Fundamental matters

In early September, we highlighted concerns we believed the markets had downside risks – and these have already surfaced again. Signs are finally pointing toward a capitulation in equities, even if the extreme stress showing in credit and currency markets has yet to be fully reflected in equities.

Fund Commentary
10 Oct 2022

In early September, we highlighted concerns we believed the markets had downside risks – and these have already surfaced again. Signs are finally pointing toward a capitulation in equities, even if the extreme stress showing in credit and currency markets has yet to be fully reflected in equities.

The selloff in stock markets has so far been an orderly one: volatility is nowhere near where it was in the early part of the year, while the STOXX 600 is still well above pandemic lows. This is a sharp contrast to the recent blowout in credit markets. A similar story can be observed for foreign exchange and government bonds.

In this blurred environment, we are always looking for advanced indicators (other than inflation or long-dated treasury yields) that could help drive our equity exposure in the months to come.

In Europe, small and mid-caps have significantly underperformed large caps YTD: the MSCI Europe Net Return at the end of September stands at -17.4%; its counterpart for mid-caps posted -27.2%; while the small caps index was down 30.1%.

The underperformance can largely be explained by different industry exposures in each of them, as opposed to just a liquidity impact, which has often been the case historically. Financials and Energy companies, which have generally done very well this year, are represented far more in the large caps index compared to small and mid-caps.

For those of you that know us well, you will often hear us mention the fact that we impose a strict 10% minimum FCF threshold on ourselves when investing in companies. In times of market stress, we are often able to find quality companies that meet this requirement, whilst in normal market conditions, they generally trade with a much lower FCF yield.

During the last period of market stress in March 2020, we found many opportunities to put money to work in such quality companies. We are yet to reach those levels this time around, but we are getting ever closer.

In our June newsletter, we mentioned that quality companies were trading at about a 20% premium to March 2020 levels. Following the selloff in August and September, these are trading at around a 5-10% premium.

Finally, we see that fundamentals are starting to matter to investors again, and stocks are reacting positively to specific announcements. Trigano, one of the Fund’s larger positions is a great example that we will use to illustrate this point later in this commentary.

For all those reasons, in a similar fashion to our last commentary released a month ago, we continue to believe that some caution is warranted for the coming months and we are currently refraining from aggressively deploying capital, even if we believe we are getting closer to a point where it will soon make sense to reduce our sizeable cash exposure in the Fund.

The Strategic European Silver Stars Fund outperformed the benchmark by 3.24% in September. The YTD outperformance stands at 5.57%.

The largest contributors to September performance were: Trigano (+0.29%), Ipsos (+0.12%) and Verallia (+0.05%). Bekaert was the largest detractor during the month (-1.54%), followed by TeamViewer (-1.03%) and Befesa (-0.81%).

Trigano’s stock price rallied post the release of reassuring Q4 sales levels on 28th September and a solid outlook. A sharp improvement in chassis deliveries was witnessed in September and chassis supply has been de-risked.

We have mentioned in several newsletters that order books for Trigano are full. If we were to assume that production in FY23 returned to FY21 levels, FY23 sales should then be >10% above consensus. Before the September release, the market was pricing in a collapse of more than 60% of Trigano’s EBITA, with the stock trading at 2.5x EV/EBITA FY23e.

One sell-side broker noticed that the company is even able to buy out minority shareholders: €598m market value for circa 40% of the share capital not owned by Mr Feuillet vs €548m of net cash by end FY23e. At 2.5x EV/EBIT, it may certainly be Trigano’s best investment opportunity, even if minority shareholders would certainly not tender at such a ridiculous valuation level.

Ipsos and Verallia’s September performance can be explained by the strong resilience of their business models, and by management attendance at several conferences during the month.

The same sadly cannot be said for Bekaert and TeamViewer, even though management participated in a number of conferences recently.

Bekaert’s management clearly expressed their ability to maintain their strong pricing power. The mood was good, and disappointment was centred around the share price performance over the last few months.

With stock trading at a PE ratio of 4x 2022 for a company that returns more than 12% of its capital to shareholders during the year (5%+ through dividends and 7%+ through buybacks), we cannot be more in line with the management’s views.

TeamViewer has recently completed its €300m buyback compared to a market cap of €1.5bn. A further buyback cannot be ruled out. A sell-side broker who initiated the stock recently with a Hold recommendation wrote that at the current valuation (15% FY24 FCF yield and 1x ND/EBITDA FY23) a potential takeover from either PE or an industry buyer cannot be ruled out, with Permira still owning ~20% of the capital. Here as well, we are fully in line with such a view.

These two examples unfortunately demonstrate that the importance of companies’ fundamentals has not come back in all segments of the market.

We recently came across a market commentary that said: “Everyone is worried about the return OF capital, not return ON capital”. This sentence must largely explain why the market remains much more driven by macro and passive flows than by active managers and fundamentals. This may change provided we hit levels in the market where the return on capital proves too tempting and cannot be ignored anymore.

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 04/10/2022 and are based on internal research and modelling. Please click on Disclaimer Page to view full disclaimers.

Morningstar™ Ratings Disclaimer
The Strategic European Silver Stars Fund – A EUR share class has a Morningstar rating of 4 stars overall and 5 stars over 3 Years. Morningstar Rating™ as of 31/05/2022. Past performance may not be a reliable guide to future performance. Returns could be reduced, or losses incurred, due to currency fluctuations. The Strategic European Silver Stars Fund received a Morningstar 3 Globe Sustainability Award. Sustainability Rating as of 30/04/2022. Out of 789 Europe Equity Mid/Small Cap funds as of 30/04/2022. Based on 98.92% of AUM.  Historical Sustainability Score as of 31/03/2022. Sustainalytics provides company-level analysis used in the calculation of Morningstar’s Historical Sustainability Score. Data is based on long positions only.