Results analysis: BlackRock Smaller Companies

• BlackRock Smaller Companies (BRSC) has released its financial results for the year ending December 28th February 2022. The trust delivered strong outperformance of its benchmark, with a NAV total return of 7.0% over the period, compared to a 1.5% rise in its benchmark, the Numis Smaller Companies plus AIM (excluding Investment Companies) Index.
• Total share price returns for the period were lower at 0.9%, reflecting a sizeable widening of the discount since the start of 2022. The discount at the end of the period stood at 12.5%, substantially wider than its 4.9% three-year average. Since the period end it has widened further to 14.9%, as of 10/05/2022.
• A downturn in the NAV and share price at the end of the reporting period reflected wider trends in the small cap market, which was hit hard by a mixture of inflationary fears and the uncertainty caused by Russia’s invasion of Ukraine.
• Total dividends per share rose to 35p for the period, a 5.1% year-on-year increase. Dividends are seen by the board as a vital source of returns for shareholders and payouts have risen every consecutive year since 2003.
• Revenue per share rose to 35.29p, a 164% increase on 2021, which reflects both the dramatic cut that companies in the portfolio undertook during the early stages of the pandemic and their subsequent bounce back in FY 2022.
• Chairman of the board Ronald Gould said: “[The] Company’s focus has always been on investing in companies with well capitalised balance sheets and strong, entrepreneurial management teams that are able to rapidly adapt their businesses to shifting market dynamics. As such we believe the portfolio is well-positioned and prepared to navigate the challenges ahead and to take advantage of the investment opportunities that may arise in these uncertain times.”

Kepler View

We think BlackRock Smaller Companies (BRSC) offers an attractive way to take up long-term exposure to UK small caps. The trust’s growth bias means it’s likely to see bouts of volatility that investors should be prepared for. But the high-quality companies in the portfolio have weathered various economic storms over the past two decades and delivered benchmark-beating returns to shareholders in the process.

That should be kept in mind given the very frustrating year small cap investors have had thus far. As we approached the end of 2021, it seemed many of the macroeconomic clouds were clearing and we were on the path back to ‘normality’. Instead a perfect storm of inflation, warfare in Europe, and supply chain problems stemming from lockdowns in China have put immense pressure on companies trading at higher valuations.  

BRSC has not been immune to these macroeconomic headwinds and the trust has seen falls in both its NAV and share price in the year to date, albeit with the drop in the latter being much more pronounced than that of the former. The trust is now trading at a c. 15% discount, substantially wider than the 4.9% it averaged over the past three years. For investors with a long-term view this could be an attractive entry point, even if volatility looks likely to continue in the short term.

Rising interest rate expectations, and any resulting increase in the cost of capital, have hit many companies in the BRSC portfolio hard. But share price contractions, if based on rising rates, need to be balanced against earnings growth. And it’s far from clear that some of the sell-offs we’ve seen in the small cap space are justified when taking that balance into consideration.

This is true of many companies in BRSC’s portfolio, with Watches of Switzerland Group, one of the trust’s largest holdings, being a good example. The company’s most recent trading update revealed quarterly YoY sales growth of 27% but its share price has fallen by over a third in the year to date.

We would also note that the trust’s manager has been very careful about ensuring the companies in the portfolio can pass on price increases to consumers. Businesses that look unable to do so have been swiftly cut from the portfolio.

Finally, the trust has not deployed gearing to a large extent, with net gearing sitting at approximately 4% as of 05/05/2022. The trust’s manager is not in a rush to leverage up but having access to cash means that he can keep his powder dry and will be able to take advantage of opportunities in the market as they arise, whether that’s adding to existing holdings or investing in new companies. In our view BRSC remains a strong option for UK small cap exposure, and such a wide discount may not persist through the cycle.

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