The two sides of the coin

January was a turbulent month for global equity markets. The month began with a sharp cyclical value rotation, driven by optimism surrounding Omicron. This was followed by a defensive, value-led selloff over the last ten days, driven by fears of Federal Reserve overtightening, on top of geopolitical stress caused by the Russia-Ukraine situation.

Fund Commentary
7 Feb 2022

January was a turbulent month for global equity markets. The month began with a sharp cyclical value rotation, driven by optimism surrounding Omicron. This was followed by a defensive, value-led selloff over the last ten days, driven by fears of Federal Reserve overtightening, on top of geopolitical stress caused by the Russia-Ukraine situation.

The change in market dynamics has already had a significant impact with the benchmark declining 6.67% this month, its worst month since October 2020. The Strategic European Silver Stars Fund returned -4.51% for January in this difficult macro environment.

As we have discussed on numerous occasions in letters and meetings, large numbers of growth stocks have soared over the past few years, which we believe is due to a misplaced focus on the growth rate of revenues without any focus on earnings. As a result, many growth stocks have remained uninvestable to us for several years.

We hold equities based solely on the underlying assets’ future expected returns, but many investors have come to see equity markets as a substitute for fixed income investments by default, given the negative central bank interest rates. In that sense, we were not surprised to see how hard the Swiss and Swedish markets were hit in January, given that those two countries share the common feature of negative central bank rates in Europe.

Given the Fed’s hawkish rhetoric since last summer and its recent message that it will do whatever it takes to restore its inflation management credentials, we see no reason for this rotation to end. On the contrary, it could even accelerate, depending on what happens in Ukraine.

We consider the market implications for the Ukraine conflict as binary: the situation will likely either improve or worsen considerably within the next month or so, and markets will probably react accordingly.

If the situation deteriorates and NATO imposes new sanctions, Russia will probably respond by cutting natural gas supplies to Europe and curbing oil sales with the intention of causing oil prices to spiral. This could result in a global inflation crisis and a drastic tightening of monetary policy. A bear market in both bonds and equities would likely follow.

If conflict is avoided, however, then the investment implications could be very different. Headline inflation should then fall rapidly from Q2 2022 onwards in the US and probably sooner in Europe. Fears of excessive monetary tightening would likely be reduced following a Fed rate hike in March, and the bull market could resume, potentially quite aggressively given how negative sentiment has become.

As Fund managers, we obviously dislike binary situations like this more than anything, with minimal insight and our inability to hedge ourselves against these two specific opposite outcomes. The Fund currently remains invested in companies with strong free cash flow yields to help protect our interests, and holds a cash cushion of 18.2% (real cash and the Hunter Douglas investment that can be considered as quasi cash given the tender offer) that can be redeployed very rapidly to avoid missing any revaluations, should the Ukrainian situation de-escalate.

The largest contributors to the January performance were: Bekaert (+0.55%), TeamViewer (+0.47%) and Gränges (+0.13%). Groupe LDLC was the largest detractor during the month (-1.03%), followed by Byggmax (-0.85%) and Pierce (-0.44%).

Bekaert’s management participated in several conferences during January, which combined with several broker upgrades, produced plenty of positive news flow and momentum to Bekaert’s stock price over the month. The stock price ended January up 5.5%, although it pulled back from +16% at mid-month.

We have very strong expectations for Bekaert’s stock price development this year as the company should be able to demonstrate that the 2020 and 2021 performances were not one-offs, but the consequences of a profound transformation, enabling the group to sustain a 10%+ margin in the future. If so, we believe the stock price could double from here.

Finally, TeamViewer makes it into the top contributors of our monthly letter! On 12th January the preliminary numbers were the first step towards helping rebuild confidence in the management’s execution following a disastrous 2021 fiscal year. The stock reacted quite euphorically on the release, which highlights if needed, how negative sentiment had become towards the company. This said Q4 can be seen as a starting point to regain the confidence of the market after a period of disappointing events.

The company also announced alongside its preliminary numbers that it would update the market on its capital allocation policy on 2nd February. On 2nd February they announced a 10% share buy-back program, which bodes well for the equity story, and once again demonstrates the strong cash-generating nature of the business.

This cash generation feature has not gone unnoticed, as according to DealReporter on 21st January, the company attracted take-private interest from a number of financial suitors last year with several buyout groups engaging investment banks at the end of 2021, to sound out the viability of launching an offer for the company. This story is far from over.

Q4 was a difficult quarter for Gränges, but this was the trough. This has led to earnings upgrades for 2022 and 2023, and target price increases from the vast majority of sell-side brokers covering the stock, given the somewhat confident outlook from Q1 already.

Groupe LDLC’s stock price development was a disappointment for us this month, in what we consider a strong overreaction to the revised guidance, which implied flattish sales for the fiscal year ending 31st March. The graphic card shortage from NVIDIA impacted the group’s growth trajectory over the Christmas period and curbed Q3 revenues.

The shortage impacted every electronics retailer and not LDLC alone. These revenues have not been lost, only postponed. This component is the only one where the group experienced supply disruptions, as unfortunately, it cannot be replaced and there is no alternative to NVIDIA today.

Fortunately, deliveries have already begun to return to normal in January. Medium-term, we see many more reasons for optimism on that front as Intel will start delivering its mid-range graphics card in 2022, and NVIDIA’s increased production facilities should also come on stream before year-end.

For all these reasons, we fail to understand why this company with a net cash position trades on 2.5x EBIT for next year with a 25%+ free cash flow yield. When observing such multiples, we strongly believe that in a world of rising interest rates, the growth to value rotation has only just begun.

Given the already long length of this communication, please reach out to us directly if you would like any specific comments about Byggmax or Pierce. Our thesis remains unchanged for both companies despite the market moves.

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 03/02/2021 and are based on internal research and modelling. Please click on Disclaimer Page to view full disclaimers.