22 Mar 2024
David Moss, Portfolio Manager, CT UK High Income Trust
Political noise is a distraction in any market environment but in an election year the clamour is heightened. So, in February we had one of our holdings, Nat West Bank, reporting its biggest annual profit since the 2007 financial crisis but in the days that followed seeing its share price fall on speculation of a possible windfall tax on the banking sector. As an investor, sometimes it feels like you can’t win.
Nat West is a fairly recent addition to the portfolio. Against the backdrop of a slow economy (the UK is now officially in a technical recession), ensuring the portfolio had diversified and sustainable sources of income was an important goal. At the time we bought Nat West it was underperforming its peers. Sentiment had taken a bit of battering following the politicised ousting of its chief executive, Alison Rose, as a result of the Nigel Farage/Coutts controversy. We took advantage of the favourable share price, looking past the difficulties prevailing at that time, confident that the underlying business was fundamentally sound and well run. The recent results are testimony to that assessment.
As well as better-than-expected results, the bank delivered an uplift in its final dividend, from 10p to 11.5p1. An annual dividend yield of over 7% is very welcome given the UK’s economic backdrop. Some of the uncertainty about the bank’s leadership has also been removed with confirmation that interim boss Paul Thwaite will become its permanent chief executive. The UK lender, which is still 35% government owned, following 2008’s £45.5bn public rescue, now waits to see when the government instigates the public sale of its shares. Again, due to this being an election year, the timing will unlikely be without a political hullabaloo. As investors, we’ll hunker down on the fundamentals and wait for the noise to pass.
An eye to the future
Another relatively recent entrant to the portfolio (we initiated a position in July) was Smurfit Kappa, one of the world’s largest manufacturers of paper and cardboard packaging. In early September the Dublin-headquartered company announced it planned to merge with US firm WestRock. The combined business will have an annual turnover of around US $34bn (£27bn)2. We purchased Smurfit based on its prospects, after the inevitable dip in on-line delivery traffic following the easing of Covid restrictions and consumers pent up desire to get back into shops and the long-term tailwind of plastic packaging substitution. Over the long run we were comfortable that on-line shopping was a trend here to stay and that as a leader in its field, Smurfit was well placed to capture further market share, deliver good income and capital growth. We are pleased to see that a recovery is emerging in Europe and better returns are also being attained by its business in the US.
The potential to soar again
Engine maker Rolls-Royce was another casualty of Covid waiting for a turnaround. Mismanaged for several years (in our view) and hurt by a temporary but extended interruption to flight travel, the company was waiting to re-find its way. That recovery is now beginning to gain traction. BP veteran Tufan Erginbilgic, who assumed the role of CEO in January 2023, was an essential piece of the jigsaw. He has settled in, engine demand has increased and, more importantly, flight hours in the air have risen alongside the pick-up in consumer demand. With much of Rolls’ income earned through maintenance contracts, this is an important development. In the field of large aircraft engines, Rolls-Royce operates in a select market with only a handful of significant competitors.
Another, even more niche, area of engineering in the company’s portfolio is small modular reactors (SMRs). In the rising quest for clean, efficient, energy sources this is a valuable feather in its cap. SMRs are designed to be built in a factory, shipped to operational sites for installation and then used to power buildings or other commercial operations. We have to wait and see how production expands but the potential is there for the company to become a world leader in this space.
Sitting out the politics
It’s always a balancing act but compared to this time last year we believe the portfolio has more diversified sources of income. This has allowed us to cover the dividend with income earned by the Trust. This adjustment has also given us room to purchase select companies that are not yet delivering a high yield but which have the potential to do so, alongside achieving capital growth. In a politically uncertain world, sometimes it’s enough to settle for.
1 NatWest Group plc 2023 Annual Report and Accounts. Issued 15 February 2024.
2 Reuters. 12 September 2023.
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