Company Announcements

Legal Entity Identifier: 213800N1B1HCQG2W4V90

This announcement contains regulated information

THE EUROPEAN SMALLER COMPANIES TRUST PLC

Financial results for the year ended 30 June 2024

Investment Objective

The Company seeks capital growth by investing in smaller and medium sized companies which are quoted, domiciled, listed or have operations in Europe (ex UK).

Chairman's Statement

It has been encouraging to see interest in the European smaller company arena return over the course of the year and the Company to have participated profitably from this trend. Inflation has been tamed though interest rates have yet to meaningfully decline. Tragically the conflict in Ukraine festers on, although the energy shock has largely been contained. A global recession has not manifested and a 'soft landing' looks increasingly plausible. The Purchasing Managers' Index has yet to see a rebound, but there is growing optimism that the market suffering is close to being over. Smaller companies are well positioned to benefit from things getting better and the fund management team is well placed to take advantage of the situation.

Performance

The Company's portfolio produced a solid return over the year ended 30 June 2024, with an NAV total return of 12.0%, ahead of the benchmark by 1.9%. The share price total return was even more impressive at 19.5%, reflecting the growing interest in Europe and its smaller companies. This continues the Company's long term NAV and share price total return track record, as the chart on page 1 clearly demonstrates. Over a five-year period, the NAV total return has been 73.3% versus the benchmark of 37.2%, with the share price total return being 82.8% compared to the AIC European Smaller Companies sector of 40.1%.

Discount management

The average discount for the period has been 13.5%. Over the course of the financial year and up to the date of this report, we repurchased a total of 6.4m shares in the market at an average price of 167.68p. Doing so has been accretive to the NAV and was one of several factors contributing to the narrowing of the discount.

The Board continually monitors the discount to NAV at which the Company's shares trade and utilises its ability to repurchase its own shares in the market with a view to reducing volatility and maintaining liquidity. We review the discount taking account of the position of our immediate competitors in the AIC European Smaller Companies sector, the investment trust sector as a whole and conditions in the wider market, particularly those in Europe, which are likely to have an impact on how the Company is perceived.

Dividend

The Board is recommending a final dividend of 3.35p per ordinary share to shareholders for approval at the forthcoming annual general meeting. If approved, the dividend will be paid to shareholders on the register on 1 November 2024.

Along with an interim dividend of 1.45p which was paid on 3 May 2024, this brings the total dividend to 4.80p, an increase of 2.1% on the total dividend paid last year.

The Company has benefitted from a handful of stocks that have had very high income distributing capacity in recent years, but as the fund management team begins to anticipate an economic expansion, there may be more of a pursuit of capital growth from among the many exciting investment opportunities in our market.

Succession planning

The forthcoming annual general meeting will be my last as Chairman. We were pleased to announce the appointment of James Williams as the chairman designate in October last year. He brings with him over 30 years' international business experience, including 20 years in the investment banking industry, and a strong suite of leadership skills. I believe I will be leaving the Company in good hands.

We have further agreed a timeline for the retirement of Simona Heidempergher and have engaged recruitment consultants to help in the search for a suitable replacement. Your new Chairman will keep you updated in this respect.

Annual General Meeting

The 34th Annual General Meeting will be held at 11.00 am on 25 November 2024 at 201 Bishopsgate, London, EC2M 3AE.

The event provides the opportunity for shareholders to meet with, and hold to account, the directors and fund management team. The Fund Manager will give his usual presentation on the year under review and the outlook for the year ahead. We therefore encourage all shareholders to attend if they can and to vote their shares, either at the meeting or via proxy beforehand.

If you are unable to attend in person, you will be able to watch the meeting live via the internet by visiting

www.janushenderson.com/esct-agm.

Outlook

I stated last year that I considered inflation to be close to settling near target. This has proved to be true and we have begun to see interest rates reduce to more appropriate levels across the globe, but most importantly in the United States.  This combined with reserve rate cuts and financial stimulus in China, is a welcome relief for the global economy and for European smaller companies. 

It is a shame that political uncertainty has poked its head up in Europe again with the French election being unhelpful for growth and elections in the US have scope to create further doubt for our markets. Notwithstanding this, the very low valuations in Europe, the falling cost of capital and the improving economic optimism should outweigh the noise of politics. Europe is fortunate to be the provider of the 'picks and shovels' of the big structural growth trends such as Artificial Intelligence, the 'Green Transition' and industrial automation. It is an exciting time for the European smaller company space.

Christopher Casey

Chairman

9 October 2024

FUND MANAGER'S REPORT

Introduction

The year to 30 June 2024 was a decent year for the Company, with an NAV total return of 12.0% outperforming the benchmark which delivered a return of 10.1%. Despite the lacklustre economy, investors put fresh eyes on the European smaller companies universe which helped the start of the recovery in valuation multiples for the space.

The year was characterised by soft markets in a tepid European economy. However, hopes of an economic pick-up began to manifest towards the end of 2023. We encountered a 'growth scare' towards the end of the financial year as fears that the European Central Bank and the Federal Reserve had been too slow to cut interest rates were exacerbated by snap elections called in France and the UK, which temporarily disrupted economic activity. A recession has been long awaited following the energy and supply chain shocks that hit the global economy in 2022. We have, however, been of the view that the global economy would have a soft landing, but that inflation and consequently interest rates would remain higher than prior to the pandemic. So far that has broadly come to pass, but we do think monetary policy is too tight in the West and that central banks need to loosen policy now that inflation has been largely tamed.

Another phenomena of the markets has been an extreme concentration in a few very large companies. In the US this was a group of companies referred to as 'The Magnificent Seven' (Apple, Microsoft, Alphabet, Amazon, Nvidia, Meta Platforms and Tesla). In Europe no exciting collective noun was settled on, but names such as semiconductor equipment titan ASML, GLP-1 producer Novo Nordisk and luxury good behemoth LVMH have dominated stock market performance in recent years. However, we began to see the broadening of the market take place over the year and smaller companies began to outperform larger companies for the first time since 2021. This was helpful for your Company that has a focus on investing in genuinely smaller companies.

Perception and reality do not always align. Much of what we do as a team is to look for companies that have a fundamental reality that is better than its perception in the stock market and to consider ways that this can change. In some respects, this is true of the European smaller company market in general. One country that firmly has a perception problem is Germany. An economic model dependent upon cheap Russian energy and Chinese demand meeting the impending demise of the internal combustion engine automobile appears to have some substantial problems. So it is gratifying to have found so many German businesses that have been able to prove the naysayers wrong and show the reality that there is some incredible innovation and great businesses in the country.

The outperformance over the twelve months to 30 June 2024 was primarily driven by stock selection, with a handful of winners driving performance, many of them being German. German listed semiconductor equipment manufacturer SUESS Microtec was a substantial contributor in the period, as demand for their Temporary Bonder machines, used in the manufacturing of Artificial Intelligence ('AI') chips, increased dramatically. German listed specialty chemical producer Alzchem also performed well as a result of the growth in their creatine and nitroguanidine businesses. Creatine is a chemical that supplies energy to muscles and has long been favoured by bodybuilders, but is increasingly being used to fend off conditions such as sarcopenia. Nitroguanidine is a propellant that goes in car air bags, but is also a key ingredient in NATO ammunition. Another German driver of performance was web hosting and cloud services solutions provider IONOS as a combination of a cheap valuation and strong earnings momentum drove the pricing of the shares.

The portfolio

We remain consistent in our strategy of investing across the corporate lifecycle with a balance of early-stage growth stocks, high return on capital growth compounders at sensible prices, undervalued cash generative mature companies and self-help turnaround stocks. The price we pay for shares in a company is a critical component of what we do and must be justified by the cash generation potential of a business. We are not a 'value fund' but we are intensely valuation aware. Our intention is that the performance of the portfolio is driven by stock selection rather than macro-economic factors and one of our key contentions is that company management matters. It is always gratifying to see underperforming companies get their act together and one such name for us this year has been Fugro, a Dutch listed collector and interpreter of geological data. The company has evolved from servicing the oil and gas industry to being a key part of the green energy transition, helping developers understand where best to locate offshore wind turbines. The company had been a stock market darling in the 2000s, but with the collapse in oil and gas capital expenditure from 2014 onwards had been struggling, earning a paltry return on capital employed. We invested in the company during the pandemic when the company was loss making and needed to raise capital. Since then, management has done a terrific job of improving returns by focusing the business on renewables and driving better margins and asset efficiency. We think the return on capital has a way to go yet, but the shares have begun to catch the markets' attention again and the holding was a strong contributor to performance this year.

Performance attribution

The Company benefitted from our investment in Dutch listed wealth manager Van Lanschot Kempen, which continued to attract strong fund inflows in the low countries. Swedish listed digital investment platform Nordnet saw an increase in business momentum as animal spirits revived in their market.

One of the joys of managing a European smaller companies portfolio is that the investable universe is so fabulously heterogeneous that we are able to find companies that are benefitting from almost any exciting trend in the world. One such trend that has obsessed the stock market this year has been AI and the growth in data centres. Swedish listed Munters, whose products help manage the climate inside data centres, has seen a terrific boost to its business as a result of this and it has been a worthwhile investment for your Company.

Another area of exciting growth is in the world of podcasts, a media broadcast over the internet and which is used for exploring any topic that interests a listener. Swedish listed Acast is the European leader in hosting, distributing and monetizing podcasts. The stock has performed very well this year as the company approached profitability and continued to grow strongly in a weak advertising market.

Corporate activity returned to the European smaller companies space with bid approaches for Swedish online gambling company, Kindred and Swedish legal services expert Karnov. Whilst we didn't think we captured all the value possible from Kindred, the offer was reasonable and we decided to take some profit. However, we, and many other public market investors, deemed the bid for Karnov to be too far from its fundamental valuation and rejected it. We are firmly of the belief that as interest rates begin to fall the very cheap valuations on display in the European smaller companies market will see a notable increase in this type of activity.

Detractors from performance have been largely driven by our misjudging where several companies were in their economic cycle, but also (unusually) by a handful of stocks that we missed the opportunity to invest in. The sins of omission mainly comprised our failure to spot Danish listed GLP-1 anti-obesity drug develop Zealand Pharma and Spanish bank Banco de Sabadell, which weighed on the Company's relative performance. In contrast, our investment in Dutch listed specialty metal producer AMG Critical Materials, which has suffered due to the abject collapse in the lithium price over the course of the year, detracted from performance. Lithium prices have been poor for a combination of reasons, but the principal one has been the weakness in the automotive market for electric vehicles (EVs) due to regulatory uncertainty on the green transition as well as interest rates. We have had too much exposure to the automotive market and a number of burdens for the Company such as German listed producer of electric boot openers Stabilus, Italian listed producer of stators and rotors for EVs Eurogroup Laminations and French listed producer of Silicon Carbide used in the rapid charging of EVs Mersen have not helped performance.

It has been a frustration to relearn some fundamental investment lessons through the medium of making mistakes, but disappointingly we have been through that process this year. One such lesson is not to bet on a binary technology outcome and German listed Manz whose battery technology had looked so promising for the EV transition has failed to turn the science into cash flow. This lesson was rammed home by our investment in Swiss listed AMS-Osram whose exciting microLED technology was abandoned by their large American tech company customer, who has historic form in rough treatment of its supply chain. We intend to do a better job of applying such lessons in the future without the impact on our investors' capital.

Geographical and sector distribution

Stock selection rather than geographical and sector exposure is the fundamental core of our investment process, though we are careful to monitor how we are positioned as part of our risk management approach. We have never viewed the benchmark as an input to our process and we are content to diverge widely from it. Our valuation discipline typically leads us away from the more expensive markets and sectors in Europe and as a result we find ourselves underweight to Switzerland and Sweden. Conversely, we are overweight to Germany and the Netherlands where multiples are lower.

Similarly, we are underweight to the sectors where we struggle to find value such as health care, utilities and real estate. We are overweight to the industrials sector, as valuations are very cheap and have scope for strong performance as the economy begins to grow again, as well as being overweight to technology where we continue to see strong structural growth trends.

Other purchases

Your Company typically invests in Europe outside of the UK, however, we have a degree of flexibility around this and with the Board's approval we took a position in UK listed online trading provider IG Group as we saw such potential in the company's cheap valuation and phenomenal cash generation capacity coupled with a strong capital return discipline. Whilst the shares have been very strong, you shouldn't expect us to invest beyond the broad remit with any great frequency.

We have added a handful of defence exposed names to the portfolio over the course of the year. German listed producer of gearboxes and transmissions for military vehicles Renk, Dutch listed producer of night vision goggles Theon International and French listed Exosens, the producer of the tubes that go into those goggles, all made it into the portfolio, benefitting from the need for European rearmament.

All three investments came from new listings on the stock market known as Initial Public Offerings ('IPOs'). The IPO market has been very quiet since the end of 2021 due to a combination of weak markets and the bad taste left in the mouth from the terrible vintage of IPOs that came through in that year. It is pleasing to report that all three investments listed above plus our investment in Greek bank Optima, have contributed positively to performance.

Another feature of the hot markets of 2020 and 2021 was the creation of a number of Special Purpose Acquisition Companies ('SPACs'). A SPAC is a company that is listed on the stock market with the sole purpose of reversing a real company into a listing. You will never encounter us investing directly in a SPAC and it will not be often that you catch us investing in, the inelegantly titled, de-SPACed companies that have had a business reversed into them, so it is notable that we have taken a position in Swiss listed R&S Group which manufactures transformers, the equipment that alters alternating current and direct current. A significant investment in the electricity grid of Europe is required and R&S Group has an exciting position in this development.

Other disposals

We exited our position in Italian listed SAES Getters having profited handsomely from the disposal of its medical devices business. We also took profits by selling our shares in Italian listed producer of commercial vehicles Iveco. We saw an increase in mergers and acquisitions activity and the Company benefitted from bids for French listed financial adviser Rothschild & Co. and Swedish listed online gambling company Kindred. As interest rates reduce and financial conditions normalise, we would not be surprised to see more frequent mergers and acquisitions activity, an arena that usually benefits smaller companies.

Currency

The Company is denominated in sterling, while investing in largely euro-denominated assets. We do not hedge this currency exposure.

Outlook

We stated last year that we feared central banks had raised interest rates too high and we were anxious that, having been too slow to raise them, they would be too slow to cut them. Although, the European smaller company universe has seen an improvement in interest and performance, and remains very attractively valued, it typically doesn't fare well in a recessionary environment. Monetary policy becoming less restrictive in recent weeks, albeit not yet supportive, is a respectable positive indicator for the global economy. We continue to believe that with sensibly applied monetary policy, the economy can experience a 'soft landing' and thereafter grow. European smaller companies due to its gearing to global growth will be a profitable place to invest in such a scenario.

Beyond the attraction of valuation, our investment universe is rich with opportunity. There are plentiful companies with exciting technologies, structural growth drivers and strong market positions. By applying our balanced investment strategy and remaining disciplined on our 'valuation aware' approach, we are confident that we can continue to find strong investment returns for our shareholders.

Ollie Beckett, Rory Stokes and Julia Scheufler

9 October 2024

Principal and emerging risks

Investing, by its nature, carries inherent risk. The Board, with the assistance of the investment manager, carries out a robust assessment of the principal and emerging risks and uncertainties facing the Company which could threaten the business model and future performance, solvency and liquidity of the portfolio. A matrix of these risks, along with the steps taken to mitigate them, is maintained and is kept under regular review. The mitigating measures include a schedule of investment limits and restrictions within which the Fund Manager must operate.

The principal risks which have been identified and the steps we have taken to mitigate these are set out below.  We do not consider these risks to have changed during the period.

Investment strategy and objective

The investment objective or policy is not appropriate in the prevailing market or sought by investors, leading to a wide discount and hostile shareholders.

Investment mandate limits established by the Board are inappropriate leading to out-of-scope investments which may negatively impact shareholder value.

Poor investment performance over an extended period leading to shareholders voting to wind up the Company. This may be the result of:

·      External factors such as geopolitical instability, including financial shock, pandemic, climate change, changes in the regulatory environment, etc.

·      internal factors such as poor stock selection, poor management of gearing, loss of key members of the fund management team, etc.

Mitigating measures: The investment manager periodically reviews the investment objective and policy in line with best practice and taking account of investor appetites. The Board receives regular updates on professional and retail investor activity from the investment manager, and reports from the corporate broker, both of whom remain in contact with professional investors throughout the year, to inform themselves of investor sentiment and how the Company is perceived in the market. From time to time, research may be undertaken by a third-party consultant to specifically ascertain the views of retail investors. The level of discount and share register are are reviewed by the Board at each meeting.

The Board reviews compliance with the investment limits at each meeting.

The Fund Manager maintains a diverse portfolio (sector, country, business life cycle) with buy/sell disciplines and employs suitable quantitative and qualitative metrics, which incorporates environmental, social and governance ('ESG') considerations, for assessing stocks for inclusion or held within the portfolio. The Board reviews the Key Performance Indicators ('KPI's), portfolio composition and levels of gearing at each meeting. The Board furthermore maintains an understanding of the fund management team's investment process and considers the potential for climate change to impact the value of the portfolio, alongside other factors which may have the same effect.

Operational

Failure of, disruption to or inadequate service levels provided by principal third-party service providers leading to a loss of shareholder value or reputational damage. This includes cyber security risks which may compromise the integrity of data and the effective operation of third-party service providers.

Mitigating measures: The Board engages reputable third-party service providers and formally evaluates their performance, and terms of engagement, at least annually.

The Audit Committee assesses the effectiveness of internal controls in place at the Company's key third-party service providers through review of their ISAE 3402 reports, quarterly internal control reports from the investment manager and monthly reporting on compliance with the investment limits established by the Board.

Legal and regulatory

Loss of investment trust status, breach of the Companies Act 2006, Listing Rules, Prospectus and/or Disclosure Guidance and Transparency Rules or the Alternative Fund Managers Directive and/or legal action brought against the Company and/or directors and/or the investment manager leading to a decrease in shareholder value and reputational damage.

Mitigating measures: The Board engages reputable third-party service providers and formally evaluates their performance, and terms of appointment, at least annually.

The Audit Committee assesses the effectiveness of internal controls in place at the Company's key third-party service providers through review of their ISAE 3402 reports and, in respect of the investment manager's investment trust operations, reporting from the investment manager's internal audit function. The investment manager's Compliance function has reporting obligations under AIFMD, with any non-compliance being captured in the investment manager's quarterly internal control reporting to the Board.

Financial

Market, liquidity and/or credit risk, inappropriate valuation of assets or poor capital management leading to a loss of shareholder value.

Mitigating measures: The Board determines the investment limits and monitors compliance with these at each meeting. The directors review the portfolio liquidity at each meeting and periodically consider the appropriateness of hedging the portfolio against currency risk.

The Board reviews the portfolio valuation at each meeting and considers the effectiveness of controls in place at its principal third-party service providers, including the fund accountants, at least annually.

Investment transactions are carried out by a large number of approved brokers whose credit standard is periodically reviewed and limits are set on the amount that may be due from any one broker, cash is only held with the custodian/depositary or reputable banks.

The Board monitors the broad structure of the Company's capital including the need to buy back or allot ordinary shares and the extent to which revenue in excess of that which is required to be distributed, should be retained.

Going concern and viability

In keeping with provisions of the Code of Corporate Governance issued by the Association of Investment Companies (the 'AIC Code'), the Board has assessed the prospects of the Company for a period of at least twelve months from the date of this report, being 9 October 2025 period (our assessment of going concern) and also over the longer period of three years (our assessment of viability).

We consider the Company's viability over a three-year period as we believe this is a reasonable timeframe reflecting the longer term investment horizon for the portfolio, but acknowledges the inherent shorter term uncertainties in equity markets.

As part of the assessment, we have considered the Company's financial position, as well as its ability to liquidate the portfolio and meet expenses as they fall due. The following aspects formed part of our assessment:

·      the closed-end nature of the Company which does not need to account for redemptions;

·      an assessment of the principal and emerging risks, as well as the uncertainties facing the Company, including the potential impact of climate change on the value of investee companies;

·      the diverse nature of the portfolio and its anticipated liquidity in normal and stressed market conditions;

·      the level of the Company's revenue reserves and the size of the bank overdraft facility; and

·      the expenses incurred by the Company, which are predictable and modest in comparison with the assets and the fact that there are no capital commitments currently foreseen which would alter that position.

Also of relevance in contemplating the duration of the Company, is the three-year cycle for its continuation vote. Shareholders were last asked at the annual general meeting in 2022 if they wished the Company to continue in operation.  The resolution was passed with the overwhelming support of 84.4% shareholders who voted.  The next continuation vote will be put to shareholders at the annual general meeting in 2025.  Based on the voting record since 2000 for such resolutions, the Board is confident that shareholders will continue to support the Company.  In the event this is not the case, the Company will be wound up in keeping with the provisions of the articles.

As well as considering the principal risks and financial position of the Company, along with the continuation vote, the Board has made the following assumptions:

·      investors will continue to wish to have exposure to investing in European small cap companies;

·      investors will continue to invest in closed-end funds;

·      the Company's performance will continue to be satisfactory; and

·      the Company will continue to have access to adequate capital when required.

Based on the results of the assessment, we have concluded that:

·      the Company has adequate resources to meet its liabilities for a period of at least twelve months from the date of this report, being 9 October 2025, meaning it is therefore appropriate to prepare these financial statements on a going concern basis; and

·      we have a reasonable expectation that the Company will be able to continue operations over the coming three-year period, as well as meeting its expenses and liabilities for that period.

Related party transactions

The Company's transactions with related parties in the year were with the directors and the investment manager.

There have been no material transactions between the Company and its directors during the year. The only amounts paid to them were in respect of remuneration and expenses for which there were no outstanding amounts payable at the year-end.

In relation to the provision of services by the investment manager, other than fees payable by the Company in the ordinary course of business and the provision of marketing activities, there have been no material transactions affecting the financial position of the Company during the year under review.

Directors' responsibility statements

Each of the directors in office at the date of this report confirm that, to the best of their knowledge:

·      the financial statements prepared in accordance with UK Adopted International Accounting Standards give a true and fair view of the assets, liabilities, financial position and profit and loss of the issuer and the undertakings included in the financial statements as a whole; and

·      the Strategic Report includes a fair review of the development and performance of the business and the position of the Company, together with a description of the principal risks and uncertainties that it faces.

For and on behalf of the Board

Daniel Burgess

Chairman of the Audit Committee

9 October 2024