288. Virus resistant pigs, Amazon TV deals and why the UK is so compelling

9 November 2023 (pre-recorded 30 October 2023)

Below is a transcript of the episode, modified for your reading pleasure. Please check the corresponding audio before quoting in print, as it may contain small errors. Please remember we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at your time of listening. For more information on the people and ideas in the episode, see the links at the bottom of the post.

[NTRODUCTION]

Staci West (SW): Welcome back to the ‘Investing on the go’ podcast brought to you by FundCalibre. Our discussion today is centered around the attractiveness of UK PLC for income investors. Our guest also highlights the importance of cutting through the broader market noise to focus purely on companies.

Chris Salih (CS): I’m Chris Salih, and today we’re joined by Charles Luke, manager of the Elite Rated Murray Income Trust. Thank you for joining us again.

Charles Luke (CL): Thank you, Chris. Thanks a lot, thank you for your time.

[INTERVIEW]

CS: So we’ve talked a couple of times before, and you’ve always been keen to focus on companies over the economy; it’s all about the companies you pick rather than the macro. But I noticed a few weeks back, you’d done a piece of work — well, you’ve been quite vocal really in explaining that the UK’s comfortably the most attractive market for income investors again, and it’s simply not the long-term case that it’s the most mature. Could you maybe explain to the listeners why?

CL: Yeah, I was really trying to look at that from the perspective of investors selling UK equity income to buy global equities. And I think I’d make three points really.

So, the first one is that the UK itself is a very international market, so around 75% of revenues earned by companies listed in the UK are actually from overseas. So the majority of earnings are from outside the UK. So, in other words, investing in the UK is investing mostly globally. So, that’s the first point.

The second point is that UK valuations are at the moment attractive in absolute terms. So the [FTSE] All Share Index trades on a P/E of around 11 times earnings, which is cheap relative to history and relative to other markets. And when you adjust for different sector compositions of regional equity markets, UK equities are around about 15% to 20% cheaper than than global equities.

And then the third point is really specifically from an income perspective. So, the UK market has a dividend yield of about 4%, which is above other regional equity markets. It’s got good dividend cover and also, you don’t have to pay withholding tax on the income from companies overseas. So, that would be the sort of the third point. So; UK itself is very international; UK valuations are attractive; and from an income perspective, the UK is also attractive.

And then I think for Murray Income, appreciating that there are certain industries that aren’t represented in the UK, we can invest in those too, with our small overseas budget. And the other point, I think just to highlight that, the shares at the moment are trading on a generous discount to NAV. So you effectively get this sort of double discount of the UK market, which is cheap, and the Trust shares, which are trading on a generous discount to their NAV.

CS: I wanted to touch on a couple of specific sort of milestones that the trust has hit this year. It’s the hundredth year of the trust, but also you’ve recently announced 50 years of dividend growth. I wanted to just focus specifically on the latter.

Could you maybe just talk us through how you’ve been able to continue this trend during your tenure on the trust, and also how challenging it was during a challenging period like Covid, which probably is about as tough as any sort of environment to do something like that. Maybe just give us some insight onto that please.

CL: Yeah, so if you look at the long term and think about the reasons why the trust has been able to grow its dividend for 50 consecutive years, I think probably two or three main reasons. And I think the first one is that the portfolio has generally been focused on a diversified selection of good quality businesses. So, that is actually something that’s particularly helpful in more difficult times, such as Covid as these sorts of companies in the portfolio tend to have less volatile earning streams and they’re more likely to fulfil their dividend aspirations. So, that’s certainly been helpful, the focus on good quality companies. And I think secondly, if you look at what’s happened to sterling over the last 50 years and also from the time that I started to manage the trust [which] was 17 years ago, then sterling has weakened and, as we’ve discussed, given the amount of revenues in the UK market from overseas, that’s very helpful given the dividend from Murray Income is paid in pence [and] in sterling.

And then just finally, I think the investment trust structure’s been really helpful in terms of maintaining that long period of dividend growth. So, we can use revenue reserves to fill in the gaps where dividends that the trust pays in a particular have exceeded earnings to maintain the dividend growth. But it’s probably worth saying that, in the 50 years of dividend growth, we’ve used the revenue reserve I think eight times, and in total paid out about 830 pence worth of dividends, of that just 10 pence has come from revenue reserves. So, it’s sort of really a combination of those three factors. The focus on good quality companies, the weakness of sterling and the benefits of the investment Trust structure that has generated that really strong, long-term track record growth.

CS: And just quickly for the listeners, the revenue reserve has been rebuilt quite well post Covid, hasn’t it? It’s almost back to the levels it was before or?

CL: Yeah, so it currently stands at about 55% of the full year dividend.

CS: Okay. Another quote from you that I’m going to ask you about; you’ve said that the more you’ve done this job, the more it’s been about sort of focusing on quality companies and doing nothing despite the noise. The market has been very noisy in the last 18 months with rising interest rates and rising inflation, lots of panic about the impact on sterling, fear about mortgages, all that sort of thing. How have you handled that on this occasion?

CL: Yeah, so I think if you just take a step back and you look at the best performing companies in the market over the long run, and I guess it shouldn’t really be surprising, but they tend to be high quality businesses with good growth and high returns on capital. So, ideally what you want to do is just find these companies, hold on for the long-term, reduce frictional costs and benefit from their compounding effect. And you know, when you look at the long-term macro impacts on those companies like inflation or interest rates, it’s not easy to divine any sort of impact.

It kind of goes back to what Benjamin Graham said; he has this quote, which is, ‘In the short run, the market’s a voting machine, in the long run, a weighing machine’. So, if you can find companies that can grow their earnings over the long-term, you’ll do well.

Having said that, unfortunately you know, doing that is one of those things that’s simple but not easy because all sorts of things can change that aren’t macro factors per se. So, that might be regulations or technologies or management or balance sheets or poor M&A, and you can experience periods of underperformance where there’s pressure to change style. So, it’s not easy to do nothing, but I do think it’s best to focus on the long-term where possible

CS: You mentioned M&A there. Let’s talk about that briefly. The UK’s been cheap for a number of years, but then there’s cheap and then there’s very cheap, and then there’s ridiculously cheap. I’m not sure how … it is obviously somewhere towards the latter end at the moment. I mean, have you seen a lot of M&A on the trust? I mean, obviously there’s private equity companies looking and sniffing around at how cheap the UK is. Is it all welcome? Is it all unwelcome? Give us a bit of an insight into what you’ve seen on the trust and have you been pushing back on any of it?

CL: So, in the last 24/30 months or so, we’ve had nine companies in the portfolio that have been taken over, the majority of those by private equity. And I think private equity typically looks for the same sort of characteristics that we do in a company. So, things like an experienced management team, strong balance sheet, low CapEx requirements, stable cash flows, good competitive positions and decent growth opportunities, not least really because all of those are helpful in terms of an exit route or crystallising value for private equity. And, of the companies that have been taken over, I think the prices paid really have been pretty fair. But we’re very happy to make a fuss if we think they’re not.

CS: Okay. As I mentioned at the start, it’s very much companies over economy for you. So, it would only be fair to talk about a few of the companies in the portfolio and some recent additions in particular. One of them is Games Workshop [Group PLC], which is a name that we’ve come across quite a few times with investment managers, but I’ve never actually talked about them before with you. Interesting that you’ve not actually held it before, so maybe just tell us why now and where is the growth now versus perhaps a couple of years ago or a few years ago. Are they doing new things that particularly interesting?

CL: Games Workshop have been on the radar for quite some time, but had always looked a little bit expensive. Then around about this time last year, it de-rated and that’s when we took the opportunity to introduce the company to the portfolio. And we like it because it has strong IP, loyal customers, it makes high margins on a relatively low cost to produce item, which are their sort of tabletop models. And future growth should come from a potential Amazon TV series. They’re expanding licensing agreements into areas such as computer games. Every couple of years, two or three years, they have a new edition of an update to Warhammer. And, also I think geographical expansion particularly in North America and Asia should also generate good growth for the future for the company.

CS: Okay. Another company is Genus [plc], which is an animal genetics company that sort of sells gene edited animals for breeding. They’re developing a new product, which I believe is all to do with virus resistant pigs. I will give you the floor and I will let you tell us all about that to the listeners.

CL: Yes, thank you. Genus is the global leader in porcine genetics and also does bovine genetics, but on the porcine side it’s developed a pig which is resistant to a nasty virus called or shortened to PRRS, which stands for Porcine Reproduction and Respiratory Syndrome. And in the US alone, that’s estimated to cost the industry about $600 million a year. And that amount of money should be able to be saved with the rollout over the probably the next three to four years of Genus’ PRRS-resistant pig. It does first need to get regulatory approval, but we’ve seen some of the first instances of that already, but the sort of two main markets where it would be very helpful is the US and also China. And, you know, overall when the benefits of the PRRS resistant pig are felt, it has the potential to really quite significantly enhance the earnings of the company which makes it very attractive from our perspective.

CS: We mentioned earlier, or you talked to us earlier about the international flavour that you’ve got in the portfolio, not just in terms of the revenues, but also some of the companies you can also hold; that allows you to look at areas where perhaps the UK is not as prominent, technology being the obvious example. Could you maybe give me an example or two of a couple of companies that you have in the portfolio that tap into that theme?

CL: We can invest up to 20% of the portfolio in overseas-listed companies. And that’s helpful for three reasons. Firstly, to find better quality versions of UK-listed companies. Secondly, to diversify risk in concentrated sectors. But, as you say, I think most importantly I think to gain access to industries that are difficult to find in the UK market.

So, I’m going to give you more than two examples, but in the portfolio we have holdings in Microsoft first, for  technology exposure; Novo Nordisk for diabetes and obesity; Kone [Oyj] for elevators; VAT Group, which is a Swiss vacuuming valve manufacturer for semiconductors; L’Oréal cosmetics; LVMH luxury goods; and finally, a company called Accton Technology, which is a Taiwanese-listed network equipment manufacturer, and that benefits from the growth of internet data and AI.

CS: Okay. I guess lastly is more a message directly for the investors, more than anything else. So I wondered if you could just give me the case for quality growth. I’m assuming it’s no different to what the long-term case is now, but obviously you’ve talked about the opportunity in UK equities in particular at the moment. Could you just explain what the benefits are to that style of investing now and over the long term?

CL: Yeah, so I’d actually call it sort of quality income rather than necessarily quality or growth. And if you take the benefits of marrying together quality on the one hand and income on the other. So, you have quality which offers earnings resilience from strong business models and good ESG characteristics. And on the other hand, you have income which helps to provide a sort of valuation backstop and reduces agency risk by encouraging a long-term approach by management teams. You have to think about the cash flows needed to continue to maintain the dividend payments. And when you put quality and income together – in the middle of the Venn diagram – what that offers is strong, long-term capital growth potential, an attractive and resilient income, which is what we’re trying to do in terms of building that Murray Income portfolio focused on good quality companies with attractive income credentials.

CS: Charles, thank you very much for joining us today once again.

CL: Thank you Chris, and thank you everyone for listening.

SW: The Murray Income Trust has reached a couple of notable milestones in 2023, not only is the trust celebrating its centenary this year, but it is also the 50th consecutive year of dividend increases for investors – which is no mean feat. We believe this is a dependable, diversified and differentiated trust, which has delivered consistently strong performance at a time when it has been challenging for UK equities. To learn more about the Murray Income Trust, visit FundCalibre.com — and don’t forget to subscribe to the ‘Investing on the go’ podcast, available wherever you get your podcasts.