Results analysis: Schroder UK Mid Cap

• Schroder UK Mid Cap (SCP) has released its financial results for the year ending 30/09/2023. Over the year, the trust saw its NAV increase by 17.6% on a total return basis, which represents outperformance of the benchmark, the FTSE 250 ex-Investment Trusts Index, of 13.6%. This was also better than the average NAV return on the AIC UK All Companies sector of 15.4%.
• Performance was driven by strong stock selection, with the largest positive contributors coming from those stocks where the managers have a large active position.
• The trust has continued to deliver strong outperformance over the long term, with annualised returns since 2003, when Schroders took over management of the trust, of 12.2% versus 10.3% for the benchmark.
• Despite the strong outperformance delivered by the manager, the discount widened slightly to 12% at the end of the period from 11.4% at the start of the period.
• The board has declared a final dividend of 15p per share, which marks an increase of 7.1% from the previous year. When combined with the increased interim dividend of 5.5p declared in June, the trust has increased its full year dividend by 7.9% versus 2022. The trust offers a yield of 3.7%, based on the most recent closing share price.
• Net gearing was reduced to 6.8% as at year end, versus 10.8% the previous year.
• Chairman Robert Talbut struck an optimistic tone stating: “We are now seeing inflation falling rapidly, bringing the prospect of lower interest rates at some stage in 2024 which should improve the outlook for economic growth.” He added that the approach of looking for, “high risk-adjusted returns with rising cash flows and earnings and with conservatively financed balance sheets […] should help to continue to deliver sustainable returns to our shareholders.”

Kepler View

Jean Roche and Andy Brough, the managers of Schroder UK Mid Cap (SCP), aim to build a focused portfolio of around 50 of the best opportunities from the mid cap sector, as measured by the FTSE 250 Index. They target this index for its dynamism and constantly evolving nature, as well as the wide range of opportunities it offers.

Due to the concentrated nature and the focus on unique businesses, stock selection is expected to typically be the primary driver of performance. This has been the case in the most recent financial report in which the trust returned 17.6%, outperforming the benchmark by 4%. Holdings in consumer focussed companies Games Workshop, Dunelm and Cranswick were three of the top four contributors to performance, despite the consumer being perceived as under pressure, which we believe demonstrates good stock selection abilities. We note the market has treated firms who have given profit warnings particularly harshly over the period, though the managers have avoided the worst effects of this, notably by not holding Spirent and Drax.

The managers have added to a diverse range of companies in the year, based on a variety of stock specific factors. These have been funded through a number of disposals, including companies that have been sold following their promotion to the FTSE 100, and after share price recoveries which have led to the managers seeing better valued ideas elsewhere. They believe the mid cap space continues to offer plenty of opportunities at attractive valuations, given that mid caps are trading at a discount to large caps, whilst providing a higher dividend yield, both of which are rare phenomena. Despite this, the managers have maintained their risk-aware approach, which has led to a portfolio that is significantly less indebted than the index.

The trust has delivered another year of dividend growth, despite it not being an explicit goal of the managers. An increased final dividend has led to a total for the year of 20.5p, up from 19p the previous financial year. The managers point to the lower debt profile for their portfolio as a supporting factor in this being sustainable. We believe the dividend yield – c. 3.7% at the current share price – adds another positive element to the total return of the trust.

Despite another positive year, the discount on the trust has remained stubbornly wide. We believe this is a result of negative sentiment towards domestically-focussed UK businesses which doesn’t reflect the easing of economic headwinds, nor the very cheap valuations of the sector – and by extension, SCP. As such, this could be seen as an attractive entry point for long-term investors, with Jean and Andy’s stock selection prowess a stand out element of the investment case.