Zeus Capital Research Director Robin Savage caught up with DirectorsTalk for an exclusive interview to discuss City of London Investment Group PLC (LON:CLIG)
Q1: Now Robin, this morning City of London Investment Group has released a pre-close trading update for the six months to the 31st December and the headline suggests a 61% in its profits before tax to £5.8 million. Is this as impressive as it looks?
A1: Well, yes. City of London Investment Group’s (CLIG) first quarter and second quarter profits have both exceeded expectations set by management in September when CLIG reported its full year results to June 2016. I estimate that the first half adjusted EPS, which isn’t in the scope today but I estimate it that it is 17.2p a share and this is just over 50% of my expectation for the year to June ’17 which is 34p. The improvement on last years’ first half is driven largely by the impact of sterling weakness against the US dollar and the improvement in emerging market equities, in 2016 the Morgan Stanley MXEF index was up 8.6% in US dollar terms and up 30% in sterling so clearly that’s a great help for the first half of the current financial year.
I should draw investors’ attention to management’s commentary on its own investment performance in the past six months, the management reveal that the closed end funds that they manage were up 3.5% in US dollar terms compared to the index which was up 4.5% in that six month period. The underperformance in this six month period is attributable to their weak country allocation and poor performance on specific closed end fund investments. Over longer periods, CLIG’s investment performance is normally in the first and second quartiles, whilst their short-term performance is not up to their long-term standards I would observe that the best time to buy closed end funds is when the discounts are widest. The management observed that the size weighted average discounts are now at 13%-14% so now is a good time to consider investing in a manager of emerging markets closed end funds such as City of London Investment Group PLC.
Q2: So, the first half of CLIG’s financial year was good, what’s the current trading like and what are the prospects for the second half and beyond
A2: The first weeks of 2017 have been good so 2017 calendar year has started well. The MXEF index is up a further 3.1% in US dollars and up 5.5% in sterling so this improvement provides a following wind for CLIG and their own operating performance. Management have provided clear guidance for all investors in the form of a template, this template and the assumptions underlying the template are set out in today’s statement and also on their website. The management expect the second half to generate slightly more profit than the first half however we should always remember that markets go down as well as up and sterling can strengthen as well as weaken. My forecasts assume no change in the emerging market index over this year or next and we assume the exchange rate is 1.25 dollars to the pound when a few months ago I was assuming it was more like 1.33 to the pound, with the pound trading at 1.21 the second half should be good even if the pound strengthens so obviously if the pound weakens the it’ll be even better. So, I feel confident that City Of London Investment Group’s full year results to 30th June 2017 will be impressive and there is scope for growth in 2018 based on their gathering further assets under management.
Q3: On valuation, CLIG’s shares are up 14% over the past year which is 21.5% with dividends reinvested, what do you think is the right price for CLIG shares?
A3: Well, a good starting point for every investment is the dividend yield, essentially is the technical point, most other valuations methods are a way of assessing the sustainable dividend yield but that’s a technical point we could discuss in depth but if we look at the past 6 years, CLIG has paid 24p in dividends each year, it’s maintained a 24p dividend per share. City of London Investment Group has a strong balance sheet, it’s got no debt, it’s got net cash of over £10 million, the business model requires minimal additional capital and targets a dividend cover of 1.2 times, that is an 83% pay-out ratio that the Board normally expects to be able to deliver. I expect CLIG will increase its adjusted EPS from 23.7p for last financial year to 34p this year so that’s a significant increase this year, the dividend cover should have been proved from just under 1 times last year to well over the Board’s targets of 1.2, I’m expecting dividend cover on an unchanged 24p dividend of 1.45 on my forecasts. So, I expect the Board will leave its interim dividend per share unchanged at 8p a share and come the decision on the final dividend to increase the final dividend by a penny to 17p a share, making a total of 25p a share. On a total of 25p total dividend per share, CLIG’s shares would provide shareholders a 7.1% dividend yield with prospects of growth in the year to 2018. This dividend yield is 90% higher than the market as a whole which is yielding 3.7% and in my view a sensible dividend yield for a business such as City of London Investment Group, which is sensitive to financial markets and sterling’s value relative to the US dollar, is a 50% premium to the market yield, in other words a 5.55% dividend yield. On that dividend yield CLIG shares would be trading at £4.55 compared to £3.50 where it is trading at the moment.