Merchants Trust: Defensively Positioned, High-Yield Dividend Stock

During the last 12 months, the Merchants Trust (MRCH.L) has outperformed its benchmark index, the FTSE 100, by 3.0% in terms of NAV total return. Despite this, the discount has gone from a premium of 5.9% to a discount of 2.0% with debt at fair value. For the half-year ended 31 July 2012, in total return terms the underlying portfolio beat the FTSE 100 by 4.2% (the FTSE 100 rose by 1.4%). Gearing added 0.8% to performance, despite an expensive tranche of debt that expires in 2018. The trust pays quarterly dividends and its recent interims suggest that the trust is well positioned to provide investors with 31 years of uninterrupted dividend growth. MRCH is managed using a value-driven investment style and remains defensively positioned.


Investment strategy: Higher-yielding FTSE 100 companies
MRCH aims to provide an above-average level of income; it currently yields 6.2% compared with the FTSE 100 index yield of 3.6% and FTSE 350 High Yield index yield of 4.8%. It invests in higher-yielding equities, uses gearing (net gearing of 22.3% as at 30 September 2012) and selectively writes covered out-of-the-money call options to generate additional revenue income. Revenue reserves have been used to support dividend payments over the last three years, but the gap has closed substantially as dividends on the underlying portfolio have increased. Management looks to invest in companies that offer at least a market yield on an 18-month view.

Sector outlook: Opportunities in cyclical stocks
The manager believes it is correct for the portfolio to be defensively positioned, given current market uncertainties. However, with increases in the valuation of defensive stocks during the last six months, it believes many are now fully valued and that there are opportunities to acquire quality cyclical stocks at compelling valuations. Reflecting this, the portfolio has become less defensive during the last six months.

Valuation: Discount above long-term averages
With the discount widening and premium contracting over the last 12 months, MRCH’s current discount of 10.6% (debt valued at par) and discount of 1.7% (debt valued at market) are above its five-year discount averages of 6.2% and -0.5% respectively. The performance of the underlying portfolio has seen an uptick in the last six months, which the price performance has not kept pace with. At 6.2% the yield remains strong, so we consider that MRCH should continue to be attractive to investors favouring a defensive portfolio with regular income at a decent yield, or those looking for geared exposure to the FTSE 100.

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