Spotlight on Thungela Resources

Thungela Resources spun out of Anglo American in June 2021. Rather than selling this tiny position of only 6,572 shares, we concluded that this highly cash-generative business was deeply under-valued, so we bought an additional 579,281 shares between June 2021 and January 2022 in order to make the holding more meaningful. We paid an average of 187 pence. The shares ended the financial year at 1,666 pence, nearly nine times higher than our initial purchase price. The stock also paid 393 pence of dividends per share during the financial year, taking the total return to 11 times our initial investment in only 15 months, making it one of the most profitable investment decisions we have made for this portfolio. Consensus estimates expect that the company will distribute over 600 pence per share (at the current exchange rate) in its next financial year indicating that the dividend received can be seen as recurring. We believe that this is a good example of the returns that our investment process can generate.

We have engaged with the management of Thungela to understand better the company’s approach to sustainability and then urge improvements where we see gaps. We have urged the company to set more ambitious goals, increase transparency and to commit to clearer timeframes for developing its sustainability roadmap, in particular on measures to reduce carbon emissions. We have provided Thungela with our recommendations on industry best practices as we seek to support the company’s growth in this area. We have been encouraged by Thungela’s development of an ESG framework, covering issues such as environmental stewardship and local community relations.

Revenue Account

Dividends distributed by our portfolio in the period under review rose by 27.0% to £13.5 million, compared to the £10.6 million received last year. This compares favourably to the Index where dividends grew by 13% over the same timeframe. The contribution from special dividends remained low at 5.9% of the dividend income (2021: 5.7%), reflecting the continuing scarcity of special dividends in the wake of the pandemic.

Net revenue was £12.2 million, or 26.3% higher than last year. Management fees were 2.1% lower, but this is a function of the decrease in the value of the portfolio. Total expenditure before interest and tax was 9.0% higher than last year. This was largely due to the comparative year’s professional fees being a rebate as a result of reversal of provisions in the year prior.

We are forecasting that the portfolio is currently delivering a gross dividend yield, before costs, of 8.1% based on the income expected to be generated by the portfolio over the financial year divided by the portfolio value at the year end, representing a significant premium to the effective monthly average dividend yield of the Index of 3.8% as at 30 September 2022.

Recent interest rate hikes are unhelpful for our investment return as they increase the cost of our overdraft facility. However, the gap between the interest rate we pay for this overdraft facility and the dividend yield we earn on the portfolio, while narrower than it was a year ago, remains very wide by historical standards at around four percentage points at the time of writing.

This sharp recovery in the revenue account is a result of our focus on achieving the priorities set out by the Board at the time of the Covid-19 crisis. The Board emphasised that our first priority should be to build a portfolio that could deliver sufficient income to cover the dividend. I welcomed this challenge as I could see that it was consistent with our investment process which favours companies whose strong cash flow and dividend potential are not priced in by the market. During the financial year we identified many examples of stocks that fit this description, enabling our dividend cover to exceed 1x sooner than might have been expected in the midst of the Covid-19 crisis.

For the wider UK equity market, the outlook for dividends has improved significantly since the pandemic, with dividend cover recovering to 2.5x (on a 12 month forward basis), suggesting some cushion for corporates in the event that macro conditions deteriorate. We also have the advantage of selecting from a broad palette of UK stocks, with many different earnings drivers. This helps to underpin our confidence in the continued progression of our dividend per share in FY23.

Activity

Purchases

The market backdrop has changed meaningfully in the past year, creating a new set of opportunities that we have attempted to seize upon. Inflation was already increasing prior to Russia’s invasion of Ukraine. Two key drivers of higher inflation were supply disruptions linked to the shutdown of the economy during Covid-19 and rampant growth in money supply caused by the Bank of England’s Quantitative Easing programme. The war in Ukraine only exacerbated existing inflationary trends, as natural gas and food supplies were disrupted. So it is against this backdrop that we have been carefully positioning the portfolio.

Our largest purchases are mostly companies whose cash flows have the potential to benefit from rising prices and interest rates, providing the portfolio with some inflation hedge characteristics:

Portfolio's review of the half year ended 30 September 2022

Loading component...