Merchants Trust : Results for the Half Year Ended 31 July 2016

15 September 2016

Highlights‌‌‌

THE MERCHANTS TRUST PLC

Half-yearly financial report For the six months ended 31 July 2016

• Net dividends declared in the first six months of 2016/17 are 12.0p per share.

• Ordinary shares yield 5.7% at 421.7p, compared with 3.8% on the FTSE 100 Index at the close of business on 14 September 2016.

  At 31 July 2016	At 31 January 2016	Capital return % change	Total return % change
  Net asset value per ordinary share (debt at market value)	447.0p	437.7p	+2.1	+4.9
  Net asset value per ordinary share (debt at par)	475.0p	458.1p	+3.7	+6.3
  Ordinary share price	424.0p	414.0p	+2.4	+5.3
  FTSE 100 Index	6,724.4	6,083.8	+10.5	+13.1
  Discount of ordinary share price to net asset value (debt at market value)	-5.1%	-5.4%	n/a	n/a
  Discount of ordinary share price to net asset value (debt at par)	-10.7%	-9.6%	n/a	n/a

• The NAV returns were as follows:

Interim management report‌ Half year results

The company achieved a positive total return. The performance against the FTSE 100 was disappointing, but reflects certain portfolio characteristics, specific market circumstances and the impact of falling bond yields on the market value of the company's debt. This is explained fully in the investment performance commentary on page 5, with an attribution analysis set out below.

Interim dividends

The board has declared a second quarterly dividend of 6.0p per ordinary share, payable on 10 November 2016 to shareholders on the register at close of business on 7 October 2016. The total distribution declared for the first half of 2016/17 is 12.0p net, maintaining payments the same as the first two dividends paid last year. As at 31 July 2016, the company's revenue reserve, after deducting the first and second quarterly dividends, represented 13.0p per share (2015 - 12.7p).

Net revenue

Earnings in the first six months of the current year, to 31 July 2016, were 14.38p per ordinary share (2015 - 14.14p).

Net asset value - capital basis

As at 31 July 2016, the NAV per ordinary share (with debt at market value) was 447.0p. On a capital basis, the NAV per ordinary share (with debt at market value) increased by 2.1%, compared with the benchmark, the FTSE 100 Index which increased by 10.5%.

Net asset value - total return basis

The total return reflects both the change in net asset value per ordinary share and the net ordinary dividends paid. For the six months to 31 July 2016, the NAV per ordinary share (with debt at market value) increased by 4.9%, whilst the FTSE 100 Index increased by 13.1%.

Material events and transactions

At the annual general meeting of the company, all the resolutions put to shareholders were passed.

The third quarterly dividend of 6.0p per share was paid on 24 February 2016 to shareholders on the register on 29 January 2016. A final dividend of 6.0p per share was paid on 26 May 2016 to shareholders on the register on 22 April 2016. The total paid and declared for the year ended 31 January 2016 was 24.0p.

There were no buy backs of shares, share issuances and no related party transactions in the period.

Since the period end, the first quarterly dividend for the year ending 31 January 2017 of 6.0p per share was paid on 12 August 2016 to shareholders on the register on 15 July 2016.

Buybacks and share issuances

In the Annual Financial Report we explained our approach to the issuance of new shares when the Company's ordinary shares are trading at a premium to NAV with debt at market value and also our proposal to buy back shares for holding in treasury to help dampen share price volatility when it is at a sustained discount to NAV. Since the approval of this programme was renewed by shareholders at the AGM in May this year we have seen the shares trading at a discount (averaging 6.2% since 24 May) through periods of market volatility which has not given rise to any issuances or buybacks.

Gearing

The company continues to have long-term debt amounting to £110million. At the end of the period our gearing level was 21.6% compared to 22.4% at 31 January 2016. The gearing is in the form of structural long term debt, primarily consisting of two long term debentures, the first of which matures in 2018 and the second in 2023, and secured bonds maturing in 2029. Since 31 July 2013, the debt has been valued using a formulaic approach by adding a margin, derived from the spread of BBB UK corporate bond yields over gilt yields, to the yield of the relevant reference gilt. All debt is deployed in the market for investment purposes.

As illustrated in the table below, the portfolio gearing had a gross beneficial effect of +2.0%, or a net effect of +1.0% after the -1.0% cost of finance. The gearing benefit was more than cancelled out by the movement in the market value of debt, which subtracted from performance by 1.7%, as bond yields fell to extremely low levels. Other costs, management fees and administration costs also reduced the total return by 1.0%.

Performance attribution analysis against FTSE 100 Index	Capital return %	Income return %	Total return %
Return of portfolio	3.4	3.2	6.6
Impact of gearing on portfolio	1.1	0.9	2.0
Movement in fair value of debt	-1.7	-	-1.7
Finance costs	-0.6	-0.4	-1.0
Management fee	-0.1	-0.1	-0.2
Administration expenses	-	-0.1	-0.1
Other	-	-0.7	-0.7
Change in net asset value per ordinary share (debt at market value)	2.1	2.8	4.9
Return of portfolio	3.4	3.2	6.6
Return of Index	10.5	2.6	13.1
Relative return on portfolio	-7.1	0.6	-6.5

Prospects

The vote to leave the EU has increased uncertainty around the outlook for the UK economy. However the UK stock market is distinct from the UK economy. Most large British companies have substantial overseas operations and may even benefit from sterling weakness. Sections of the UK stock market look more fully valued, after a strong recovery so far this year. However, our fund managers are still finding many attractive investment opportunities, capable of delivering a combination of income and capital growth.

With government bonds and cash offering negligible income, we believe that Merchants' high yield, generated from a diversified portfolio of reasonably valued equities, is particularly well suited to the current environment.

Simon Fraser Chairman

199 Bishopsgate London EC2M 3TY

15 September 2016

Principal Risks and Uncertainties

The principal risks and uncertainties facing the company are broadly unchanged from those described in the Annual Financial Report for the year ended 31 January 2016 and are as follows:

• Investment Activity and Strategy including Gearing and Market Volatility - An inappropriate investment strategy, e.g., on asset allocation or the level of gearing, may lead to significant under-performance against the company's benchmark index and peer group companies, and may also result in the company's shares trading on a wider discount;

• Corporate Governance, Shareholder Relations and Marketing - If there is weak adherence to best practice in corporate governance, shareholder discontent could arise resulting in potential reputational damage to the company. Inadequate marketing and communication about the company could result in selling of the shares and a significant impact on the rating of the company.

• Financial and Regulatory - Failure to contain financial risks could result in losses to the company. Failure to comply with relevant regulations could damage the company and its ability to continue in business.

• Operational - The company is dependent on third parties for the provision of all systems and services and there are risks of control failures and gaps in these systems and services resulting in loss or damage to the company.

The board's approach to mitigating these risks and uncertainties is set out in the annual financial report. In the board's view these will remain the principal risks and uncertainties for the six months to 31 January 2017. The board will over the coming months continue to monitor closely the impact on markets and the effect on the company of the UK voting to leave the European Union.

Responsibility statements

The directors confirm to the best of their knowledge that:

•The condensed set of financial statements contained within the half-yearly financial report has been prepared in accordance with FRS102 and FRS104, as set out in Note 2, the Accounting Standards Board's Statement 'Half-Yearly Financial Reports'; and

•The interim management report includes a fair review of the information required by Disclosure and Transparency Rule 4.2.7 R of important events that have occurred during the first six months of the financial year and their impact on the condensed set of financial statements, and a description of the principal risks and uncertainties for the remaining six months of the financial year; and

•The interim management report includes a fair review of the information concerning related parties transactions as required by the Disclosure and Transparency Rule 4.2.8 R.

Simon Fraser Chairman

15 September 2016

Fund Manager's Report Economic and Market Background

The UK stock market performed well in the first half of the financial year, rebounding from the low levels it reached last year. Early on, there were concerns over slowing growth in China, rising interest rates in the USA and the "Brexit" referendum in the UK. However these concerns abated over subsequent months. The Chinese government stimulated their economy with a large credit injection. The Federal Reserve Board in the USA backed away from a second interest rate increase this cycle, after a particularly weak employment figure for May, although this report seems to have been an aberration.

The UK voted to leave the EU on 23 June. However, after an initial wobble, the stock market regained its poise and performed well until the period end. Many of the largest UK companies, in industries like natural resources, pharmaceuticals and consumer products, are multinationals that derive the bulk of their sales and profits overseas. These companies have only limited exposure to the domestic economy. The sharp drop in the value of the pound makes their overseas earnings more valuable to UK investors and explains their strong performance.

The FTSE 100 Index produced a total return of 13.1% in the six month period. In contrast to the larger companies in the FTSE 100 Index, the FTSE 250 Index of medium sized companies is far more dependent upon the domestic economy. This index significantly underperformed the FTSE 100, particularly after the referendum, with a total return of 6.5%.

In the wake of the EU referendum result, the prime minister David Cameron resigned. He was replaced, surprisingly quickly, by Theresa May. Despite being in the "remain" camp during the referendum campaign, Mrs May was very quick to state that "Brexit means Brexit", although she indicated that it will take some time before the UK is ready to invoke Article 50 of the Lisbon Treaty, which governs countries leaving the EU. She also set out strong views on corporate governance, calling for employee and shareholder representation on company boards, binding votes on remuneration and disclosure of the ratio of chief executive pay to average workers' pay. Furthermore, she indicated a possible change of emphasis in industrial policy, with greater consideration of whether overseas takeover bids for British companies would be in the national interest.

Although the overall market return was strong, this masks extreme dispersion of returns between and within different sectors. In general, natural resources, internationally exposed sectors and more defensive industries performed well, whilst domestic, cyclical and financial sectors were weak. Mining was the strongest sector, with a 72% total return, including Anglo American and Glencore which rose by 200% and 168%, respectively. The major oil stocks also rallied with the rebound in the oil price, with Royal Dutch Shell "B" returning 37%. Other notable performers included the large pharmaceuticals and tobacco sectors, which produced 20% returns.

On the other hand, the general retail sector produced a negative return of 17%, with fixed line telecoms and food producers also down in double digits, reflecting specific stock moves. The banks sector was broadly flat, in aggregate, but the divergence within the sector reflected the divergent stock market. Standard Chartered and HSBC gave positive returns of 28% and 6%, respectively, whilst Barclays, Lloyds and RBS fell by between 15% and 24%.