Smaller, Cheaper, Better

12/23/2009 12:01 am EST


Andrew McHattie

Editor, Investment Trust Newsletter

A UK small-cap trust that's cheaper than its beaten-down sector is yielding well while racking up strong absolute returns, reports Andrew McHattie in the Investment Trust Newsletter.

A note from Collins Stewart on Aberforth Smaller Companies (LSE: ASL) on December 1st rated the shares a Buy. The brokers explained that Aberforth’s value discipline, with a focus on strong balance sheets and reasonably high and sustainable dividends, has been a drag on relative returns this year, although a 50% price total return goes some way to cushion the blow for shareholders.

The trust’s portfolio is positioned for recovery, with a cyclical bias, and there is also a focus on ‘smaller’ small companies. That said, the risks are controlled by the focus on underlying balance sheet strength: 38% of the portfolio has net cash, while 26% has net debt/EBITDA of less than 1. The manager deployed gearing in the second half of last year, for the first time since 1999, and current gearing levels reflect confidence that further progress can be made. The price/earnings ratio of the portfolio is at a 19% discount to the benchmark, while the historic yield is at a 23% premium. A recovery in mergers and acquisitions activity may act as a catalyst for these valuation gaps to close.

Collins Stewart notes the shares offer an “attractive dividend yield” of 3.8% against the peer group average of 2%. Over the past ten years, the dividend has grown by 10% compound, compared to 4% for the FTSE All Share. The rating looks attractive, too, after the shares have de-rated sharply in recent months, and the broker comments “notably, on two previous occasions when the discount was in line with the peers, in March 2000 and in April 2008, shareholders enjoyed significant outperformance over the following three years and one year, respectively.”

The note concludes “in terms of NAV performance relative to its benchmark, Aberforth has just endured its seventh worst ten-month period since 1990, during which time the underlying universe has recorded its third highest absolute gain out of 217 distinct periods. Given the current appetite for risk, Aberforth may continue to lag in the short term, but at some point in the not-too-distant future, we expect a rotation. Given poor marketability in the UK small-cap sector, we would recommend investors begin to position their portfolios accordingly. Buy.”

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