UIL : Edison Research Note - Confident in portfolio companies' strong prospects

UIL

Confident in portfolio companies' strong prospects

UIL Limited (UIL) is managed by Charles Jillings at deep-value investor ICM. The portfolio reflects his three medium-term views: the world's

financial markets are over indebted; technological change offers strong investment upside; and emerging markets offer better GDP growth opportunities than developed markets. Despite a difficult macroeconomic backdrop, characterised by the war in Ukraine and central banks raising interest rates to combat higher inflation, the manager has a high degree of confidence in the prospects for UIL's investee companies. He believes that they are well placed to trade through the current uncertain period and emerge the other side as even stronger businesses.

Higher growth potential in emerging and developing economies

	7
	6
(%)	5
4
growth			6.7
3	6.2	5.4
GDP	2				4.0	3.1
			3.9
			3.4	4.2
	1			2.7	2.9
					1.2	1.4
	0
		2021		2022e	2023p	2024p
			World	Advanced economies	Emerging & developing economies

Source: International Monetary Fund World Economic Outlook January 2023, Edison

Investment Research. Note: e is estimated, p is projected.

The analyst's view

UIL is unique in that it offers investors a differentiated portfolio structure compared with other global funds; it has c 45% weighting in financial services businesses and a c 40% allocation to Australian companies. Holdings are a mix of platform companies (collective investment vehicles, c 70% of the fund) and direct investments (c 30%). UIL suffered a period of weak relative performance in 2022, as investor preference shifted away from growth stocks in a rising interest rate environment; unfortunately, this has negatively affected the company's longer-term record. However, patience should be rewarded as the manager's approach of buying undervalued niche assets has proved to be a successful strategy. Data from UIL show that since the fund's inception in 2003 until the end of H123, the company's NAV total return has compounded at an annual rate of 8.9%, which compares with an annual 7.3% total return for the broad UK stock market.

Valuation: More than meets the eye

UIL's headline share price discount to cum-income net asset value (NAV) of 37.3% does not tell the whole story, as some of its platform companies are also trading at a discount, thereby affording UIL's shareholders a 'double discount'. For example, at end-February 2023, Zeta Resources (15.1% of the fund) was trading at a 24.6% discount to net tangible assets and Utilico Emerging Markets Trust(12.2% of the fund) was trading at a 13.7% discount to NAV.

Investment companies

Global value

9 March 2023

Price		142.0p
Market cap		£119m
Total assets		£336m
NAV*		226.3p
Discount to NAV		37.3%
*Including income. At 6 March 2023.
Yield		5.6%
Ordinary shares in issue		83.8m
Code/ISIN	UTL/BMG917071026
Primary exchange		LSE
AIC sector	Flexible Investment
Financial year end		30 June
52-week high/low	246.0p	142.0p
NAV* high/low	386.4p	224.8p
*Including income
Net gearing*		77.2%

*Including zero discount preference (ZDP) shares. At 28 February 2023.

Fund objective

UIL's objective is to maximise shareholder returns by identifying and investing in investments worldwide where the estimated underlying value is not fully recognised. The company's investment performance is benchmarked against the broad UK equity market. UIL is a member of the AIC flexible investment sector.

Bull points

• High-convictionportfolio of undervalued assets.
• Regular quarterly dividend payments and an attractive yield.
• Scope for a higher valuation given large discount to NAV.

Bear points

• Levered strategy means losses are amplified in a falling market.
• Modest 20% free float - the majority of UIL's shares are closely held.
• Relatively high concentration risk as the largest holding is c 19% of the fund on a look-through basis.

Analyst

Mel Jenner

[phone]

[e-mail]

Edison profile page

UIL is a research client of Edison Investment Research Limited

NOT INTENDED FOR PERSONS IN THE EEA

Market outlook: A longer-term perspective is warranted

Many investors will be pleased to draw a line under a difficult 2022, where in the United States (the largest global stock market), the bellwether S&P 500 Index declined by c 20% and the technology heavy Nasdaq fared even worse, falling by around a third. However, in 2023, the macroeconomic backdrop remains very uncertain. Corporate earnings are being negatively affected by higher interest rates and rising input costs, while consumers are struggling with an increased cost of living. The war in Ukraine continues to place upward pressure on energy and food prices and is dampening investor sentiment. China's U-turn on its zero-COVID policy is a positive development for global growth, but multinational manufacturers have been reducing their reliance on China, by bringing their operations closer to home, which can increase costs, thereby adding to inflation pressures. Central banks in the developed world are actively raising interest rates to combat higher prices, which increases the risk of recessions. In an uncertain world, investors are likely to be better served by adopting a longer-term perspective. Focusing on high-quality companies that are trading on reasonable valuations should prove beneficial for when the macroeconomic clouds clear, given that over the long term, share prices are driven by company fundamentals rather than stock market 'noise'.

Exhibit 1: Market performance and valuation

Performance of indices (last 10 years, £)

350
300
250
200
150
100
50
Mar-13	Mar-14	Mar-15	Mar-16	Mar-17	Mar-18	Mar-19	Mar-20	Mar-21	Mar-22	Mar-23
	CBOE UK All Companies			MSCI AC World
	MSCI Emerging Markets

Datastream indices forward P/E multiples (at 7 March 2023)

(x)	Last	High	Low	10-year	Last as % of
				average	average
UK	11.1	15.7	9.4	13.5	82
Developed markets	15.8	20.7	12.7	15.9	99
Emerging markets	10.5	16.6	10.5	13.1	80
World	14.9	19.9	12.5	15.4	96

Source: Refinitiv, Edison Investment Research

The fund manager: Charles Jillings

The manager's view: Central banks will tame higher inflation

Jillings says that inflation has been exacerbated by the war in Ukraine, especially for energy and food prices, while a tight labour market is also adding to cost pressures. He comments that central banks face the challenge of bringing down inflation when there is full employment. The manager suggests that if employment data remain firm, inflation will remain elevated and central banks will have to keep interest rates higher for longer. Going into 2023 Jillings thought that inflation would moderate by the middle of the year and then roll over in the third or fourth quarter; this view has now been pushed out by a quarter. He believes that central banks will prevail, inflation will come down and within two to three years, will be behind us.

The manager explains that China's zero-COVID approach could not square up with the country's economic growth aspirations, and there were protests from all quarters of the country against the strict policy. He says that the speed of the policy pivot was surprising, as was the move to complete tolerance of COVID. Although individual fatalities are tragic, herd immunity developed in a month

UIL | 9 March 2023

2

once the Chinese economy had reopened, and activity is now back to more normal levels. Jillings reports that Chinese metro usage is now above pre-pandemic levels; people have returned to work and the government is focused on wealth creation. While there is also a focus on wealth redistribution, the manager suggests that the Chinese authorities have the levers required to get the domestic economy growing again, including interest rate and housing market policies. Chinese GDP growth is targeted at 5% for 2023, so with weakness in Q123 due to lockdowns, activity should accelerate through the balance of this year.

Jillings says that as China's economy reopens, there should be a step-up in demand for commodities such as copper and iron ore, and copper production is currently being affected by disruptions in Peru. In the medium term, he believes that there should also be support for commodity prices and producers due to a multi-year period of underinvestment.

The manager comments that, in general, investee companies are experiencing strong top-line growth. During the global pandemic company margins expanded but are now being squeezed by higher input prices. Jillings says that the corporate response will be to tackle costs and with labour being a large part of these, he expects unemployment to rise. The manager opines that as and when there is no longer full employment, inflation should moderate, and central banks will have achieved their desired outcome.

Jillings highlights the devastating war in Ukraine. He believes that at some point both parties will find that support for, and the ability to continue, the war will weaken, so peace negotiations will happen. The manager suggests that there could be a series of false starts, but there has been too much invested in the war by both sides to not find a resolution. He believes that the conflict could last a few more months, but neither Russia nor Ukraine will likely want to be at war throughout another winter. Jillings says that there are neutral countries that could broker negotiations, but while the conflict continues it is very disruptive to asset markets.

Current portfolio positioning

At end-February 2023, UIL's top 10 holdings made up 91.4% of the fund, which was a lower concentration compared with 96.1% a year earlier; five positions were common to both periods. However, the four top holdings (Somers, Zeta Resources, Utilico Emerging Markets Trust and Allectus Capital) are platforms with a portfolio of underlying investments, so UIL's fund is more diversified than these numbers suggest.

Exhibit 2: Top 10 holdings (at 28 February 2023)

Company

Country*

	Sector		Portfolio weight %
		28 Feb 2023		28 Feb 2022**

Somers	Bermuda	Financial services investment holding co	37.5	39.0
Zeta Resources	Australia	Resources investment company	15.1	20.0
Utilico Emerging Markets Trust	UK	Emerging markets investment trust	12.2	15.2
Allectus Capital	Bermuda	Fintech investment company	7.1	5.1
Resimac Group	Australia	Financial services	6.3	N/A
West Hamilton Holdings	Bermuda	Property	4.5	N/A
The Market Herald	Australia	Financial services	4.0	N/A
Allectus Quantum Holdings	UK	Investment holding company	1.7	N/A
Littlepay	UK	Payments technology	1.6	N/A
AssetCo	UK	Asset and wealth management services	1.4	1.1
Top 10 (% of portfolio)			91.4	96.1

Source: UIL, Edison Investment Research. Note *Country of listing or domicile. **N/A where not in end- February 2022 top 10.

On a look-through basis, at end-February 2023, UIL's top 10 positions made up 61.7% of the fund, with the top 20 at 75.3% and the top 50 at 88.2%. The three largest holdings were: Resimac (18.8%, held by UIL and Somers); Waverton Investment Management (12.7%, Somers); and Alliance Mining Commodities (4.8%, Zeta Resources).

UIL | 9 March 2023

3

The total number of positions including the platforms is c 35 and c 11% of the fund is held in unlisted investments (excluding loans to listed companies and listed companies classed as level 3 investments, which are valued using inputs that are not based on observable market data).

Following board approval, on 11 October 2022, UIL sold its holdings in unlisted ICM Mobility Group and Snapper Services (UK) for £45.6m to Somers. The consideration for the sale was satisfied through the transfer to UIL of Somers' holdings in West Hamilton Holdings (a Bermuda property holding company, listed on the Bermuda Stock Exchange), BNK Banking Corporation (an Australian banking group, listed on the Australian Stock Exchange) and WT Financial Group (an Australian financial advisory group, listed on the Australian Stock Exchange), which had an aggregate fair value of £23.3m; a cash payment of £13.6m; and a loan of £8.7m to UIL repayable by Somers. The cash payment contributed to UIL's repayment of the 2022 ZDPs on 31 October 2022.

Exhibit 3: Portfolio geographic exposure on a look-through basis (% unless stated)

Portfolio end-February 2023

Portfolio end-February 2022*

Change (pp)

Australia	39.4	33.5	5.9
UK	16.0	14.0	2.0
Bermuda	9.0	4.3	4.7
Asia	7.5	11.4	(3.9)
Europe (ex-UK)	6.5	6.7	(0.2)
Middle East/Africa	6.4	1.2	5.2
US	5.9	N/S	N/A
Canada	4.7	N/S	N/A
Latin America	3.8	4.2	(0.4)
New Zealand	0.8	1.4	(0.6)
Total adjusted for cash	100.0	100.0

Source: UIL, Edison Investment Research. Note: N/S is not stated separately. *At end-February 2022, North America made up 18.8% of the fund, with 4.5% classified as other - gold mining.

Exhibit 3 shows UIL's geographic breakdown. It has a differentiated geographic exposure compared with other global funds, with Australia making up c 40% of the portfolio followed by c 15% in the UK. Year-on-year comparisons are not straightforward as classifications have changed during the 12 months ending 28 February 2023. The United States and Canada are now disclosed separately, whereas at 28 February 2022, North America made up 18.8% of the fund, with 4.5% classified as other - gold mining. Some of the other - gold mining assets were sold with the balance now classified within Middle East/Africa.

Exhibit 4: Portfolio sector exposure on a look-through basis (% unless stated)

Portfolio end-February 2023 Portfolio end-February 2022

Change (pp)

Financial services	45.3	39.0	6.3
Technology	20.8	18.5	2.3
Resources	14.1	18.0	(3.9)
Gold mining	2.7	4.5	(1.8)
Ports	2.5	3.4	(0.9)
Electricity	2.2	2.1	0.1
Renewables	1.6	1.2	0.4
Telecoms	1.1	1.9	(0.8)
Oil & gas	1.0	1.7	(0.7)
Water	0.9	0.7	0.2
Airports	0.9	0.8	0.1
Infrastructure investments	0.5	1.0	(0.5)
Other	6.4	7.2	(0.8)
	100.0	100.0

Source: UIL, Edison Investment Research

Over the 12 months to end-February 2023, there is a notable increase in UIL's financial services exposure (+6.3pp). The largest decrease is a 3.9pp decline in the fund's allocation to resources.

Some of UIL's top 10 holdings are recent additions to the list:

• West Hamilton Holdings is a Bermuda-listed property investment and management company with commercial and residential property assets in Hamilton, Bermuda.

UIL | 9 March 2023

4

• The Market Herald is an Australia-listed,multi-platform publisher and media company. It operates one of the largest digital business communities in Australia and Canada and, in September 2022, it acquired the online classifieds business, GCA Group, which has a portfolio of complementary brands: Gumtree, Carsguide and Autotrader. These three businesses reach approximately one in three Australians per month and have significant further potential for monetisation. Jillings believes that there should be considerable upside from cross-selling opportunities between the company's business segments and that the firm is undervalued.
• Allectus Quantum Holdings is an investment holding company set up to invest in Diraq, a quantum computing company seeking to develop a full-stack quantum computer based on electron spins in silicon. Diraq is building a value chain to open the transformational applications of quantum computing that require many millions to billions of qubits.
• Littlepay provides fare pay systems to transport operators. Its technology enables travellers to tap to pay using credit cards such as Mastercard and Visa. The availability of a simple contactless payment method is linked to increased ridership and more frequent travel using public transit. Littlepay was founded in 2017, but already has over 250 customers globally and over 20,000 installed payment readers.

Performance: Tough period over the last 12 months

Exhibit 5: Five-year discrete performance data

12 months ending

	Share price		NAV
	(%)		(%)

	CBOE UK All		MSCI AC
	Companies (%)		World (%)

MSCI Emerging Markets (%)

28/02/19	10.2	15.9	1.6	3.3	(6.3)
29/02/20	22.9	2.4	(2.1)	8.8	2.6
28/02/21	33.3	20.8	2.8	19.6	24.7
28/02/22	(9.2)	(3.3)	16.7	12.8	(6.6)
28/02/23	(35.0)	(31.6)	8.2	2.2	(5.7)

Source: Refinitiv. Note: All % on a total return basis in pounds sterling.

Exhibit 6: Investment company performance to 28 February 2023

Price, NAV* and index total return performance, one-year rebased

110
100
90
80
70
60	Mar-22Apr-22		Jun-22	Jul-22Aug-22		Oct-22Nov-22Dec-22Jan-23Feb-23
Feb-22	May-22	Sep-22
	UTL Equity			UTL NAV		CBOE UK All Companies

Price, NAV and index total return performance (%)

10

5

	0
Performance	-5
-10
	-15
	-20
	-25
	-30
	-35
	1 m	3 m	6 m	1 y	3 y	5 y	10 y
		UTL Equity		UTL NAV		CBOE UK All Companies

Source: Refinitiv, Edison Investment Research. Note: Three-, five- and 10-year performance figures annualised. *Monthly NAVs.

In H123 (ending 31 December 2022), UIL's NAV and share price total returns of -6.5% and -12.6% respectively trailed the broad UK market index's +5.1% total return. Part of the underperformance is due to the market index having a double-digit weighting in the energy sector, which performed very well in 2022, whereas UIL has no energy exposure.

Somers' valuation declined by 14.8% in H123, (+10.8% including the August 2022 $4.55p per share dividend payment). Resimac's share price declined by 10.9% due to net interest margin compression caused by its securitising funding model and higher interest rates. Net interest margins should rise when interest rates decline. Despite the current headwind, Resimac is generating strong cash flow and profits and the stock is trading on a mid-single digit P/E multiple.

UIL | 9 March 2023

5