December 2019 Quarterly Report - ECP Flagship European Value

160120 Market Commentary

December 2019 Quarterly Report - ECP Flagship European Value

Executive Summary

  • Performance overview
    • Strong finish of the year for markets and our strategy
    • Our value approach outperformed in Q4 the market, the value and growth indices
  • Investment cases
    • We invested in Jost Werke, Norma and Origin Enterprises, all market leaders with solid competitive positions in important markets and strong fundamentals
    • We sold Loomis for valuation reasons and Europcar because we lost faith in management
  • Market environment & outlook
    • Attractive environment for European value equities and ample investment opportunities make us confident our approach will deliver solid results

Performance overview

The last quarter of 2019 continued to build on the positive returns made earlier in the year. For MSCI Europe the return for Q4 2019 was 5.71% and for the full year 26.05%. By all measures a good year. Those returns have been made in a volatile fashion with worsening fundamentals on both corporate and macroeconomic levels and investor sentiment ranging from FOLM (fear of losing money) over outright summer panic to FOMO (fear of missing out) in the autumn. It is fair to say that 2019 had something for everybody.

As the year progressed, and particularly in the second half, investors had more clarity on both Brexit and the trade war between US and China. This made the glass look more half-full than half-empty. During the last quarter the business cycle also improved from a sharp correction driven by too high inventories and lack of new orders.

How can equity markets generate these returns in such a volatile environment? Equity market returns are always generated from a combination of fundamental factors and psychological factors. And more importantly: the CHANGE in those factors.

The start of 2019 was close to perfect: 2018 was a weak year with losses of 10-20% across several markets and almost all of the losses were made in the last quarter of 2018. Many single stocks had losses 2x the market for the year. Investor panic (the psychological factor) was present as the perception of a nearby recession (the fundamental factor) created an urge to sell just about anything at any price.

In short, by January 2019 some asset prices were pressed far below their long-term value in fear of a recession that did not come in 2019. Buying lowly valued assets and wait for sentiment and/or fundamentals to improve is enough to make a lot of money in equity markets. This is what happened in 2019 and the psychological factor has as always been far more pronounced than the fundamental factor. The combined compounded annual return of 2018 and 2019 is 6.15% per year which is closer to the long-term average returns for European equities. A longer perspective helps a better judgement of short-term results.

We close the year with a sense of satisfaction and high hopes for the years ahead of us. Value stocks are now able to keep up with Growth stocks and some of the small- to midsized companies that were left in dust one year ago have been rediscovered. That’s a good thing because it means that solid company fundamentals again start to matter. We finally see valuation-based strategies like our own make a comeback. The last 10 years have favoured Momentum and Growth strategies fueled by falling interest rates and leadership of a few companies within the technology sector. We see early signs that the next decade may belong to Value investors.

Our strategy outperformed both the broad market and also the Value and the Growth indices in Q4 2019. We find that quite impressive since our strategy is more defensive than the market. All our investments are made on a company-by-company basis. We like to spread our investments across +/- 40 companies where a good part of the companies will provide high and growing cash flows in any economic environment. The other part is of more cyclical character and we like to buy those when they are priced for recession.

Investment cases

Jost Werke

Jost Werke is the global leader in safety critical solutions for commercial vehicles. Most of the company revenues are generated in product categories where Jost has a global market share of 60%. The company is facing the truck and trailer industry and is thereby cyclical. Cyclical concerns in the end markets caused a collapse in the share price from 45 EUR in November 2017 to 25 EUR in October 2019. While we share the concerns for the truck and trailer market those concerns are well known to everyone. Above all, the concerns are of temporary nature and more than compensated for in a share price of 25 EUR at purchase. Higher safety requirements globally for the connection between truck and trailer helps pushing the fleet owners to renew their fleets which creates demand for Jost’s products. We see a low risk for business disruption as road transport is still the most important form for goods transport globally. We also see low risk of price pressure because customers do not want to fight hard with their suppliers of safety critical components in fear of any reputational damage that could have on the customers’ business should an accident happen.

The balance sheet is strong and Jost can pay off its debt in just 1,5 years. At our time of purchase Jost was trading at 12% free cash flow yield so we feel very well compensated for taking the cyclical risk on the end market. After we bought the shares, the price has gone up by more than 40%.

Norma Group

Norma Group produces clamps and connectors as well as fluid handling devices. Their products are used in all thinkable end markets from automobiles, construction, battery cooling, washing machines etc. Norma sells more than 40.000 different products each with an average unit price of 0,6 EUR. Most of the products are highly engineered and developed in connection with their customers. In short, Norma sells each year a high number of components where the value of the component is only a tiny fraction of the value of the end product. Any malfunction of Norma’s product can have severe impact of the functioning of the final product and therefore Norma is less subject to price pressure from their customers.

Norma Group is a clear industry leader and consolidate the market by buying smaller competitors or new technologies. The company is 2-3x bigger than nearest competitor and 8-9x bigger than competitor number 3. The company will benefit strongly from any shift towards hybrid vehicles. Two profit warnings during 2019 made it possible for us to buy the shares below 30 EUR. In the summer of 2018 shares were priced at 70 EUR on earnings similar to today. Some of the excess operating costs of 2019 clearly have a one-off character and additional planned cost savings will in our view expand the margin from 13% back to 16% and as business owners we shall be rewarded accordingly.

Origin Enterprises 

Our third addition to the portfolio is Origin Enterprises which is an agricultural service company operating in Ireland, United Kingdom, Brazil and Eastern European countries. Origin offers agronomy services including advisory and fertilizer products tailormade to the individual farmer with the objective to enhance the farmer’s production yield. The main markets are UK and Ireland where they are 2x larger than their closest competitor and has built customer relationships over decades. The company is now diversifying away from UK into for example Ukraine where the agricultural land is 10x bigger than UK but where fertilizer spend is only 50% of the level in the United Kingdom. If Origin is successful in making farmers more efficient in their new markets it is a big business opportunity for the company.

Weather is obviously an important topic for Origin. Bad weather can destroy the planting season and in result reduce the need for Origin’s fertilizer products. The autumn of 2019 was particularly rainy, so Origin had to issue a profit warning and the stock was sent down below 4 EUR for earnings similar to what the market was willing to pay 9 EUR for in 2015. The company now trades at a 7x EBIT which makes Origin a clear takeover target in the industry. While we wait for future planting seasons to be better than the one in autumn 2019, we will be paid 5-6% dividend yield from an almost debt free balance sheet.

Market environment & outlook

With the new decade starting, we wanted to wrap-up the current state of affairs in European Value-land. In order to keep it short, we summarize the environment in European value-land with a couple of hopefully self-explaining graphs:

Graph 1: European equities are attractively valued.

Despite the run-up, European equities remain attractive on most valuation measures compared to their own history and compared to other developed markets like the US. In the graph below, we compare the dividend yield of Europe, US and UK to the respective 10-year bond yields. This is a good indication of how cheap equities are in Europe compared to bonds.

source: Bloomberg


Graph 2: Positioning in European equities remains light.

European equities remain an out-of-favor asset class with more than 100 bn USD outflows in 2019. Over the last weeks, investors appear however to rediscover Europe and we saw timid inflows again. More clarity on Brexit, better news on tariffs and improving economic sentiment could see this trend continuing.

source: JP Morgan


Graph 3: Signs of improving business sentiment in Germany

Recent economic data suggest indeed an improvement in business sentiment in the Germany. This increase in sentiment, partly on the back of the recent U.S.-China trade agreement, is still fragile and just the first step. As a reminder that the road to better economic hard data is still shaky, both industrial production and factory orders dropped at the start of the fourth quarter.

source: Bloomberg


Graph 4/5: Value is cheap and interest rates start to provide support to value

The valuation gap between growth and value stocks remains at an all-time high.

source: Bloomberg

One reason is the low interest rates in place since the financial crisis. There is indeed a strong correlation between interest rates (in this case the US ten-year treasury yield and the relative performance of MSCI Europe Value and MSCI Europe Growth. US interest rates have been edging up over the last weeks towards 2% supported by solid US economic data and retreating risks of escalating tariff war.

source: Bloomberg


The current environment creates opportunities for the long-term investors we are. Staying rational and having a consistent view of the intrinsic value of a company are two cornerstones in our investment process. When investing in “out of fashion” companies it requires that you go against the crowd. More often than not, it involves increasing the position when prices are dropping. Therefore, we have always held the view that volatility ultimately is a good thing for the long-term investor.  For 20 years this has generated healthy long-term returns for our strategies. The flip side is that being contrarian always involves the risk of looking foolish, sometimes even for an extended period. This is just something we have to accept.

In our existing portfolio the margin of safety of the median company is currently at 35%. It is one of the highest margin of safety we have seen since we launched the European strategy at ECP in Dec 2014 and probably one of the highest we have seen since the bottom of the market after the financial crisis in March 2009. Our portfolio is positioned very attractively for the long-term investor.

European equities are for the moment unloved by Mr Market and  value stocks are at a historically high valuation discount to their growth peers. It is only a matter of time till we reap the full benefits of our long-term approach.