Chelverton UK Dividend Trust plc: ACS-Annual Financial Report

Chelverton UK Dividend Trust PLC

Annual Results for the year to 30 April 2023

Printed copies of the Annual Report will be sent to shareholders shortly. Additional copies may be obtained from the Company Secretary - Apex Fund Administration Services (UK) Limited (formerly Maitland Administration Services Limited), Hamilton Centre, Rodney Way, Chelmsford, Essex CM1 3BY.

The financial information set out below does not constitute the Company's statutory accounts for the year ended 30 April 2023.  The financial information for 2023 is derived from the statutory accounts for that year.  The auditors, Hazlewoods LLP, have reported on the 2023 accounts. Their report was unqualified and did not include a reference to any matters to which the auditors draw attention by way of emphasis without qualifying their report.  The financial information for 2022 is derived from the statutory accounts for that year. The following text is copied from the Annual Report and Accounts.

Strategic Report

Financial Highlights

* Adding back dividends paid in the year.

** Calculated in accordance with the Association of Investment Companies (‘AIC’) guidelines. Based

 on total expenses, excluding finance costs, for the year and average net asset value.

***    Based on gross assets.

Chairman’s Statement

It gives me great pleasure to present this Annual Report, my first one as Chairman, for the financial year to 30 April 2023.

I start by repeating what my predecessor Lord Lamont wrote in this report last year. The last 12 months have undoubtedly continued to be challenging. Although the Covid-19 pandemic and the associated lockdowns are now well in the past, the impact is still being felt, not only in the UK but also in Europe. In addition, the war in Ukraine started by Russia in February 2022 continues and there are no signs of an end to it this year.

Whilst we all recall the turmoil in the markets in the autumn, caused by a febrile political situation in addition to the events around the ‘mini-budget’ and the more recent market volatility caused by the collapse of the Silicon Valley Bank and the distressed emergency takeover of Credit Suisse, the UK appears to be gradually recovering from these low points.

At this time in the UK, we are living with elevated inflation and interest rates at multi-year highs which, since December 2021, have risen multiple times from 0.1% to the current 5%. The Bank of England has been forecasting for some time that the UK economy would move into recession, which we are very pleased to see has, to date, proven to be wrong. Recently the International Monetary Fund (‘IMF’) announced that the UK will be the worst performing economy in the G20 with a decline in GDP of 0.3% in the next year. However, and true to form, where it should also be noted that of the last 26 forecasts by the IMF, 24 have proven to be too pessimistic and they have now upgraded their forecast of the UK economy to grow by 0.4%!

In addition to an economy that has been stagnating, combined with a major uptick in industrial action and a shortage of labour, there have been significant rises in energy prices, industry-wide increases in costs and supply chain issues. However, there has been recent evidence that these issues are easing as time passes and the economies of the world move away from the period of Covid-19 lockdowns.

In the last few months, a debate has begun in respect of the reduced interest in investing in UK equities, in particular those shares outside the FTSE 100. The Government and the Treasury are consulting on the introduction of new policies aimed at encouraging all parties to increase their weighting in UK equities. With a highly UK-centric portfolio, invested only in smaller and mid-cap companies traded on UK markets, the shares this Company is invested in are very underrated on an historical basis notwithstanding the fact that the underlying trading performance of the companies is very satisfactory. However, history suggests that a recovery will take place in time, leading to longer term outperformance.

Results

The Company’s net asset value per ordinary share as at 30 April 2023 was 168.15p (2022: 198.47p), a decrease over the year of 15.3%, with an ordinary share price of 174.50p per share (2022: 192.50p). Total assets, including audited revenue reserves, were £53.674m (2022: £58.805m), a decrease over the year of 8.7%, and the total net assets were £35.563m (2021: £41.382m). During the same period the MSCI Small Cap Index decreased by 5.2%.

The Company was launched on 12 May 1999, and since that time the net asset value per Ordinary share has risen by 70.35% while in addition a total of 228.89p has been paid to shareholders in the form of dividends, including the fourth interim dividend announced with this report. In the year under review, total dividends of 11.77p per Ordinary share were paid and proposed, including the fourth interim dividend of 2.9425p. The total dividend in 2023 represents an increase of 7% year-on-year. The Company has now returned to a position where the dividend is being paid entirely from the current year revenue surplus after costs. The balance of the surplus of £280,000, after the payment of the dividend, has been taken to bolster revenue reserves. The intention in the future is to increase dividends by 7% per annum and to take any surplus to replenish the revenue reserves that have been used over the past two years to ensure the dividend is not only being maintained but can be increased.

The underlying portfolio yield has increased this year as our investee companies have continued to grow their dividends, whilst at the same time there has been a continued general derating of shares. The portfolio yield is currently 5.6%, which is significantly higher than the normal range of 4% to 4.5% for this Company over its 24-year life. It is also worth pointing out that 6.5% of the portfolio is currently not paying a dividend as the Investment Manager manages the balance between revenue and capital growth.

The Company has increased its dividend each year for the last 13 years. Because of the strength of the revenue reserves, and the intention to add to them in the future, the Company is in a strong position and the Board is confident in the Company’s ability to further grow the annual dividend, assuming the current macro-economic conditions continue to improve.

The Company is currently invested in 81 positions across 17 sectors. This spread creates a well-diversified portfolio which should, in the future, lead to a strong return of dividend income and subsequently steady growth in revenue and, in time, capital.

Capital structure

Over the year the Board has approved the modest issuance of shares at a small premium to the prevailing

net asset value. The number of ordinary shares has increased by 510,000 to 21,360,000 shares.

In the past, the Company has been regularly asked to issue new shares to meet market demand. However, the Board’s policy is that it will only consider issuing new shares if it can do so at a premium to NAV which is sufficient not only to cover all the costs of issuance but also to recognise the value of the revenue reserves that have been built up over many years and where there are attractive opportunities for investment.

Currently the Investment Manager considers that there are sufficient undervalued high yielding shares in the market for the recycling of existing funds and also for the proceeds of new share issuance to be invested. The issue of new shares at a premium enhances net asset value per share, and the increase in the size of the Company should improve liquidity in the market for its shares while making it more attractive to potential new investors.

Dividend

As briefly discussed in the Results Section, the Board has declared a fourth interim dividend of 2.9425p per Ordinary share (2022: 2.75p) which, when added to the three quarterly interim dividends of 2.9425p per Ordinary share, brings the total paid and declared to 11.77p (2022: 11.00p) for the year ended 30 April 2023, an increase of 7% over the previous year.

Under the dividend distribution policy, the Board has not declared a special dividend (2022: nil) to be paid with the fourth interim dividend. The Company has revenue reserves which, after payment of the fourth interim dividend, represent 83.7% of the current annual dividend of 11.77p, or some 9.85p per Ordinary share. The Board is committed to progressively improving the Company’s dividend for investors and expects that the four interim dividends paid in respect of the financial year ending 30 April 2024 will very likely exceed, but in any event will not be less than, that paid in respect of the financial year ended 30 April 2023.

Outlook

As mentioned above, there is currently a great deal of uncertainty across Europe and in the UK. Sadly, the war in Ukraine is continuing and at this time there appears to be no end in sight. However, European countries have rebalanced their economies and have achieved major savings in energy costs which it is to be hoped will become embedded.

With the global impact of the draconian lockdown in China and after seeing the effect of the blocking of the Suez Canal by the “Ever Given” container vessel, it has become clear to European investors that they had been under-pricing the risk of sourcing products from China; as a result we are likely to see a major rebalancing of production to much closer to home.

The UK economy is expected to flat-line in 2023 but to recover to near long-term trend growth in 2024. Inflation is expected to decline by the end of the year, and it might well be that interest rates are therefore close to a peak. As the countries of Europe and the world return to ‘normal’ we can hope for a period of steady growth in the UK economy.

Howard Myles

Chairman

29 June 2023

Investment Manager’s Report

The year to April 2023 has been another challenging one, with the global economy feeling the effects of the war in Ukraine, supply chain challenges, inflation, rising interest rates and a banking crisis. In the UK, these combined forces were exacerbated by political turmoil, culminating in multiple leadership changes and the mini-budget in September, which severely dented both corporate and consumer confidence. With this as the backdrop, it is not surprising that share prices have suffered, with the small and midcap companies in which we invest particularly affected. It should also be noted that the large open-ended funds which invest in small and midcap UK equities have seen significant redemptions over the past year, which has put further pressure on stock market valuations in our part of the market. In the year to 30 April 2023, there was a 15.28% decline in the Company’s net asset value per share from 198.47p to 168.15p. During the same period the MSCI Small Cap Index decreased by 5.18%. At the same time the core dividend increased 7% to 11.77p, as explained in the half-year report in October 2022. The Company has not paid a special dividend in respect of the 2022/2023 financial year, in line with the dividend policy announced in March 2019.

It is encouraging that the underlying performance of the companies in the portfolio continues to be resilient with the majority of businesses reporting results in line with market expectations during the recent reporting season. The more efficient processes developed during the pandemic have helped our investee companies to navigate the difficult trading conditions over the past year and have left them well prepared to take advantage when the macro environment improves. Despite the resilient underlying trading, the small and midcap market has de-rated, resulting in the decline in the Company’s NAV. This was something of a year of two halves, however, with the above conditions resulting in a 22.92% reduction in the Company’s NAV to 152.99p in the first six months of the year, before it rebounded to 168.15p at the end of the year. The stock market is a forward-looking instrument and we believe the rebound in the second half of the year is a signal that investors are starting to look forward towards the end of interest rate rises and generally more stable macro conditions.

Equally encouragingly, the resilient underlying performance of our portfolio companies was reflected in good cash generation and dividends which were generally in line with or ahead of expectations. This has allowed us to continue rebuilding the income account after the pandemic shock, while also building positions in companies which we believe will deliver strong capital growth in the coming years. We are pleased to have delivered an annual 7% rise in the dividend and, after three years of utilising reserves to pay the increasing dividends, the Company has a covered dividend and we are now able to pay the increased dividend from current revenue.

Portfolio review

We reported last year that the de-rating of UK equities had resulted in a pickup in corporate activity across the market. This trend continued into the year to April 2023, with six bids received for our portfolio companies in the year. At the beginning of the year we saw a recommend bid by KKR for ContourGlobal. As the year progressed and uncertainty over interest rates resulted in private equity deals drying up, corporates took up the baton. Over the course of the year Appreciate, Curtis Banks, Devro, Numis and RPS all received bids from trade buyers. While the takeout prices generally represented attractive premiums to the prevailing share prices at the time, it is fair to say that, overall, we feel the buyers have managed to purchase these assets at advantageous prices. Including five of the six bid situations (the Numis bid was announced on 28 April 2023), we exited seven positions in their entirety with Braemar Shipping and Centaur Media exited on yield grounds. Shareholdings were reduced in ten companies including Belvoir Lettings, Bloomsbury Publishing, Conduit, Kitwave Group, ME Group, Ramsdens Holdings, TP ICAP and Wilmington Group.

Twelve new shareholdings were added to the Company’s portfolio in the year including private and commercial banking group Arbuthnot Banking Group, Conduit – pure-play reinsurance business, Fonix Mobile – mobile payments, Hilton Foods – meat and fish processing, Liontrust – asset management, Marshalls – building materials, OSB Group – specialist mortgage lending, One Health – outsourced NHS Surgery, RWS – content and IP translation and Somero – concrete levelling equipment. Shareholdings were also increased in 17 companies including Bakkavor, Chesnara, Close Brothers Group, Crest Nicholson, Headlam Group, Personal Group Holdings, Regional REIT, Spectra Systems, UP Global Sourcing Holdings and Vector Capital.

Outlook

After several years of significant negative events affecting markets, there are some positive signs on the horizon for equity investors. Expectations are starting to shift towards interest rates peaking and inflation falling to more manageable levels, while the spectre of a lasting UK recession appears to be receding. If this is the case, we would expect investor sentiment to gradually improve over the coming year, which would benefit our small and mid-cap universe.

We also continue to see an elevated number of companies undertaking share buy-backs, another consequence of current valuations combined with good cash generation and strong balance sheets. As we have previously said, buy-backs are a positive for our stocks, as long as they are instigated alongside an appropriate dividend policy.

We continue to have confidence in our investee companies and believe we are yet to benefit from the positive steps taken to improve the underlying operating efficiency of the businesses through the pandemic. Having traded through the challenges of the last twelve months, our companies are generally entering the next phase of the cycle as more lean, nimble enterprises. It will take a positive shift in investor sentiment for our companies to receive the ratings they deserve, but we are confident that the small and midcap universe in which we invest will return to outperformance over the medium term.

David Horner

Chelverton Asset Management Limited

29 June 2023

Breakdown of Portfolio by Industry