The Merchant’s Trust PLC

A Value View: A return to Fundamentals?

Transcript: Hello, and welcome to A Value View from The Merchants Trust. In each edition Simon Gergel, fund manager at The Merchants Trust, offers his thoughts on developments affecting the UK market and what it means for investors.

JC: Simon, it’s good to catch up; I hope you had a great break. Obviously in 2020 we found ourselves dealing with a global health crisis and the implications for the stock market that we’ve covered throughout the last year, but this edition seems a good opportunity to think about where we are and look to the future. I’m very keen to hear your thoughts on 2021 and on the market, but before we get there, let’s look back at the year that we’ve just been through; Simon, 2020, we weren’t expecting what happened, what are your reflections?

Simon Gergel: Thanks, Jon, it’s great to be back; 2020 was a really extraordinary year. The second quarter, with the Covid pandemic, saw the sharpest drop in recorded growth ever as the government shut down large sections of the economy. Subsequently, we had the sharpest ever recorded recovery, but it was a very difficult year, primarily for people’s health of course, but also for the economy. Unsurprisingly, companies had a difficult time, but if anything they’ve come out of the pandemic faster and stronger than we feared back in April and May when we didn’t know how bad things were going to get. Towards the end of the year, many companies had rebuilt their balance sheets stronger than we thought they might and we saw much more confident trading statements – not in every industry, but most I would say. With that stronger financial position dividends started coming back; mid-year saw a huge number of dividends cancelled, but by the end of the year companies were more confident, paying back government furlough money and so on. They started to reinitiate dividend payments, so we enter this year in a much better position, having seen a really quite strong recovery from many industries.

JC: So, a year of many contrasts; taking stock of what we’ve experienced, and what that might mean for the year ahead, what are your thoughts Simon? How do you anticipate this year playing out, if you even dare imagine, given the circumstances last year?!

SG: Well, it’s a brave call, because as we discussed a year ago, I felt last year would be more about the fundamentals and putting other factors behind us; now I do really think that 2021 will be about the fundamentals of businesses – how well they’re trading, their prospects, their competitive position – hopefully putting issues such as the pandemic, Brexit, U.S elections, perhaps even polarisation – behind us, focusing on how companies are performing and their prospects. Clearly the effects of the pandemic will be with us for many months to come, but we can now see a way through with vaccines being rolled out; I think this year will be more about individual companies and industries, and what’s going on in the real world, rather than the bigger-picture themes that dominated the market last year.

JC: That’s where you come into your own Simon and where The Merchants Trust has such a level of expertise, looking at the fundamentals of businesses; what are some of your key investment ideas  looking forward?

SG: One thing we have to do is to separate the recovery from Covid with business-as-usual performance and it will be distorted through this year; we’ll see many companies and industries recovering and others in much more normal state of affairs, but we see several areas that are really interesting. A big area for us is construction, housing and related products – furniture etc; we see more spending on infrastructure as governments try to stimulate the economy, and also the continuation of a theme we saw last year with people spending more money on their homes as I don’t think the working-from-home trend is going to go away completely. Spending more time at home, people often want to improve their home environment; whether they seek more space, to redecorate, or just a more comfortable sofa, I think we will see more spending on the home and construction generally. We can find plenty of companies with strong market positions, still attractively valued, and that’s one area where we have significant investments. Another theme, with interest rates staying very low, I think companies that can pay high, sustainable dividend yields will remain very attractive for investors, and we’ve got big investment in areas like utilities, like tobacco, which benefit from high dividend yields, and I think will continue to play quite well through 2021. The third area, which is a bit more disparate, is the whole area of recovery; companies that are not structurally challenged, that have a good long-term outlook but depressed to some extent by the pandemic and with the scope to recover and very modestly valued if you build that recovery into their prospects. So industries like civil aerospace, media, telecommunications – the shares are quite depressed in that sector – and energy; industries with further to go on the recovery path, could see good returns. We’ve got some significant investments there as well, so quite a broad array of areas we’ve found to invest in, yeah.

JC: Building on that, Simon, do you think we’re finally seeing a resurgence of value investing? Do you think some of the more challenging aspects that we face there might be over, and that this is a space to explore more and potentially yield results?

SG: Yeah, we saw a sharp recovery in value in the last quarter of 2020; after a period of extreme polarisation, value has started to perform better. The gap between lowly and more highly-rated growth companies remains historically extremely high; the market is still quite polarised, with further scope for those areas of the market to come together. There may be reasons why that might happen this year, because as economies recover there tends to be a better environment for more cyclical, value businesses. Also interest rate expectations or government bond yields could rise if there’s any sign of inflation coming through. Historically, low interest rates have supported high-growth companies, but higher interest rates tend to support the more depressed, cyclical companies, so there are reasons why we think that that value-versus-growth polarisation can narrow. However, we focus on individual companies, individual situations, trying to buy good businesses that are lowly rated for their own prospects, so we’re not totally dependent on the whole value/growth cycle turning. That’s not the only thing we’re thinking about. We are buying real businesses, making real products or services, at sensible prices; hopefully the value trade continues, but we’re not totally dependent on that sort of big-picture style view, we focus on individual companies.

JC: So Simon, final question - your thoughts on the fact that the UK has successfully negotiated a trade deal with the European Union; what do you think that means for markets going forward given all the uncertainty that has predated this move?

SG: Thanks, Jon, it’s good to get the news out of the way and focus on the future; as we discussed many times last year, whether or not we got a trade deal was not the biggest issue. The biggest issue to the market was the uncertainty; now that uncertainty has been removed, like we saw on news of the Pfizer vaccine in November, when the market could look ahead to life after Covid. With the news out of the way, we know what the arrangements are and investors can look forward and reassess from first principles whether companies in the UK are good places to invest. We were quite optimistic anyway, because the vast majority of profits and sales – something like three-quarters – for UK listed companies come from abroad; most companies in the UK are actually global businesses that happen to be listed here. Some industries – like banking, like housing – are quite dependent on the domestic economy, but many others are global. So we were never overly concerned for the UK company profit outlook from the Brexit negotiations, but it’s good to have some certainty so we can focus on the fundamentals for 2021.

JC: OK Simon, we are out of time; it’s always a pleasure, but thank you very much indeed.

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