Annual Financial Report

Montanaro European Smaller C.TstPLC

23 June 2023

 

Montanaro European Smaller Companies Trust Plc

(Incorporated in Scotland)

Company Number: SC074677                                                                                                                                

ISIN: GB00BM8H3X05      

LEI: 213800CWSC5B8BG3RS21

('Montanaro European Smaller Companies Trust', or the 'Company')

Montanaro EUROPEAN Smaller Companies trust PLC

2023 ANNUAL RESULTS ANNOUNCEMENT

and

notice of annual general meeting

Montanaro European Smaller Companies Trust PLC announces its annual results for the year ended 31 March 2023 and the publication of its annual report and accounts for the same period, which includes the notice of its 2023 annual general meeting.

Highlights

For the year ended 31 March 2023

Performance

Capital Returns%(1)	1 year	3 year	5 year	10 year	MAM*(2)
Ordinary share price	(18.1%)^	56.4%	72.0%	165.0%	331.1%
Net Asset Value ('NAV') per Ordinary share**	(7.6%)^	65.6%	75.9%	183.1%	363.4%
Benchmark **	(5.5%)	50.4%	19.7%	131.4%	178.0%

Total Returns%(1)	1 year	3 year	5 year	10 year	MAM*(2)
Ordinary share price	(17.6%)^	59.2%	78.4%	193.5%	424.5%
NAV per Ordinary share**	(7.1%)^	68.7%	82.2%	212.1%	452.5%
Benchmark **	(3.2%)	58.7%	31.3%	177.1%	278.6%

Sources: Morningstar Direct, Association of Investment Companies ('AIC'), Montanaro Asset Management ("MAM").

	As at 31 March 2023	As at 31 March 2022	12 month % change
Ordinary share price	137.6p	168.0p	(18.1%)
NAV per Ordinary share**	158.4p	171.5p	(7.6%)
Discount to NAV(1)	(13.1%)	(2.0%)
Net assets** (£'000s)	299,975	324,905	(7.7%)
Market capitalisation** (£'000s)	260,652	318,238	(18.1%)
Net gearing employed(1)	3.3%	4.6%

	Year ended 31 March 2023	Year ended 31 March 2022	12 month % change
Revenue return per Ordinary share	1.10p	0.96p	14.6%
Dividend per Ordinary share	0.970p	0.925p	4.9%
Ongoing charges(1)	1.0%	1.1%
Portfolio turnover**	14%	11%

*   From 5 September 2006, when MAM was appointed as Investment Manager.

** Details provided in the Glossary on pages 68 and 69 of the full annual report and accounts.

(1) Refer to Alternative Performance Measures on pages 66 and 67 of the full annual report and accounts.

(2) From 5 September 2006, the benchmark was the MSCI Europe SmallCap Index. The benchmark was changed on 1 June 2009 to the MSCI Europe ex-UK SmallCap Index (in sterling terms).

^   Alternative Performance Measures Calculations provided on page 66 of the full annual report and accounts.

ChairMAN's statement

For the year ended 31 March 2023

Results

The MSCI Europe (ex-UK) Small Cap Index (in Sterling terms) fell by -5.5% during the financial year ended 31 March 2023. In comparison, the Net Asset Value ("NAV") of your Trust fell by -7.6% to 158.4p per share. Over this period, the share price widened from a discount to NAV of -2% to a discount of -13.1%. As a result, the share price total return of the Trust was -17.6%. The Board recognises that while it is not out of line with the peer group, this change in discount is significant for shareholders: we continue to monitor it closely.

As discussed in the interim report, inflationary pressures and subsequent monetary tightening by central banks increased the cost of capital globally. Such increases disproportionately affected quality growth stocks: high quality companies underperformed low quality companies in Europe; and growth companies underperformed "value" companies. These style shifts created headwinds for the Trust as the Manager invests exclusively in high quality, growth companies that were out of favour. As a result, in the first half of the year the NAV total return of your Trust was -27.3%, versus -19.3% for the benchmark.

The second half of the year saw these headwinds fade as bond yields stabilised and inflationary pressures began to lessen. It was therefore pleasing to see strong returns in both absolute and relative terms during the 6-month period to 31 March 2023: the NAV total return was 27.8%, 7.9% ahead of the benchmark.

Short term fluctuations aside, over 5 and 10 years your Trust has delivered NAV total returns of 82.2% and 212.1%, outperforming the benchmark by 50.9% and 35.0% respectively. Since Montanaro were appointed in September 2006 the NAV total return has been 452.5%, 173.9% ahead of the benchmark and 2.5% ahead of the benchmark on a per annum basis.

Earnings and Dividends

Revenue earnings per share rose to 1.10p in the period (2022: 0.96p). An interim dividend of 0.20p per share was paid on 5 January 2023. The Board recommends the payment of a final dividend of 0.77p per share payable on 15 September 2023 to shareholders on the register on 18 August 2023. Subject to shareholder approval, this would bring the total dividends for the year to 0.97p per share. The overall dividend increase of 5% over last year's dividend reflects the underlying performance of our investments and is made out of this year's revenue reserves.

The Trust also holds substantial revenue reserves available for distribution, which gives the Board the ability to smooth any short-term income volatility. Moreover, the companies in the portfolio continue to have strong balance sheets and therefore do not face the prospect of having significant levels of cash flow diverted to cover increased interest payments.

ESG

Montanaro believe there is a clear correlation between how well a business fares on Environmental, Social and Corporate Governance grounds and the value it creates for its shareholders. This is why ESG considerations have formed an integral part of their assessment of a company's "Quality" and have been fully integrated into their investment process for many years.

The depth of Montanaro's commitment is perhaps best exemplified by the fact that they are one of the few UK asset managers to be a certified B Corporation. Certified B Corporations are businesses that meet the highest standards of verified social and environmental performance, public transparency and legal accountability to balance profit and purpose. It is a certification Montanaro have held since 2019 and which was renewed for a further three years in 2023. Montanaro's score rose from 81.8 to 105.5 (a strong result), demonstrating their commitment to continual improvement.

An ESG Report is included on pages 8 to 9 of the full Annual Report. It covers the developments in Montanaro's approach and commitment to ESG as well as how they are interacting with investee companies.

Borrowings

The Board, in discussion with the Alternative Investment Fund Manager ("AIFM"), regularly reviews the gearing strategy of the Trust and approves any gearing facility. Gearing increases (or decreases) the returns from underlying profits or losses generated by the investment portfolio.

The Board has set a maximum limit on borrowing (net of cash) of 30% of shareholders' funds at the time of borrowing. At the end of the fiscal year, the Trust had borrowings (net of cash) of 3.3% compared to 4.6% at the beginning of the year. The Trust currently has borrowings in the form of a €10 million fixed rate loan and a partially drawn down €15 million revolving credit facility, both of which are due to mature on 13 September 2023. The Board expect to replace these with new borrowings upon maturity.

Shares

The Board actively tracks the level of NAV discount for the Trust relative to its peers over the short and medium term and how it compares with the average discount for the whole investment trust sector. We recognise the discount is significant at the year end and has been around this level since the shift in market sentiment against our quality growth investment style. It is not out of line with our peer group at this time and we have made neither share buy backs nor share issuances in line with our stated policies which are set out in our Annual Report on pages 27 and 28. In line with those policies, the Board will seek to renew the Trust's share buyback and issuance authorities at the forthcoming Annual General Meeting.

Administrator and Company Secretary

The Company has appointed, with effect from 1 July 2023, Juniper Partners Limited as Company Secretary and Administrator, in place of Link Company Matters Limited and Link Alternative Fund Administrators Limited respectively. On behalf of the Board and the Manager, I would like to thank the entire team at Link for their service and commitment to the Trust.

Communication with Shareholders

Over the past few years, the composition of our shareholder base has changed significantly with an increasing number of individual investors coming onto the register via investment platforms. We continue to explore how best to communicate with all our shareholders irrespective of how they access us. We are keen to find ways to encourage an open dialogue to keep all shareholders up to date with key developments. Our website -www.montanaro.co.uk/trust/mesct - is continually updated with factsheets, reports, presentations, webinar recordings and commentaries as well as more details about the Manager, investment philosophy and process. We encourage shareholders to visit regularly and welcome any feedback and suggestions.

Annual General Meeting

The AGM will be held at the offices of Montanaro Asset Management Limited, 53 Threadneedle Street, London EC2R 8AR, on 7 September 2023 at 11.00 am. Shareholders are encouraged to attend the Meeting where there will be an opportunity to meet and ask questions of the Board and the Manager.

Outlook

The last few years have been extraordinary. The aftershocks of Covid-19 continue to be felt across the world and indeed by the companies in the portfolio. Fractured politics both within and between countries show, sometimes tragically, little sign of improving. Banks on both sides of the Atlantic have once again needed to be rescued. It should be little surprise then that stock markets have been so volatile. The stock market indices do not tell the full story: beneath the surface, we have witnessed some of the biggest style and factor swings in history.

Perhaps we should take a moment to reflect. No-one at the end of 2019 could have predicted the combination of a global pandemic, a Russian invasion of Ukraine, soaring inflation and rising interest rates. Yet they have been major drivers of stock markets since. Montanaro believe that, rather than attempting such predictions, investors are best served by long-term ownership of high quality businesses that can thrive and grow irrespective of the general macroeconomic or political environment.

Although the pandemic has come to an end and inflation is showing signs of easing, investors remain relatively cautious. The forward P/E of the MSCI Europe ex-UK Small Cap Index has fallen below its long-term average and sits at a 15% discount to LargeCap. Meanwhile, the forward P/E of your portfolio declined by more than a third since its peak in August 2021 to the end of March 2023. This is more than the fall in NAV over this period, highlighting the difference we have seen between the progress of the underlying businesses in the portfolio and their share prices.

While doubtless the world will again change in ways we cannot imagine in the coming years, we believe that current valuations offer an attractive entry point for long-term investors. Together with the Manager's disciplined investment process, experienced team, and strong track record since being appointed in 2006, this allows us to look forward to the future with confidence.

R M CURLING

Chairman

22 June 2023

Manager's Report

The Attractions of Quoted European Smaller Companies ('SmallCap')

The key attraction of investing in smaller companies is their long-term record of delivering higher returns to investors than large companies. In the UK, over the last 68 years, this has amounted to an average of 3.1% per annum ("the SmallCap Effect"). £1 invested in UK large companies on 1 January 1955 would now be worth £1,255, whereas the same £1 invested in smaller companies would now be worth over £8,300 - nearly seven times more.

There is less comprehensive data on Europe - it only goes back to 2000. However, this suggests that the SmallCap Effect is even more pronounced on the Continent: as the chart in the full annual report and accounts illustrates, European "small" companies have outperformed by 4.8% p.a. Moreover, while European LargeCaps have underperformed their US counterparts, the same is not true for SmallCaps. Since 2000, the MSCI Europe (ex-UK) Small Cap Index has delivered gross USD returns of 9.4% p.a. - ahead of the MSCI USA Small Cap Index at 9.3% p.a.

The market for European smaller companies is inefficient. While some large companies are analysed by more than 50 brokers, many smaller companies in Europe have little or no coverage at all. This makes it easier for those with a high level of internal resources to identify attractive, undervalued investment opportunities that are undiscovered by the wider investing community. This in turn makes it possible to deliver long-term performance over and above that of the benchmark.

Montanaro

Montanaro was established in 1991. We have one of the largest and most experienced specialist teams in the UK dedicated exclusively to researching and investing in quoted small companies. Our team of 38 includes 14 analysts and 12 nationalities, which gives us the breadth of resources and diversity of experience to conduct thorough fundamental research internally.

At 31 March 2023, we were looking after £3.7 billion of client assets. We have been the Investment Manager for your Trust since September 2006.

Investment Philosophy and Approach

We specialise in researching and investing in quoted small companies. We have a disciplined, two-stage investment process which is applied to all the products we manage, including your Trust.

In the first stage, we identify "good businesses" within our investable universe. We look for high quality companies in markets that are growing. They must be profitable; have good and experienced management; deliver sustainably high returns on capital employed; enjoy high and ideally growing profit margins reflecting pricing power and a strong market position; and provide goods and services that are in demand and likely to remain so. We prefer companies that can deliver self-funded organic growth and remain focused on their core areas of expertise, rather than businesses that spend a lot of time on acquisitions.

Conversely, we avoid those with stretched balance sheets; poor free cash flow generation; incomprehensible or heavily adjusted accounts; unproven or unreliable management; or that face structurally challenged business models with stiff competition.

A company must also pass our stringent quality and ESG checklists. ESG has been integrated into our disciplined investment process for almost two decades.

When we have found a company that we believe is high quality, has structural growth and is well managed from a business and ESG perspective, it must be approved by the Investment Committee before it can be added to the Montanaro "Approved List".

We then determine the intrinsic value of each company on the Approved List, typically through a proprietary discounted cashflow analysis, to ensure they will make a "good investment" ("good businesses" and "good investments" are not always the same). Companies that are on the Approved List and which we also believe are attractively valued are then eligible for inclusion in your portfolio.

We have an investment team of 17, including 14 sector and ESG specialists covering many languages. Utilising their industry knowledge and a range of proprietary screens, they are continually searching for new ideas. With thousands of quoted companies from which to choose, we are spoiled for choice.

We believe that a deep understanding of a company's business model and the way it is managed are essential. We visit our investee companies on a regular basis. We examine management's past track record in detail as we seek to understand their goals and aspirations. In smaller companies, the decisions of the entrepreneurial management can make or break a company, which is why meeting them is so important. We look closely at the board structure; the level of insider ownership; and examine remuneration and corporate governance policies.

Once a company has been added to the portfolio, our team conducts ongoing analysis. We will sell a holding if we believe that the company's underlying quality is deteriorating or if there has been a fundamental change to the investment case or management.

In summary, we invest in well managed, high quality, growing companies bought at sensible valuations. We keep turnover and transaction costs low and follow our companies closely over many years. We would rather pay more for a higher quality, more predictable company that can be valued with greater certainty. Finally, we align our interests with our investors by investing meaningful amounts of our own money alongside yours. We are significant shareholders in the Trust.

The Portfolio

At 31 March 2023, the portfolio consisted of 49 companies of which the top ten holdings represented 39%.  Sector and country distribution within the portfolio is driven by stock selection. Although weightings relative to the market are monitored, overweight and underweight positions are held based on where the greatest value and upside are perceived to be.

Performance Attribution

The year to 31 March 2023 saw strong performances from some of our largest investments:

Kitron is an Electronics Manufacturing Services (EMS) business with its headquarters in Norway. The company had an excellent year as supply chain constraints in the electronics industry eased, allowing Kitron to deliver orders that had built up during the pandemic.

Brunello Cucinelli is an Italian luxury goods company that is particularly famous for its cashmere products. Its focus on "quiet luxury" and a resurgence in luxury sales worldwide led to the company raising its financial guidance repeatedly during the year, buoying the share price as a result.

Fortnox Fortnox provides cloud-based accounting systems to companies in Sweden. The stock performed well on news of further price increases combined with continued success in attracting new customers. It has now been a top three contributor for three years in a row.

The year was not without some stock price falls as well. Our three largest detractors are detailed below:

MIPS develops patented inserts for helmets, which protects the brain against rotational motion in a fall. After many years of strong performance, destocking by helmet retailers led to a weaker year for the company, particularly in the cycling market.

QT Group is a Finnish company that provides software tools used to design and build graphical user interfaces. The company saw a slowdown in developer license sales as customers pushed out the timing of new projects. We grew concerned that the competitive environment was also worsening and as a result we sold the position.

ChemoMetec is a globally leading developer of cell counters that are used in the development of cell therapies. The share price declined due to a slowdown in new instrument sales as the funding environment for cell-based therapy R&D became more restrictive. Consumable and service sales nevertheless continued to grow.

Portfolio Changes

We try to keep portfolio turnover as low as possible. However, we typically make a few changes each year as we identify new investment ideas that we expect will provide stronger long-term returns than existing holdings. Companies that become too large, are acquired or where the investment case deteriorates are also replaced with new ideas from our Approved List.

In the year to 31 March 2023, we exited positions in companies including Vitrolife, the developer of media and consumables for IVF treatment, after the company made an expensive acquisition and saw the departure of key executives. Endor, which sells hardware used for sim racing, was sold as new competitors entered the market. Nolato, a third-party manufacturer of plastic components, was sold as the company grew its tobacco heat-not-burn sales to levels that we deem to be too high to pass our ethical exclusion tests.

Technoprobe, the Italian developer of probe cards used in the testing of semiconductors and Bachem, the Swiss peptide contract manufacturer, were additions to the portfolio.

Continual Improvement

Each year we take time to look back at our successes and mistakes to assess how our systems and processes can be improved.

Our Investment Committee has for many years played an important role as "gatekeeper" to the Approved List: no company can be added to the Approved List or, therefore, bought, until the Investment Committee has agreed that it meets our stringent quality and growth thresholds. This is the first stage of our process. The second stage is valuation, where the analysts determine whether the companies on the Approved List are currently good investments. This year we have introduced Investment Committee oversight and approval for this second stage too. We believe this will help to ensure consistency across the team with respect to forecast assumptions as well as improving communication between analysts and fund managers on this critical topic.

From a systems perspective we have made some significant developments. We identified the need for a system to help us better manage and internally communicate the large amounts of research that we produce. At the end of 2022 we successfully moved our entire research team from a legacy on-premise folder based system to a cloud based system built within Microsoft Teams. This new system has better functionality, organisation and security, as well as being globally accessible from anywhere with an internet connection. Moreover, having all our files in the cloud has opened up possibilities to collaborate and cross-reference which were not available before - we are scratching the surface of this at the moment but already developing some interesting tools as a result. Looking ahead, we are keeping abreast of recent developments in AI and exploring how we can best utilise these tools to improve our processes.

The systems overhaul has not been confined to the research team. Significant IT investments mean we now have 24/7 threat monitoring and management and continuous staff training including simulated phishing attacks, on top of a state-of-the-art software stack, throughout the company.

Gearing

The Alternative Investment Fund Manager ("AIFM"), in consultation with the Board, is responsible for determining the net gearing level of the Trust. The Trust ended the fiscal year with gearing of 3.3% (31 March 2022: 4.6%).

How to invest

We have invested a great deal of time to make the Trust readily available to all investors. We have continued to grow our presence across the UK's investment platforms and are delighted to see a steady increase, year after year, in the Trust's retail following. With the Board, we have appointed Marten & Co to provide sponsored research - you can find the initiation report published in March 2019 here: https://www.montanaro.co.uk/mesct-quality-business/ and an update report published in March 2022 here: https://quoteddata.com/research/montanaro-european-smaller-companies-unfazed-by-market-turmoil-mc/

For further details about how to invest, please refer to the website: www.montanaro.co.uk/trust/mesct

MONTANARO ASSET MANAGEMENT LIMITED
22 June 2023

Twenty Largest Holdings

as at 31 March 2023

1.                    NCAB

is a global full-service supplier of printed circuit boards (PCBs).

2.                    MTU Aero Engines

manufactures and maintains aircraft engines and components.

3.                    Kitron

is a leading Scandinavian Electronics Manufacturing Services (EMS) company.

4.                    Fortnox

is Sweden's leading provider of cloud-based applications for accounting, invoicing and payroll administration.

5.                    Melexis

is a leading designer of sensors, with a particular focus on automotive applications.

6.                    Brunello Cucinelli

is a luxury fashion company, particularly famous for its cashmere products.

7.                    IMCD

is one of the world's largest speciality chemical distributors.

8.                    Brembo

is a global leader in the design and production of high end automotive braking systems.

9.                    VZ Holding

is a Swiss independent financial consultant and wealth manager.

10.                 Amadeus FiRe

is a leading personnel service company in Germany, with integrated training and further education offerings.

11.                 CTS Eventim

is the market leading ticketing company in Europe, providing an online platform from which to sell tickets to a range of events such as operas and pop concerts.

12.                 Sartorius Stedim

is a world leading supplier of equipment and technologies used to produce biopharmaceuticals.

13.                 Bachem

is a leading manufacturer of peptides and oligonucleotides.

14.                 Atoss Software

develops and sells workforce management software in Europe.

15.                 Christian Hansen

is a leading developer of microbial solutions for the food, beverage, nutritional, pharmaceutical and agricultural industries.

16.                 Tecan

develops automated instruments and solutions that are used in laboratories.

17.                 Viscofan

Is a global leader in production of casings for meat products.

18.                 Belimo Holding

develops and manufactures electrical motorised control devices (actuators) for air and water. These are predominantly used in large buildings with sophisticated Heating, Ventilation and Air Conditioning ('HVAC') systems.

19.                 MIPS

develops patented inserts for helmets, which protects the brain against rotational motion.

20.                 Reply

is an Italian IT services company.

Holding	Country	31 March 2023 Value £'000	31 March         2022 Value £'000	31 March 2023 % of investment portfolio	31 March 2023 % of net assets	31 March 2023 Market cap £m
NCAB	Sweden	15,643	18,810	5.0	5.2	887
MTU Aero Engines	Germany	14,192	12,444	4.6	4.7	10,840
Kitron	Norway	14,173	7,873	4.6	4.7	560
Fortnox	Sweden	12,479	14,196	4.0	4.2	3,382
Melexis	Belgium	12,144	5,678	3.9	4.0	3,767
Brunello Cucinelli	Italy	12,016	6,730	3.9	4.0	5,437
IMCD	Netherlands	11,235	10,494	3.6	3.8	7,518
Brembo	Italy	9,972	6,394	3.2	3.3	3,910
VZ Holding	Switzerland	9,933	10,837	3.2	3.3	2,648
Amadeus FiRe	Germany	9,758	8,224	3.2	3.3	696
CTS Eventim	Germany	9,356	8,395	3.0	3.1	4,846
Sartorius Stedim	France	8,674	13,205	2.8	2.9	22,802
Bachem	Switzerland	8,091	-	2.6	2.7	6,066
Atoss Software	Germany	8,014	9,115	2.6	2.7	1,157
Christian Hansen	Denmark	7,999	5,355	2.6	2.7	8,110
Tecan	Switzerland	7,948	7,584	2.6	2.6	4,497
Viscofan	Spain	7,250	5,682	2.3	2.4	2,692
Belimo Holdings	Switzerland	7,222	7,515	2.3	2.4	4,800
MIPS	Sweden	7,142	15,030	2.3	2.4	1,069
Reply	Italy	6,951	8,238	2.2	2.3	3,708
Twenty Largest Holdings		200,192		64.5	66.7

FURTHER INFORMATION

Montanaro European Smaller Companies Investment Trust PLC's annual report and accounts for the year ended 31 March 2023 (which includes the notice of meeting for the Company's AGM) is available at http://www.rns-pdf.londonstockexchange.com/rns/6627D_1-2023-6-22.pdf and will be available today on https://montanaro.co.uk/trust/montanaro-european-smaller-companies-trust/

It has also been submitted in full unedited text to the Financial Conduct Authority's National Storage Mechanism and is available for inspection at data.fca.org.uk/#/nsm/nationalstoragemechanism in accordance with DTR 6.3.5(1A) of the Financial Conduct Authority's Disclosure Guidance and Transparency Rules.

 

END