BY BERTRAND FAURE
March turned out to be another volatile and poor performing month for European Equities. In spite of a solid earnings’ season, and expectations for continued positive earnings’ momentum, very few companies in Europe traded upwards post their annual release.
The reasons were manifold: FX impact, raw materials, wage inflation at the corporates’ specific level or inflation expectations, interest rate increases, trade war negotiations, Facebook and related dominance and control questions surrounding large US tech companies from a macro perspective. In that respect, it felt like running through a minefield.
During the month, the Fund reported a decline of -4.64% on an absolute basis. Granges, like in February, was the largest monthly contributor, followed by Brembo and Andritz. On the other side of the spectrum, Rieter, Spie and Metall Zug were the three largest detractors.
The team are very enthusiastic about the current portfolio. The recent market adjustments, combined with the actions taken by the Investment Adviser (selling positions that have moved up strongly and have less upside potential now, whilst taking advantages of buying opportunities to add to new and existing positions) have resulted in a portfolio with significantly superior long-term upside potential than at the beginning of the year. In general, the positions that have declined have done so by far more than the underlying fundamentals imply.
Granges continued its positive performance as a consequence of anticipated benefits from the US tax reform, and an optimistic outlook painted at the Company’s Capital Markets Day on the 21st March.
Since the beginning of the year, Brembo’s stock price was heavily penalised for little reason in the Investment Adviser’s mind. Full year numbers released on 5th March showed a solid sales growth trend (+8.1% published), way above growth in the automotive sector. Management’s guidance was for similar growth in 2018, in spite of negative counter effects from FX moves. According to the Investment Adviser, Brembo will benefit over the coming years from the ramping up of newly opened production sites in Mexico, Poland and China, from a top line as well as a margin perspective. The team entered this position in May 2015 at an average price of €9.0 and subsequently took significant profits in May 2017, reducing the position by approximately 60% to a below 2% position weighting at a price of €15. Last month, the position was sizably increased again due to improved risk return characteristics and an increased discount to the team’s fundamental valuation, a 4%+ position weighting at a price below €12.5 per share.
Andritz was sold at a profit in mid-March, prior to a stock price decline, to concentrate the Fund’s exposure in the Pulp & Paper manufacturers market on Valmet. At this stage, the Investment Adviser believes that Valmet – as the other half of the duopoly – offers a purer play on Pulp & Paper and greater long-term potential.
Rieter dropped by 17.2% in March, following an indication by the Management that EBIT is likely to be flattish in H1. After several conversations with the management team, the Investment Adviser believes that H1 is likely to be the perfect “misalignment of stars” for the Company, and that the phenomenon should reverse in H2 18. Looking at consensus numbers, Rieter trades at 7.8 2019 EV/EBIT, with downside protection coming from hidden assets and a Free Cash Flow yield north of 10%.
Spie was also severely penalised with an 11.5% decline during the month, as a result of rather dull margin guidance. Once again, the Investment Adviser thinks that this fails to capture the cash generating abilities of the business, which translates into a 9 to 11% Free Cash Flow Yield for the next 3 years.
Lastly, Metall Zug still suffers from losses stemming from a tiny business representing 5% of the Group’s turnover. The implementation of SAP has shown that the business’ underlying losses were more significant than expected and stronger measures are needed to put it afloat. The management has taken sizeable provisions in the 2017 accounts (CHF13M for a CHF50M business) and committed to communicate its decision around mid-year in 2018. This set-back is clearly a disappointment; however the business only represents 1% of Metall Zug’s Enterprise Value and has certainly caught the majority of the market’s attention according to the Investment Adviser’s view. Overall, the team believes that the situation is well under control and that the investment thesis remains unchanged, albeit being delayed.
In addition to the disposal of Andritz mentioned earlier, the team also closed the position in Aubay during March. Aubay was a successful investment that generated an 85% return for the Fund over the life of the trade, which was initiated in May 2015. These two sales, along with the four in February have increased the concentration of the Fund’s portfolio to 30 positions, with sizeable upside potential and free cash flow protection.
The views and statements contained herein are those of Pascal Investment Advisers SA in their capacity as Investment Adviser to the Fund as of 10/04/18 and are based on internal research and modelling.