European Equities: keeping the faith!

Whilst those around us capitulated, and greed turned to fear, we held steady and continued buying more of the weaker names. Was this easy?
January 2020

Philip Webster

Director, Portfolio Manager, European Equities

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Risk Disclaimer 

The value of investments and any income derived from them can go down as well as up as a result of market or currency movements and investors may not get back the original amount invested.

Past performance should not be seen as an indication of future performance.

Views and opinions have been arrived at by BMO Global Asset Management and should not be considered to be a recommendation or solicitation to buy or sell any products that may be mentioned.

The wonder of hindsight, and the age-old comment, “I told you so”. In our 2018 review, we said there was no way to sugar-coat the year – it had been the worst year for equities since 2008. In the same breath, we also stated: this is not a time “to panic”, or as Buffett put it, “to be the idiot”.

Whilst those around us capitulated, and greed turned to fear, we held steady and continued buying more of the weaker names. Was this easy? No, and it’s not meant to be. But our experience has taught us one thing: capitulating at the point of most fear is ‘rarely’ the right thing to do.

2019 was all about “keeping the faith”. Looking into 2020, we don’t have a crystal ball but we enter the year with strong conviction in a portfolio in which our top 10 positions account for around 54% of the fund.

Risk Disclaimer 

The value of investments and any income derived from them can go down as well as up as a result of market or currency movements and investors may not get back the original amount invested.

 

Nothing has fundamentally changed

Our year’s performance was a function of what we have done over many years, not just in 2019. In 2018 we underperformed, but the difference isn’t the fundamentals of the stocks, but rather the market’s perception of them. Throughout this time, we’ve maintained our focus on strong and attractively valued businesses held on a longterm view. In 2019, only one new name entered the portfolio. Therefore, the very reason we underperformed in 2018 – maintaining our conviction – was the reason we outperformed by around 6% in 2019. When you run a 25-stock portfolio you don’t need many things to go right. An average position size of 4% means that those that begin to perform can make a significant difference.

 

What changed, if anything, in 2019?

It was a year during which there was a lot of background noise to deal with – Brexit, the China-US trade war, Hong Kong protests, and the general global economic slowdown, which seemed to take a back seat. For us, the biggest shift was in expectations post a very weak final quarter of 2018. We not only witnessed a sharp derating; in tandem we had a raft of analyst downgrades. That meant European earnings were negative as we entered the year, etching a negative outcome for 2019 into the minds of investors.

Past performance should not be seen as an indication of future performance.

Views and opinions have been arrived at by BMO Global Asset Management and should not be considered to be a recommendation or solicitation to buy or sell any products that may be mentioned.

Use our handy glossary to look up any technical jargon you are unfamiliar with.
A bottom-up perspective

We regularly remind our clients that we spend little time worrying about how to build a portfolio from a macro perspective. Our focus is on the qualities of the businesses we choose to invest in. That means their moat (competitive advantage), structural growth prospects and, ultimately, their cash-flow. The market will then decide whether it likes the business and what valuation it will ascribe. We have long talked about the perils of ‘expensive quality’, so the rotation in Q4 2019 was a welcome start, though not yet a prolonged shift towards value. It is value that’s key to us – there are a number of ‘quality businesses’ we would love to own, it is just that our disciplined approach to the price we pay precludes us from doing so.

What worked in 2019?

Before we touch on the companies that drove 2019, here are two links reminding us of the points we were making last year.

Technology: love it or loath it?

BMO European Select Equity Fund – 2018 Review

This isn’t about being right at this exact juncture, as it may not have transpired in 2019 – it’s more about demonstrating that we stick to the fundamentals of the investment thesis. Also, while this might be stating the obvious, companies sow seeds and then reap rewards down the line. At times there can be a lot more of the former than the latter going on in your portfolio, and with that in mind, real success should be measured over a longer period than a year or two.

Delivery hero, share price and fund activity

Source: Bloomberg as at 31-Dec-19

With hindsight, our initiation in Delivery Hero at €45 was not ideally timed. Post our purchase, they proceeded to announce the sale of their German business to Takeaway. com (which is also held in the strategy) but coupled this with a huge investment programme that would depress shortterm profitability. The share price subsequently slid to a low of €31. Despite the short-term disappointment, we retained the view that the food delivery platforms have very strong market positions, for the ones that have survived, and the barriers to entry in this market are significant. This will allow them to monetise their core markets once they get over the investment and consolidation hurdles. This backdrop, and the net-cash balance sheet, gave us comfort to raise our weight to over 4%, prior to the announcement of the deal in Korea to acquire their main competitor. Korea has been a major battleground in the Asian region and was a key asset for Delivery Hero to win, locally and for the region. The valuation for the deal was well received for a high-growth asset and helped to drive the share price to all-time highs, closing the year just above €70.

Whilst we chose to lock in some profits post the announcement, we are mindful that Delivery Hero hasn’t yet turned a profit in any year since its IPO. The trajectory to profitability is much clearer post this deal, but this is a business where we see considerable upside over the next 5 to 10 years. As a result, it has potential to be a core holding for some time.

Technology

We have long advocated old and new technology plays and feel these are some of the strongest business models in the portfolio. The platforms are asset-light and generate significant margins and cash-flow when they have scaled which is a powerful tool and a huge barrier to entry.

The Delivery Hero story is very similar to other top performers, which were mainly technology names: CTS Eventim, Zalando, Takeaway.com and ASML.

ASML is the only outlier, given the expected rebound in the semiconductor market and strong order growth for their new EUV (ultra violet) systems, which will drive the next wave of growth. These names, including Delivery Hero, contributed just over 6% to the outperformance over the year.

Where from here?

We are cautious around making broader market forecasts and remain focused on stock-picking, with a view to realising value over the longer term. Currently, the top 10 makes up 54% of the portfolio, and within that, Ryanair (largest weight), Cairn Homes, Richemont, Delivery Hero and Neinor account for 26%. We believe that the stability of the portfolio should also provide comfort – we don’t need any new names, although it would be nice to have one or two quality names (we don’t own) profit warn. As a team we avoid chasing themes or trends and avoid listening to short-term noise about what the market thinks investors should own. Our focus is on fundamentals and companies we believe will deliver in time.

Top 10 contributors for 2019

Sector Fund Weight Benchmark Weight Active Weight Contribution

Delivery Hero

3.89

0.08

3.81

2.64

CTS Eventim

3.41

0.00

3.41

1.10

Zalando

1.97

0.09

1.88

1.02

ASML Holding

3.56

1.34

2.22

0.92

Schneider Electric

3.51

0.68

2.84

0.59

Takeaway.com

3.12

0.01

3.11

0.55

Deutsche Boerse

5.98

0.40

5.58

0.49

Ryanair Holdings

5.11

0.00

5.11

0.49

SAP

5.65

1.82

3.84

0.28

New Work

2.72

0.00

2.72

0.23

Source: BMO Global Asset Management as at 31-Dec-19

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