Bucking the trend

With a difficult first quarter ending, equity investors were hoping to enter what is historically the best month of the year in a better mood. Over the past 25 years, the STOXX 600 Index has on average provided 2.3% gains in April, with only seven negative returns, less than any other month. Unfortunately, history does not always repeat itself and an additional negative print was added for April.

Fund Commentary
9 May 2022

With a difficult first quarter ending, equity investors were hoping to enter what is historically the best month of the year in a better mood. Over the past 25 years, the STOXX 600 Index has on average provided 2.3% gains in April, with only seven negative returns, less than any other month. Unfortunately, history does not always repeat itself and an additional negative print was added for April.

Few risks were taken off the table last month, apart from the re-election of Emmanuel Macron with a wider margin than the opinion polls had projected. His reprieve may be short-lived though, as he now faces an uphill battle to win a majority in the June legislative elections.

Overall, nothing has changed with the main risks remaining in place: the Ukraine war and its repercussions on energy markets; increased uncertainty amid monetary policy normalisation, and supply chain disruptions linked to the COVID resurgence in China.

So far this earnings season, investors have been in a bearish mood, punishing companies reporting top or bottom-line misses, or those that downgrade their full-year forecast. Making matters worse, markets are not always giving credit to companies that are successful in outmanoeuvring inflation, resisting downturn on the back of the war in Ukraine, or delivering impressive earnings beats.

Our general observations during this European earnings season have been that a large majority of companies reported better than expected results for Q1, and the outlook for Q2 remains favourable, even if visibility has inevitably reduced. That said, as in the second half of 2021, the rosy P&L picture is far from being translated into the cash flow statement, with working capital (especially inventories) eating away the earnings improvement.

There are multiple reasons for this: inflation is the main factor, but also increases in safety stock levels post-pandemic and upfront buying pre-price increases. The two curves, P&L and Cash Flow will de facto converge again in the future. At this stage, it remains unclear which one will move towards the other. It goes without saying that investment implications will be materially different as a result.

The Strategic European Silver Stars Fund‘s performance for April was -0.26% versus -1.72% for the benchmark. The year to date return stands at -7.11%, a 4.12% outperformance compared to the benchmark at -11.23%.

The largest contributors to performance in April were: Albioma (+1.57%), Verallia (+0.76%) and Barco (+0.42%). Befesa was the largest detractor during the month (-0.89%), followed by TeamViewer (-0.85%) and Just Eat Takeaway (-0.51%).

For the third month in a row, Albioma was the largest contributor. On 28th April, Albioma announced that it had entered into a strategic agreement with KKR for a friendly takeover bid. The offer price is €50 per share, plus a dividend of €0.84.

As previously mentioned, Albioma could also attract interest from: infrastructure investors; other private equity companies; green energy producers; oil and gas producers, or utilities seeking to boost their renewables exposure. We are holding our investment until the tender offer opens to keep that optionality.

We initiated the position in Verallia in late February 2022. The company has nearly 200 years of experience in glassmaking, is the leading European glass packaging supplier for food & beverages and is in the top three producers worldwide.

Like other companies heavily relying on gas in their manufacturing processes, the stock took a severe hit in 2022 from €31 on 31st December 2021, to €20 in the early days of March.

Our fundamental view disagreed with the stock markets top-down view because:

1. Glass manufacturing remains an extremely resilient market (volume down 1.4% in 2020);

2. Verallia has a strict hedging policy with 85% of the next three years’ gas exposure covered;

3. The product has strong pricing power: glass packaging costs are low compared to goods sold within the packaging (wine, champagne, liquors);

4. There is a shortage of glass manufacturing in Europe following the COVID investment freeze;

5. The Ukrainian war has amplified the shortage with several sites shelled or temporarily suspended across several European manufacturers.

The Q1 2022 numbers were a perfect illustration of pricing power, cost discipline and the ability to cope with inflation. Revenues came in at €750m vs the €682m consensus, while adj. EBITDA was €183m vs €158m cons.

The results imply 24% revenue growth and almost flat margins at 24.4% vs 25.1% in Q1 2021. Verallia reiterated its FY targets of >10% top line growth and over €700m adj. EBITDA.

Contrary to our negative comment on cash conversion, it was not the case for Verallia as leverage fell further to 1.7x (last 12 months) vs 1.9x at year-end 2021. The stock now trades at over €26, more than 20% above our entry price of €21.8 a month ago.

2022 has started well for Barco with strong order intake and sales, despite increasing supply chain issues (€25m vs €15m in Q3 / Q4). As a result, the Q1 performance was only 8% shy of Q1 2019.

On top of this, Barco announced a contract in the US worth $250m to install laser projectors in 3,500 of its US auditoriums. The first tranche of 500 projectors should be delivered over the next 12 months. AMC is a new Barco client, replacing Sony (which decided to exit the market and should stop support by the end of 2026). Other similar orders may follow.

Befesa falls into the detractor category this month after being one of the top contributors last month, because of what we consider a miscommunication – the group’s 2022 guidance unveiled in April: EBITDA of €220m-€270m, which is this wide for caution’s sake. The low point of the guidance is a scenario of a marked recession as of H2 2022, which is far from the most likely scenario.

The median point of the guidance corresponds to the iteration of Q1 performance at the same zinc price conditions as in Q1 (~€ 3,337/T) when prices are currently at ~€ 4,000/T. The high point of the guidance is based on today’s market conditions in terms of zinc prices and stands above consensus pre-release. The recent sell-off offers an attractive entry point into a structural growth winner and key circular economy player in Europe.

TeamViewer shares have been particularly weak in April, driven by wider tech weakness and cuts to consensus estimates, potentially de-risking the Q1 results as Q1 is by far the quarter with the most difficult comparison basis for the company. Q1 results released on 4th May reported inline bookings, with significantly better than expected profitability thanks to improved cost control. The stock price recovered more than 10% within days of the news, recouping April’s negative impact.

Just Eat Takeaway reported its Q1 results on the 19th of April. Their management cut the FY22 Gross Transactional Value (GTV) growth guidance from “mid-teens” to “mid-single digits”, while correspondingly increasing adj. EBITDA as a % of GTV from a range of “-0.6% to -0.8%” to “-0.5% to -0.7%”.

The new guidance implies a 6% downgrade to GTV and circa €40m – €50m improvement in adjusted EBITDA for the financial year. The latter shows that the positive catalyst is shaping up nicely with further improvement in profitability coming through.

As always, we invite investors and prospective investors, to contact us should they wish to understand our views on the current situation and the positions held in the portfolio. Download the latest factsheet. 

Please do not hesitate to contact us or visit the Strategic European Silver Stars Fund Page.

Adam TurbervilleAdam Turberville
+44 1481 742380

The views and statements contained herein, including those pertaining to contribution analysis, are those of Pascal Investment Advisers SA in their capacity as Investment Adviser to the Fund as of 05/05/2022 and are based on internal research and modelling. Please click on Disclaimer Page to view full disclaimers.