Henderson EuroTrust – Q3 Commentary 2022
Jamie Ross, Portfolio Manager of Henderson EuroTrust, delivers an update on the Company, highlighting factors currently impacting European markets, the key drivers of performance, and recent portfolio activity.
4 minute read
The market has now lost almost 11% since the end of July.¹ Last month we mentioned how ‘the market’ seemed nervous about seeing likely earnings downgrades in the third quarter. These concerns grew during September, and we started to see a number of companies pre-announce weaker than expected third quarter earnings. We have seen warnings from companies across a range of sectors, but the areas that have seen the largest drop-off in trading conditions seem to be consumer discretionary -especially ecommerce, food retail and mass market clothing -along with some parts of industrials and semi-conductors. We certainly believe there will be more to come.
Value style stocks slightly outperformed growth stocks during the month. While this did not help relative returns, our marginal underperformance was more to do with stock specifics and our leverage in a sharply negative market.
Starting with our top 10 contributors; as with August there was a clear pattern as financials (Munich Re, Bawag, UniCredit and Deutsch Boerse) and energy companies (Total) produced strong returns. It is quite unusual, for banks in particular, to outperform in such a negative, risk-off market. But at the moment, equities and fixed income are selling off in tandem and it is this sell-off in fixed income (due to rising interest rates) which is driving positive sentiment towards the banks. From here, the debate around banks is whether the benefit from rising rates (higher net interest income) can offset any deterioration in credit quality, which would eventually result in the higher cost of risk. We maintain a decent weighting towards banks at the moment and have two large positions in the subsector: Bawag at 4.3% and UniCredit at 3.4%. Our other strong performers in September tended to be defensive businesses such as Roche, UMG, Beiersdorf and Pernod Ricard.
The biggest detractors during September included market-sensitive holdings such as Amundi and Partners Group, businesses with a typically inverse correlation to interest rates such as Cellnex, and companies with leverage, such as Grifols and Kion which both announced profit warnings during the month. Kion was particularly painful. There are two parts of this business: a forklift truck division (ITS) and a warehouse automation business (SCS). The issues facing the company at the moment are centred around the latter -SCS. SCS involves Kion signing long-term agreements with customers to design and build automated warehouse solutions. These long-term agreements tend to be signed without, or with limited-scope, price escalation clauses. In a more typical environment, this business model has worked fine, but in the current environment of spiking cost pressures and supply-chain pressures, it has caused Kion problems that can only be resolved over a multi-quarter period. Kion took substantial provisions in the third quarter to account for the likely margin hit in its backlog of already signed contracts, and the shares responded very negatively.
During September, we sold the holding in the telco company KPN and initiated a small position in semi-conductor company ASM International. KPN has materially outperformed the market over the last couple of years. However, its defensive qualities have seen its valuation multiple expand to levels that we felt uncomfortable with. It also has a significant amount of debt, some of which is floating rate. This could lead analysts to downgrade earnings and cash flow expectations as they ‘mark-to-market’.
We purchased a small position (75 basis points) in ASM to get exposure to semi-conductors as share prices weakened and earnings were downgraded. ASM is a market-leader in advanced deposition techniques (an essential stage in creating semi-conductors). The company has over a 60% market share in its core technology, has been generating strong margins and returns.
We will continue to retain balance in our exposures by considering two types of business for investment; those where we see the potential for high and sustainable returns that we think are undervalued by the market and those companies where we can see a material improvement in medium-term business prospects.
¹Source: Bloomberg as at 30 September 2022
Bond yield – The level of income on a security, typically expressed as a percentage rate. For a bond, this is calculated as the coupon payment divided by the current bond price. Lower bond yields means higher bond prices.
Cyclical – Companies that sell discretionary consumer items, such as cars, or industries highly sensitive to changes in the economy, such as miners. The prices of equities and bonds issued by cyclical companies tend to be strongly affected by ups and downs in the overall economy, when compared to non-cyclical companies.
Floating rate – A floating-rate note (FRN) is a debt instrument with a variable interest rate. The interest rate for an FRN is tied to a benchmark rate.
Growth investing – Growth investors search for companies they believe have strong growth potential. Their earnings are expected to grow at an above-average rate compared to the rest of the market, and therefore there is an expectation that their share prices will increase in value.
Leverage – The use of borrowing to increase exposure to an asset/market. This can be done by borrowing cash and using it to buy an asset, or by using financial instruments such as derivatives to simulate the effect of borrowing for further investment in assets.
Quality investing – Quality investing is an investment strategy based on a set of clearly defined fundamental criteria that seeks to identify companies with outstanding quality characteristics. The quality assessment is made based on soft (e.g. management credibility) and hard criteria (e.g. balance sheet stability).
Value investing – Value investors search for companies that they believe are undervalued by the market, and therefore expect their share price to increase. One of the favoured techniques is to buy companies with low price to earnings (P/E) ratios.
Valuation metrics – Metrics used to gauge a company’s performance, financial health, and expectations for future earnings e.g. price to earnings (P/E) ratio and return on equity (ROE).
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