Merchants Trust (MRCH)

[Spet0789]

Solid half year results last week.

http://www.lse.co.uk/share-regulatory-n ... ear_Report

After many years of tiny dividend increases every 2 years (so just preserving the multi-decade record for rising YoY divis), a second dividend increase in six months.

This reflects the impending roll off of insanely expensive legacy debt. This alone should increase earnings per share by around 5% for the foreseeable future and potentially close the discount.

With the current yield >5%, lowish fees and a decent manager track record, I see this IT as the best one stop HYP available. Any views?

Disclosure:- I hold MRCH and FGT as my UK equity allocation as they have complementary strategies and concentrated active portfolios.

[Dod1010]

The very expensive debt should unravel at the end of January 2018 and at a current rate of over 15%(!),this should certainly have some effect on revenue so as to allow an increase in the dividend but they hold 50% of the lenders according to Note 9 of the Annual Report so the benefit might not be as dramatic as it seems. I hate these over complicated arrangements because they are so difficult to assess. The discount is only about 3% so its main benefit is likely to be the dividend at over 5% and they still have rather expensive debt in place. Not sure that I see a great deal going for it and would certainly prefer City of London for this type of trust (Income oriented and a lot of UK shares)

Incidentally I would not call the portfolio of Finsbury active; Nick Train in fact makes a virtue of doing very little with it. I think it is a much higher quality trust than Merchants. I hold Finsbury but not Merchants.

Dod

[Spet0789]

I think they hold a nominal stake in the SPV used for the issuance. This is a legally complex arrangement but it's economically quite simple. They don't get any of the interest they pay back so the full benefit of refinancing the high cost debt (c15% as you say) should flow through to shareholders.

With regard to FGT, I agree that Lindsell Train's low turnover is an attractive aspect of their strategy. When I say that both FGT and MRCH are active I mean that in the usual fund sense of 'not-passive' - they both deviate boldly from their benchmark indices. The managers have views on stocks and aren't afraid to express them.

Any other views on MRCH?

[Hariseldon58]

Merchants was not alone in having very expensive debt in the late 80’s early 90’s , the long term nature of this debt has to make you think about the collective mind set of Investment Trust boards in that era.

At that time NAV was expressed with debt at par and these trusts traded at huge discounts in the 90’s and on until NAV was expressed as with debt at market price, in that fashion the cost of this legacy debt was “in the price” a few trusts SIT springs to mind repaid the debt at a significant premium, years ago and with the progress of interest rates since then, it proved to be a smart move.

I like investment trusts but there have been some almighty errors of judgement in the past , taking on debt at double digit interest rates for 20 plus years thinking you could consistently get investment returns above that level .......incestuous investing in split capital trusts a few years later .....

I’m not convinced that Merchants past performance is anything special and I doubt if the repayment of the legacy debt will make any significant change, the benefit has been seen in recent years as the market price of the debt moved closer to par with the passage of time. If Merchants has been smart they would have repaid the debt , albeit at a premium,many years ago, every year that went by with falling general interest rates simply lifted the cost of the debt market price.

They are not alone... I looked at another trust accounts recently, it held around 12% of the portfolio in 1-5 year U.K. corporate bonds yielding 1+% to balance borrowings at around 9%, it would have been much better just to sell assets, repay the loans , take a hit and mea culpa then move on, learn from the experience and be careful with gearing in the future but sadly we don’t see this.

[Spet0789]

I too wonder what the boards were thinking at the time. Leverage for ITs does make sense but only if they think they can access debt at much better terms than their average shareholder.

The ITs that have recently secured 30yr borrowing at or below 3% (City of London and Wotan among others, I think) have done the right thing in my opinion.

I agree that the pull to par if the debt will already be baked into the NAV but I do think (hope!) that greater earnings power and higher dividend growth will further close the discount.

[Dod1010]

I think they hold a nominal stake in the SPV used for the issuance. This is a legally complex arrangement but it's economically quite simple. They don't get any of the interest they pay back so the full benefit of refinancing the high cost debt (c15% as you say) should flow through to shareholders.

With regard to FGT, I agree that Lindsell Train's low turnover is an attractive aspect of their strategy. When I say that both FGT and MRCH are active I mean that in the usual fund sense of 'not-passive' - they both deviate boldly from their benchmark indices. The managers have views on stocks and aren't afraid to express them.

Any other views on MRCH?

As I said they hold 50% in what you call the SPV. Not what I would call nominal. It is not clear to me if they get any economic benefit or not.

Dod