Results analysis: Rockwood Strategic

• Rockwood Strategic (RKW) has released its results for the six month period ending 30/09/2023. The trust saw NAV and share price total returns of -5.5% and -2.5% respectively during the period, compared to equivalent returns of -10.3% in the FTSE AIM All Share Index and 2.9% in the FTSE Small Cap (Ex-ITs) Index.
• That six month period captured a difficult period for UK small company shares which follows an exceptional fund track record over longer periods. In the 12 months to 30/09/2023, RKW delivered total returns for shareholders that were close to 30%. Since the period end and as at 22/11/2023, RKW was the top performer in the AIC’s UK Small Cap sector over 1, 3, and 5 year periods. Annualised returns for that five year period were in excess of 20% on a share price total return basis.
• This strong track record meant that RKW traded at a premium for much of the period, enabling the board to issue new equity to investors, expanding the shareholder base by 5.7%. We note that this is at a time when UK small caps and the wider investment trust sector have been massively out of favour, with average discounts for closed-ended funds at levels last seen during the financial crisis.
• RKW added four new companies to the portfolio during the period. The trust managers also increased their stake in Trifast, a manufacturer of industrial fastening products and other components used in manufacturing.
• Finsbury Food, another RKW holding, saw a takeover bid at the period end, which represented an IRR of 38.5% at that point. Since the period end, the trust has seen a further three takeover bids for Smoove, Onthemarket, and the City Pub Group – all at substantial premiums to their share prices.
• RKW Chairman Noel Lamb said: “The first half of our financial year has been a challenging one for UK small company stock market investors, with sustained outflows from the asset class amidst negative sentiment as interest rates continued to rise against a subdued economic backdrop. For those with sensible time horizons these are typically the conditions for positive future medium-term returns, not least due to the heavily depressed valuations of small company shares relative to history.  Private Equity and Trade Buyers are clearly recognising the opportunities created by this environment with the drumbeat of takeovers within Rockwood's portfolio continuing throughout 2023.”

Kepler View

Rockwood Strategic (RKW) takes a unique approach to the UK small cap sector, with manager Richard Staveley investing at the smallest end of the London Stock Exchange. He looks for companies that are undervalued and which have the potential to deliver a 15% IRR over a three to five year time frame. This process is helped by the fact that few other fund managers can invest in these companies, mainly due to size and liquidity constraints, and that they typically have little to no research coverage. RKW also takes an active approach with the firms it invests in, meaning members of the RKW team regularly taking up board positions with portfolio companies and push for change where needed. In the period Nick Mills from the investment team joined Trifast as a NED.

The proposed takeover of Finsbury Food at the end of the six months to 30/09/2023, which represented a nearly 40% IRR for RKW, was a sign of how effective this process can be. However, we think – more than would normally be the case when looking at performance over a short period of time – that half year does not capture quite how impressive RKW’s returns have been and the extent to which the manager’s strategy has proven itself. As noted, the trust has been the top performer in its peer group in the 1, 3, and 5 year periods up to 22/11/2023, with annualised returns over that final period in excess of 20% on a share price total return basis.

Three takeover bids in the RKW portfolio since the end of September are also a validation of the trust’s investment process. These were all announced at substantial premiums to prior day closing prices, with Smoove acquired at a 69% premium, Onthemarket a 56% premium, and The Pub Group a 46% premium. We note that the prospective uplift for RKW was superior to each of these, given the entry point at which the managers invested.

Another factor to consider here is the extent to which the macro picture has been working against the managers. The UK is unloved and trading at lower levels than peers and its own historical average, small caps are viewed as being more susceptible to an economic downturn, and investment trust discounts have widened to average levels not seen since the financial crisis. To have issued new shares and delivered 12 month returns that were close to 30% in this environment is impressive.

RKW is also arguably well-positioned to continue its impressive track record moving forwards. The increasing level of M&A activity we are seeing in the portfolio and wider UK stock market is a sign that trade buyers and private equity firms clearly see the value these companies offer, even if other investors do not. At the same time, we think Richard’s focus on valuations, cash flows, and strong balance sheets mean the RKW strategy can succeed, regardless of whether we are in a period in which rates have peaked or where they remain ‘higher for longer’. Recent news that Downing Strategic Microcap (DSM) has plans to wind up means the trust is now one of the only closed-ended funds offering investors access to the UK’s smallest companies.

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