Merchants 09 December 2024

Merchants Trust’s (MRCH) objective is to provide investors with a high, progressively growing income stream, alongside capital growth. To achieve this, lead manager Simon Gergel and his team employ a disciplined value approach, targeting undervalued companies trading significantly below their fair or intrinsic values. However, unlike traditional deep-value strategies, they are selective, refusing to invest in companies solely because of attractive valuations. Whilst valuations are fundamental to their stock selection process, companies must also offer a high yield, strong growth potential, financial resilience, sustainable profitability, and consistent cash generation that supports rising dividends over time (see Portfolio).

This selective, value-driven approach, strictly adhering to investing in undervalued companies with latent recovery potential, has underpinned MRCH’s strong Dividend and Performance track records. On the income front, MRCH boasts a 42-year record of consecutive dividend increases, with an annualised growth rate of 6.4%, consistently outpacing inflation, which has grown 3.8%. MRCH has also demonstrated its ability to raise dividends not only in prosperous periods but during market stress as well, supported by prudent stock selection and a sizeable revenue reserve.

MRCH has also outperformed its benchmark, the FTSE All-Share, over both five and ten years (see Performance). In our opinion, this is notable given investors’ preference for higher-valued growth stocks for much of the last decade—an area where MRCH is deliberately underweight—and thus highlights the potential effectiveness of the manager’s high-conviction, value-oriented strategy. However, there have been periods where growth investing has dominated market returns, like in 2020, during which MRCH lagged, making it somewhat susceptible to style-driven markets.

At the time of writing, MRCH trades at a 2.1% discount, slightly wider than its five-year average premium of 0.3%, yet narrower than the UK equity income sector’s five-year average discount of 3.7%.

Given the various challenges the UK has faced over recent years, we find the current value dispersion in the stock market compelling. The UK hosts a number of well-established companies that have not only stood the test of time but also remain operationally strong and derive a large portion of revenues overseas, meaning they offer exposure to global opportunities as well. The challenge, however, lies in sifting through the noise to identify companies that are undervalued yet possess strong upside—a task where MRCH, managed by a seasoned investor like Simon Gergel, proves potentially advantageous, in our view.

Simon has consistently identified companies trading at discounts that also exhibit strong fundamentals, many of which have rerated materially as the market corrects its mispricing over time. His unwavering focus on undervalued companies with robust balance sheets and strong profitability has been instrumental in building MRCH’s impressive Dividend growth track record and its premium dividend yield relative to the market.

Over the past year a key driver of Performance for MRCH has been high interest rates, which have boosted portfolio holdings within the banking and insurance sectors, with companies like Lloyds and Barclays Bank benefitting from rises in net interest margins and strong earnings.

Whilst there is an argument that these more value-oriented companies could face challenges as interest rates ease in the coming years, we think that rates are unlikely to return to the extraordinary lows that overly favoured ‘growth’ stocks. Looking ahead, the economic environment may pose fewer headwinds to a value-driven approach—an encouraging prospect for value investment trusts and managers like Simon, who possess the expertise to uncover undervalued stocks with strong recovery potential.