVID contracts and currency effects. It also recently reported that one of its biggest and most profitable contracts (worth close to $700 million) had been renewed for another five years. The Company has a large exposure to the outsourcing sector, where many companies have benefited from self-help and a stable demand environment, which has allowed their businesses to grow. They also benefit from having a degree of inflation protection in their contracts, which is particularly helpful in the current environment.
Shares in pharmaceutical group Roche Holdings also fell after the company warned that profits in 2023 will decline, as falling demand for its COVID therapy and diagnostics kits is likely to weaken sales. While this year was always going to prove more challenging after strong pandemic-related demand, the medium term outlook for the company remains strong with solid underlying growth and a broad drugs pipeline. Consequently, we have increased our holding in Roche whilst exiting our smaller position in AstraZeneca, given the former’s relatively more attractive risk/ reward profile.
In the energy sector, the underweight stance in BP and Shell proved unhelpful over the review period after they announced a shift in their strategies alongside annual results. Both companies are allowing oil production to fall and using cash profits to invest in highly competitive renewable power industries, where future profitability is uncertain and likely lower than in their existing oil operations.
However, both announced a partial strategic U-turn and said they would invest more in oil production and less in renewables. We, on the other hand, prefer smaller, overseas-listed oil and gas producers because they trade on more attractive valuations, their focus is on maintaining or growing their oil and gas production and their profits are used to reward shareholders via dividends and buybacks.
Among other detractors, a small oil and gas producer and recent addition to the portfolio, Ithaca Energy, underperformed following the Government’s decision to increase the windfall tax on profits made from extracting UK oil and gas. Nevertheless, we took advantage of the share price weakness and increased our position in the company. Ithaca Energy has acquired and developed an attractive portfolio of long-life oil and gas assets. The latter is of particular interest given the stronger longer term outlook for European gas prices in the wake of Western sanctions on Russia. Ithaca has a strong balance sheet, offers a very generous dividend yield of more than 20%, and has a clear distribution policy to pay a fixed percentage of its cash flows as dividends.
USE OF GEARING
During the review period, we continued to use contracts for difference (CFDs) to gear the Company’s portfolio of long exposures and to eliminate some of the currency exposure for those holdings listed outside of the UK. Overall, there was a meaningful reduction in the Company’s gearing level over the reporting period. Gearing stood at 5.3% at the end of February 2023 (compared to 10.0% at the end of August 2022). This reflects the completion of bids for five of the Company’s holdings: ContourGlobal, Meggitt, RPS Group, Biffa and Euromoney Institutional Investor. Since the end of the reporting period, gearing has increased back to around 10%, as market volatility in March presented us with new investment opportunities across a number of sectors.
OUTLOOK
We remain selective and favour companies with lower levels of debt and the resilience to navigate uncertainty. Current valuations have priced in a weaker economic environment, which is likely to remain challenging in the near term, especially for those corporates and consumers in need of refinancing their debts.
Financials form the biggest part of the Company’s portfolio, primarily banks and insurers. Higher interest rates have allowed banks to significantly improve their profitability at a time where earnings in many industries are under pressure, yet many investors continue to avoid them because they are scarred from the 2008 global financial crisis. However, UK and Irish banks have become far higher quality businesses since the changes to the regulatory environment over the past decade. They have strengthened their balance sheets, trimmed bloated cost bases, and pulled back from riskier lending. Furthermore, they are subject to robust regulatory frameworks, transparent accounting practices and have diversified deposit structures. Some of these attributes were absent from several smaller regional US banks and at Credit Suisse, leading to recent negative headlines and outcomes for investors in these companies.
Our holdings within the sector are diversified in terms of geographic and banking model exposure, with idiosyncratic factors driving their growth. For example, our largest holding, AIB Group, is not only an interest rate story but is also the beneficiary of an improvement in Ireland’s banking market, where the number of competing groups has recently shrunk from five to three. The rising rate environment is also positive for life insurers, where we have a meaningful overweight position. Their earnings have proved resilient during the pandemic and should continue to benefit from an acceleration in the pace of pension fund re-risking.
Ongoing value in some defensive areas remain, such as tobacco or hidden defensives, for example, Government outsourcer Serco. However, we steer clear of crowded areas comprising expensively valued dollar-earning companies and other consumer staples.
The relative attractiveness of UK valuations versus other markets and the large divergence in performance between different parts of the market continue to create good opportunities for attractive returns from UK stocks on a three-to-five-year view. The smaller end of the market cap spectrum is particularly rich in investment opportunities given the lack of research coverage. For us, this has always been a big structural overweight, and the Company’s portfolio currently has a mid and small cap exposure at around 60%. Smaller companies have incurred severe deratings over the past year as they are thought to be more cyclical and thus more susceptible to an economic slowdown or recession. However, in our opinion, some of the share price falls have been indiscriminate.
The attractive valuations in the UK have not gone unnoticed and after several months of limited activity there has been a recent uptick in M&A activity with private equity approaches for several UK companies, including our holding in John Wood Group. It demonstrates that valuations for UK stocks are low enough to maintain interest levels even in an uncertain market.
In our opinion, the UK market with its high dividends and low valuations offers better prospective returns than many other asset classes, including global equities.
ALEX WRIGHT
Portfolio Manager
27 April 2023
TWENTY LARGEST INVESTMENTS AS AT 28 FEBRUARY 2023
The Asset Exposures shown below measure exposure to market price movements as a result of owning shares, corporate bonds and derivative instruments. The Fair Value is the actual value of the portfolio as reported in the Balance Sheet. Where a contract for difference (“CFD”) is held, the Fair Value reflects the profit or loss on the contract since it was opened and is based on how much the share price of the underlying share has moved.
| Asset Exposure | Fair Value £’000 | ||
£’000 | %1 | ||
| Long Exposures – shares unless otherwise stated | |||
| AIB Group (corporate bond and long CFD) | |||
| Banks | 42,513 | 4.3 | 4,701 |
| ————— | ————— | ————— | |
| Serco Group | |||
| Industrial Support Services | 37,618 | 3.8 | 37,618 |
| ————— | ————— | ————— | |
| NatWest Group | |||
| Banks | 37,284 | 3.7 | 37,284 |
| ————— | ————— | ————— | |
| Imperial Brands | |||
| Tobacco | 36,439 | 3.6 | 36,439 |
| ————— | ————— | ————— | |
| Phoenix Group Holdings | |||
| Life Insurance | 35,572 | 3.6 | 35,572 |
| ————— | ————— | ————— | |
| Aviva | |||
| Life Insurance | 33,617 | 3.4 | 33,617 |
| ————— | ————— | ————— | |
| DCC | |||
| Industrial Support Services | 33,058 | 3.3 | 33,058 |
| ————— | ————— | ————— | |
| Sanofi (long CFD) | |||
| Pharmaceuticals & Biotechnology | 32,819 | 3.3 | 454 |
| ————— | ————— | ————— | |
| Barclays | |||
| Banks | 32,075 | 3.2 | 32,075 |
| ————— | ————— | ————— | |
| Roche Holdings | |||
| Pharmaceuticals & Biotechnology | 31,672 | 3.2 | 31,672 |
| ————— | ————— | ————— | |
| Mitie Group | |||
| Industrial Support Services | 27,772 | 2.8 | 27,772 |
| ————— | ————— | ————— | |
| OMV | |||
| Oil, Gas & Coal | 25,578 | 2.5 | 25,578 |
| ————— | ————— | ————— | |
| Ryanair Holdings (shares and long CFD) | |||
| Travel & Leisure | 22,883 | 2.3 | 2,895 |
| ————— | ————— | ————— | |
| Spire Healthcare Group | |||
| Health Care Providers | 20,636 | 2.0 | 20,636 |
| ————— | ————— | ————— | |
| Babcock International Group | |||
| Aerospace & Defense | 19,035 | 1.9 | 19,035 |
| ————— | ————— | ————— | |
| C&C Group (shares and long CFD) | |||
| Beverages | 17,928 | 1.8 | 15,038 |
| ————— | ————— | ————— | |
| Legal & General Group (long CFD) | |||
| Life Insurance | 17,779 | 1.8 | (250) |
| ————— | ————— | ————— | |
| Conduit Holdings | |||
| Non-Life Insurance | 17,293 | 1.7 | 17,293 |
| ————— | ————— | ————— | |
| Ithaca Energy | |||
| Oil, Gas & Coal | 16,496 | 1.6 | 16,496 |
| ————— | ————— | ————— | |
| Close Brothers Group | |||
| Banks | 16,273 | 1.6 | 16,273 |
| ========= | ========= | ========= | |
| Twenty largest long exposures | 554,340 | 55.4 | 443,256 |
| Other long exposures | 498,488 | 49.9 | 463,146 |
| ========= | ========= | ========= | |
| Gross Asset Exposure (102 holdings) | 1,052,828 | 105.3 | |
| ————— | ————— | ||
| Portfolio Fair Value | 906,402 | ||
| ========= | |||
1 Asset Exposure is expressed as a percentage of Shareholders’ Funds.
Below are details of the Fair Value and Asset Exposure of Investments.
FAIR VALUE AND ASSET EXPOSURE OF INVESTMENTS AS AT 28 FEBRUARY 2023
| Fair Value £’000 | Asset Exposure | ||
£’000 | %1 | ||
| Investments | 904,659 | 904,659 | 90.5 |
| Long CFDs | 1,743 | 148,169 | 14.8 |
| ————— | ————— | ————— | |
| 906,402 | 1,052,828 | 105.3 | |
| ========= | ========= | ========= | |
| Cash at bank2 | 2,868 | (143,558) | (14.4) |
| Fidelity Institutional Liquidity Fund | 86,573 | 86,573 | 8.7 |
| Other net current assets (excluding derivative assets and liabilities) | 4,187 | 4,187 | 0.4 |
| ————— | ————— | ————— | |
| Shareholders’ Funds | 1,000,030 | 1,000,030 | 100.0 |
| ========= | ========= | ========= | |
The Company uses gearing through the use of long CFD positions. Gross gearing as at 28 February 2023 was 5.3% (31 August 2022: 10.0% and 28 February 2022: 6.9%).
1 Asset Exposure is expressed as a percentage of Shareholders’ Funds
2 The asset exposure column for cash at bank has been adjusted to assume the Company traded direct holdings rather than exposure being gained through long CFD positions. The amount is derived by taking the cost of the shares underlying the long CFDs when the contracts were opened less the cash at bank balance at the period end.
INTERIM MANAGEMENT REPORT
BOARD CHANGES
Andy Irvine stepped down as Chairman of the Board and as a non-executive Director at the conclusion of the Annual General Meeting (“AGM”) held on 14 December 2022. He was replaced as Chairman by Dean Buckley and Nigel Foster replaced Mr Buckley as Senior Independent Director at the same time.
DISCOUNT MANAGEMENT AND SHARE REPURCHASES
Under the Company’s discount management policy, the Board seeks to maintain the discount in single digits in normal market conditions and will repurchase shares to help stabilise the share price discount.
The Board will approve the issuance of shares if the Company’s shares are trading at a sufficient level of premium to ensure that it adds value for Shareholders and that the issue of shares is not dilutive. Issuing shares increases the size of the Company, making it more liquid and allowing costs to be spread out over a larger pool of assets.
Over the reporting period, the Company’s shares traded at a discount ranging from 2.8% to 10.3% with an average discount of 6.3%. The peer group average discount as at 28 February 2023 was 9.8%.
In the reporting period, the Company did not issue any shares or carry out any share repurchases and this remains the case up until the date of this report.
The Board continues to monitor the level of the Company’s discount closely and will take action when it believes to do so will be effective and to the benefit of Shareholders.
INTERIM DIVIDEND
The Board’s policy is to pay dividends twice yearly in order to smooth the dividend payments for the Company’s financial year. The Company’s revenue return for the six months to 28 February 2023 was 3.04 pence per share.
The Board has declared an interim dividend of 2.53 pence per share which is 10.0% higher than the 2.30 pence per share paid as the interim dividend in 2022. This will be paid on 21 June 2023 to Shareholders on the register on 12 May 2023 (ex-dividend date 11 May 2023). Shareholders should note that the Board will review the final dividend payment later in the year based on dividend receipts from the companies held in the portfolio. However, based on current forecasts, the Board would hope to maintain at least the same level of dividend as paid in the prior year and would intend to pay it entirely from the revenue earned in the reporting period.
PRINCIPAL RISKS AND UNCERTAINTIES
The Board, with the assistance of the Manager (FIL Investment Services (UK) Limited), has developed a risk matrix which, as part of the risk management and internal controls process, identifies the key existing and emerging risks and uncertainties faced by the Company.
The Board considers that the principal risks and uncertainties faced by the Company continues to fall into the following categories: market, economic and political; cybercrime and information security; investment performance (including the use of derivatives and gearing); environmental, social and governance (“ESG”); competition; regulatory; key person and operational support; business continuity and discount control risks. Information on each of these risks is given in the Strategic Report section of the Annual Report for the year ended 31 August 2022, a copy of which can be found on the Company’s pages of the Manager’s website at www.fidelity.co.uk/specialvalues.
While the principal risks and uncertainties are the same as those at the previous year end, the uncertainty continues to be heightened by the ongoing Russia and Ukraine conflict dominating political risks and industry concerns. There is geopolitical and economic uncertainty, in addition to events currently being faced globally such as the various crisis situations in energy, the cost of living, rising inflation, food supply and the threat of cyberattacks on critical infrastructure. More recently, the collapse of Silicon Valley Bank and the buyout of Credit Suisse by UBS Group has caused turmoil in the global banking sector and volatility in the markets. The quantum of risks continues to change and the Board remains vigilant in monitoring such risks.
Climate change continues to be a key emerging issue, as well as a principal risk, that is confronting asset managers and their investors. The Board notes that the Manager has integrated ESG considerations, including climate change, into the Company’s investment process. The Board will continue to monitor how this may potentially impact the Company, the main risk being the impact on investment valuations and shareholder returns.
Investors should be prepared for market fluctuations and remember that holding shares in the Company should be considered to be a long term investment. Risks are mitigated by the investment trust structure of the Company which means that no forced sales need to take place to deal with any redemptions. Therefore, investments in the Company’s portfolio can be held over a longer time horizon.
The Manager has appropriate business continuity and operational plans in place to ensure the uninterrupted provision of services, including investment team key activities, including those of portfolio managers, analysts and trading/support functions. It reviews its operational resilience strategies on an ongoing basis and continues to take all reasonable steps in meeting its regulatory obligations and to assess operational risks, the ability to continue operating and the steps it needs to take to serve and support its clients, including the Board.
The Company’s other third party service providers also have similar measures to ensure that business disruption is kept to a minimum.
TRANSACTIONS WITH THE MANAGER AND RELATED PARTIES
The Manager has delegated the Company’s portfolio management and company secretariat services to FIL Investments International. Transactions with the Manager and related party transactions with the Directors are disclosed in Note 13 to the Financial Statements below.
GOING CONCERN STATEMENT
The Directors have considered the Company’s investment objective, risk management policies, liquidity risk, credit risk, capital management policies and procedures, the nature of its portfolio, its expenditure and cash flow projections. The Directors, having considered the liquidity of the Company’s portfolio of investments (being mainly securities which are readily realisable) and the projected income and expenditure, are satisfied that the Company is financially sound and has adequate resources to meet all of its liabilities and ongoing expenses and can continue in operational existence for a period of at least twelve months from the date of this Half-Yearly Report.
This conclusion also takes into account the Board’s assessment of the ongoing risks from the war in Ukraine, significant market events and regulatory changes and continued evolving variants of COVID.
Accordingly, the Financial Statements of the Company have been prepared on a going concern basis.
Continuation votes are held every three years and the next continuation vote will be put to shareholders at the AGM in 2025.
BY ORDER OF THE BOARD
FIL INVESTMENTS INTERNATIONAL
27 April 2023
DIRECTORS’ RESPONSIBILITY STATEMENT
The Disclosure and Transparency Rules (“DTR”) of the UK Listing Authority require the Directors to confirm their responsibilities in relation to the preparation and publication of the Interim Management Report and Financial Statements.
The Directors confirm to the best of their knowledge that:
a) the condensed set of Financial Statements contained within the Half-Yearly Report has been prepared in accordance with the Financial Reporting Council’s Standard: FRS 104: Interim Financial Reporting; and
b) the Portfolio Manager’s Half-Yearly Review and the Interim Management Report above, include a fair review of the information required by DTR 4.2.7R and 4.2.8R.
In line with previous years, the Half-Yearly Report has not been audited by the Company’s Independent Auditor.
The Half-Yearly Report was approved by the Board on 27 April 2023 and the above responsibility statement was signed on its behalf by Dean Buckley, Chairman.
Fidelity Special Values PLC (LON:FSV) aims to seek out underappreciated companies primarily listed in the UK and is an actively managed contrarian Investment Trust that thrives on volatility and uncertainty.
