Australian Listed Investment Company Report September 2021

Weekly Reports | Oct 08 2021

This story features WASHINGTON H. SOUL PATTINSON AND CO. LIMITED, and other companies. For more info SHARE ANALYSIS: SOL

Download related file: Monthly-LMI-Update_September-2021

A Listed Investment Company (LIC) is a listed investment vehicle that offers investors access to a diversified portfolio of shares in other companies also listed on the stock market. Also known as Listed Investment Trusts or Listed Managed Investments.

For comprehensive comparative data tables for LICs please see attached.

LMI Market News

MLT Shareholders Approve Merger with SOL & MLT Ceases Trading

On 13 September 2021, Milton Corp (MLT) shareholders voted in favour of the merger with Washington H. Soul Pattinson and Company Limited ((SOL)). During the month, the merger received the requisite court approvals with the Scheme becoming legally effective on 21 September 2021. MLT ceased trading on the ASX on 21 September 2021.

On the Implementation Date (5 October), all MLT shareholders will receive their Scheme consideration, being the new SOL shares as per the exchange ratio, and the Special Dividend which is expected to be 37 cents per MLT share. The Special Dividend has a Record Date of 22 September 2021.

The Fight is On for PM Capital Asian Opportunities Fund Limited ((PAF))

On 15 September 2021, PAF announced it had entered into a Scheme Implementation Deed (Scheme) to merge with PM Capital Global Opportunities Fund Limited. Under the Scheme, PAF shareholders will be offered PGF shares as consideration with the number of PGF shares issued based on PAF’s after-tax NTA per share divided by PGF’s after-tax NTA per share on the determined calculation date. Based on the after-tax NTA’s as at 10 September 2021, the Offer represented a 23.8% premium to PAF’s closing price immediately prior to the announcement. PGF currently have a 19.9% shareholding in PAF.

On 28 September 2021, WAM Capital ((WAM)) submitted an off-market takeover bid for PAF, rivalling the PGF merger proposal. The proposed bid represents an implied value of $1.147 per share, a 9.8% premium to the share price at the close of the day prior to the announcement. Under the WAM proposal, PAF shareholders will receive 1 WAM share for every 1.99 PAF shares or 1.975 in the event the break fee is removed. WAM’s offer is subject to a minimum acceptance of 50.1% and a no PAF NTA fall condition of more than 5% and a no market fall condition of more than 5%.

PAF is engaging with both parties to see whether either of the parties are prepared to improve their offers.

FSI to Issue Convertible Notes

On 31 August 2021, Flagship Investments Limited ((FSI)) announced the Company is seeking raise $20m through the issue of listed, redeemable, unsecured convertible notes (Notes). The Notes will have a face value of $2.70 (in line with the pre-tax NTA) and will pay an interest rate of 5.50%p.a, paid quarterly, until the first step-up date of 30 September 2024 at which point the interest rate will increase to 6.50%p.a if the 2-year BBSW [bank bill swap rate] is above 1.2832%. If the BBSW is not above this rate, the interest payment will remain at 5.50% until maturity. The Notes will have a maturity date of 1 October 2026, if not converted or redeemed prior.

The Offer opened on 7 September 2021 and closed on 24 September 2021. The Notes are expected to commence trading on the ASX on 4 October 2021, with the ticker FSIGA.

Noteholders may convert some or all of their Notes into FSI ordinary shares during the Conversion Period, which commences on the second anniversary of the Initial Issue Date and ends 10 days prior to the Maturity Date. Notes will be converted on a one-for-one basis.

The Board intends to participate in the Offer, intending to invest $5.2m, with Manny Pohl expected to invest the lion’s share of the Board’s investment.

FSI believe the issue of the Notes provides the ability to increase the size of the portfolio without being dilutive to existing shareholders.

KKC Seeks to Narrow the Discount

The Manager and Responsible Entity of KKR Credit Income Fund ((KKC)) have announced the implementation of initiatives to narrow the discount to NAV. The trust has announced that it will be: (1) undertaking an on market buy back in FY22 with no stated minimum or maximum number of securities to be purchased; (2) establishing an unlisted credit fund with similar objectives to KKC that has the ability to purchase units in KKC; and (3) continue with improved unitholder engagement and education.

KKC has struggled to narrow the discount to NAV with the trust trading at a discount for most of its listed life. The Manager has undertaken a number of initiatives to narrow the discount including restructuring the underlying investments, unit buy backs, improving unitholder engagement and increasing the frequency of distributions from quarterly to monthly.

At 31 August 2021, KKC was trading at a discount to NAV of 13.1%, the largest discount of the fixed income peer group. At the unit price as at 31 August 2021, KKC offered a distribution yield of 5.0%.

Future Generation Investment Company ((FGX)) Announces Bonus Options Issue

On 3 September 2021, FGX announced the issue of Bonus Options to shareholders on a one-for-one basis. The options will have an exercise price of $1.48 and can be exercised at any time up until the maturity date of 28 April 2023. The options will be listed under the code FGXOA. The options are intended to be issued on 4 October and commence trading on the ASX on 5 October 2021. Options that are exercised on or before 17 November 2021 and shares held at the dividend record date of 22 November 2021 will receive the fully franked interim dividend of 3cps.

The exercise price is in line with the pre-tax NTA of the Company at the time of the announcement and represents a premium of 3.5% to the closing price at the close of the trading day before the announcement. Assuming 100% of shares on issue are held by eligible shareholders on the Record Date (1 October 2021), the maximum number of options that may be issued is 401.26m and if all options are exercised the Company would raise $593.9m.

Cadence Capital ((CDM)) Proposes Global Demerger

CDM’s $6m investment in DeepGreen (an unlisted company that was preparing for IPO) is currently valued at approximately $85m, ~14x the initial investment. The uplift in value comes after DeepGreen merged with Sustainable Opportunities Acquisition Corporation to create The Metals Company, which has subsequently listed on the NASDAQ with the ticker TMC.

The uplift in valuation has seen the position become a substantial position in the portfolio at approximately 20% of the portfolio. With a position of this size, any movement in the value of the position will cause significant volatility in the portfolio value. Further to this, CDM’s shares in TMC are subject to escrow arrangements with the manager not able to exit its position until the shorter of 180 days post listing or if TMC shares trade at or above US$12 for 20 trading days within a 30 day period.

As an early stage investor, CDM has been issued with Warrants, whereby CDM receives ‘earn out’ shares at no cost upon certain price targets being met by TMC. The earn out shares will be issued across eight tranches and the shares vest if the share price trades above the strike price for 20 out of 30 trading days. The tranches of Warrants and potential value to CDM are outlined in the investor presentation released on 20 September 2021.

Given the significant potential value that exists in the TMC position, CDM are proposing a demerger of the position from the CDM portfolio into a separate LIC. The new LIC would invest only in global securities and would initially comprise solely of the TMC position and $15m cash. The demerger would eliminate the stock concentration risk in CDM and allow shareholders to choose the level of exposure to the TMC position. We await further details regarding the demerger.

Templeton Global Growth ((TGG)) Shareholders Approve Merger with WAM Global ((WGB))

TGG shareholders have voted in favour of the merger with WGB with the merger now subject to court approvals. If the requisite approv­als are obtained, TGG shares will be suspended from trading on 20 October 2021.

In addition to voting in favour of the merger, shareholders voted in fa­vour of TGG’s offer to buy-back shares from those shareholders who do not want scrip consideration for the merger. The buy-back will remain open until 6 October 2021. Under the offer, TGG will buy-back TGG shares for a cash amount equal to the after-tax NTA per share.

SNC 1 for 4 Entitlement Offer

Sandon Capital Investment Limited ((SNC)) is seeking to raise up to $27.9m through a 1-for-4 Non-Renounceable Entitlement Offer. The Offer opened on 15 September 2021 and closed on 29 September 2021.

Under the Offer, eligible SNC shareholders could acquire 1 new SNC share at a price of $1.01 for every 4 shares owned. Shares issued under the Offer will be eligible for the fully franked final and special dividend of 3.75 cents per share to be paid in December.

Eligible Shareholders who exercise their Entitlements in full will be able to apply for additional shares in the Top-Up Facility at the Offer Price. If there remains any shortfall (including after shares to be issued under the top-up facility) the Directors of SNC reserve the right (in their absolute discretion) to issue all or any of the shortfall through a placement to eligible professional and sophisticated investors at the same price and on the same terms as the Entitlement Offer.

Dividend Stocktake

Dividends are often an important consideration for those investing in LICs. As such we have done a stocktake of dividends and yields post the completion of the FY21 reporting season. Strong earnings were reported in FY21 on the back of the market rebound post the initial COVID-19 shock in March 2020. LICs took the opportunity to top up their profit reserves for future dividend payments.

Note we have only included LICs in the below analysis as LITs act as a pass through vehicle with all realised capital gains and income to be distributed in any given year. LITs cannot hold earnings on balance sheet. This is a key differentiator between LICs and LITs. The company structure allows LICs to retain earnings and allocate earnings to profit reserves for future dividend payments. This allows for a LIC to smooth the dividend stream.

Why are profit reserves and the level of dividend coverage important? If you are reliant on dividends as an income stream, the level of dividend coverage in combination with the pool of franking credits is important as these are key indicators as to the sustainability of the current dividend. In the event the profit reserves or retained earnings for a LIC become depleted, this may put in jeopardy their ability to maintain or pay a dividend in future periods.

It is important for investors to understand a LICs individual dividend policy. For example, BKI Investment Company ((BKI)) seeks to payout the majority of income earned in any given period to shareholders. As was experienced in 2020 when companies in the portfolio cut dividends, the income received by the portfolio was reduced and dividends were cut as a result. In the case of BKI, the profit reserves are not a key focus with the level of dividends being paid by the underlying companies in the portfolio being a more important indicator of dividend income.

Below we take a look at a number of metrics for the LIC sector, including: (1) Dividends declared for the FY21 period (excluding special dividends); (2) The percentage change in the dividends declared from the FY20 period (excluding special dividends); (3) The dividend coverage ratio based on the most recently released financials, the shares on issue as at 31 August 2021 and assuming maintenance of the FY21 dividends declared; (4) Net and grossed up dividend yield based on the dividends declared for FY21 and the share price as at 31 August 2021; and (5) The premium/discount to pre-tax NTA as at 31 August 2021.

As a whole, LICs have good dividend coverage with an average dividend coverage ratio of 6.2x. Whilst not included in this report, we note that the pool of franking credits is also important with LICs seeking to provide fully franked dividends. Many LICs will only pay dividends to the extent they can be fully franked to provide the maximum tax benefits to its shareholders. 96.4% of LIC dividends declared for FY21 were fully franked.

A number of LICs are paying attractive dividend yields compared to the broader market, particularly on a grossed up basis. A reminder that the grossed up yields are based on the dividends declared for the FY21 period. Some of these dividends declared are yet to go ex.

For the Australian Shares – Large Cap category, LICs typically had relatively healthy dividend coverage levels. FSI had the largest increase in dividends declared. We note if you were to include the special dividend of $0.0225 paid for the FY20 period, the percentage increase declines to 5.9%. We have included MLT in the above, however, note that the company ceased trading in September after the approval of the merger with SOL.

A number of companies in the category saw a reduction in their dividends given the impact of the COVID-19 market shock in 1H’FY21, which saw a number of ASX-listed companies reducing or suspending dividends. This had a flow on effect to a number of the large cap managers.

After trading at a significant premium for a number of years, Djerriwarrh Investments ((DJW)) is trading at a double digit discount. DJW’s share price has declined and the discount to pre-tax NTA expanded as a result of the company cutting dividends over the last few years, resulting in a substantially reduced yield. Given the key objective of the company is to provide an enhanced yield, this saw shareholders seeking yield elsewhere. The ability of the company to stabilise and change the trajectory of dividends will likely result in the company narrowing the discount.

The Australian Share-Mid/Small Cap category typically had healthy dividend coverage ratios. We note the grossed up yields in this category are generally attractive when compared to both the ASX All Ordinaries Index and the ASX Small Ordinaries Index. LICs such as WAM Research ((WAX)) and WAM Microcap ((WMI)) are offering attractive yields despite trading at significant premiums to pre-tax NTA, however, there are also a number of LICs trading closer to pre-tax NTA and at discounts also offering attractive yields with strong coverage ratios.

LICs in the Australian/International Blended category offered attractive grossed up dividend yields with strong dividend coverage ratios, all with greater than 4 years coverage. We note Hearts & Minds Investments’ ((HM1)) dividend policy is to pay an annual dividend following the realisation of the previous year’s conference portfolio.

Many LICs providing exposure to international portfolios offer an attractive proposition for those seeking access to an international portfolio with the added benefit of franked dividends. 94% of LICs in this category declared fully franked dividends for the FY21 period. PGF, WQG, WGB, PIA, PMC, PAI, EAI and PAF all offered grossed up dividend yields of greater than 5% as at 31 August 2021. This compares to the Vanguard MSCI Index International Shares ETF ((VGS)), which provided a grossed up dividend yield of 1.8%. The category as a whole had healthy dividend coverage ratios.

With regard to the remaining categories, a number of LICs didn’t declare dividends in FY21. Of note is L1 Long Short Fund ((LSF)), which commenced dividend payments in FY21 after reporting strong returns. The company took the opportunity to supercharge its profit reserves with a whopping 18.5x dividend coverage based on the FY21 dividend declared. This provides plenty of room for dividend growth over time. At 30 June 2021, LSF had 9.3 cents per share in franking credits, providing the company with sufficient franking credits for multiple years based on the FY21 dividend declared.

Global Value Fund ((GVF)) and WMA also have an attractive grossed up yield. With respect to WMA, the ability of the company to continue to pay a dividend will depend on income received by the portfolio and the levels of cash held given the illiquidity of the underlying investments.

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