Manager’s stock picks deliver for Henderson Euro Trust

Manager’s stock picks deliver for Henderson Euro Trust – Henderson Euro Trust (HNE) delivered an NAV total return of 6.6% over the year to 30 July 2019. This was 1.9% ahead of its benchmark (FTSE World Europe (ex UK)) in sterling terms.

Chairman, Nicola Ralston, said: “The portfolio we hold at the moment is relatively concentrated, with 40 holdings in the portfolio. Although the performance of the European equity index as a whole inevitably has a major influence on our performance in absolute terms, performance relative to the index is driven by the stocks our manager chooses to hold. In recent weeks, there has been a resurgence in “value” stocks, which are generally – and somewhat crudely – defined as securities which trade on a valuation lower than the market average. It is very possible that this will continue, as “value” stocks have been out of favour for a considerable period.  We are not concerned about this, as the focus of the company is on the consistency of performance and the ability to compound earnings over time, rather than to capture a short term rebound due to a change in valuation. We do not want to buy securities which we consider to be valued more highly than their prospects justify, but to find companies which can deliver attractive returns through a variety of economic and political circumstances in a consistent manner. Whilst we have to make judgements about which companies can best do this at any one time, and do so with a suitable degree of diversification, this focus will not change.”

Performance attribution

The manager’s stock picks added value over the year, contributing 2.6% to the NAV total return figure. The table below shows the performance driver figures for the year.

Comments from the manager, Jamie Ross, on the main contributors and detractors: “Starting with the strongest contributors, I will begin by mentioning a couple of stand-out performances from amongst the Improvers in the portfolio. Koninklijke DSM (“DSM”) was historically a poor, polymer-focused business with average ROIC and unpredictable end markets. DSM has since transformed itself into a business that is now >75% exposed to much more profitable, higher ROIC and less volatile ingredients end markets. This transition has resulted in a material re-rating of the equity valuation of the company and I see scope for a further re-rating over the coming years.

Philips was originally focused on light bulbs and then on consumer electronics. Both of these markets became heavily commoditised over time and the business began to transition towards some niche, high value-add areas of healthcare equipment. Philips is now a global leader in these areas and, as with DSM, it has seen a material re-rating as it has transitioned.

Within the Compounders, Hermès and SAP both performed well. Hermès is reaping the rewards from a consistently long term capital allocation focus and the classic timeliness of its brands. This is an expensive company, but one that I am more than willing to run with given their well entrenched market position, exceptional ROIC profile and exposure to structural growth. SAP has been a business the Company has owned for a while and has been, at times, a source of frustration. However, towards the end of the period under review, management came out with some new medium term targets that implied a 400bps improvement in operating margins and this was taken well by the market.

From amongst our detractors, Equinor, the Norwegian oil & gas company, suffered from weak end markets, a higher-than-peers exposure to European gas markets and from a generally weak operational performance. Novartis, a company that I sold during the period, rallied strongly after our sale causing its negative contribution. This was disappointing, but I sold for long term fundamental reasons and I will never time every sale (or purchase) right. Finally, UBS has suffered from an underperforming Wealth Management business.”

Outlook

Jamie went on to say: “As the last year has progressed, there has been a clear weakening in end market demand in several areas of the market, for example autos, semi-conductors and chemicals as three of the most obvious of these areas. All three are exposed to the vagaries of Chinese demand (and supply) as well as being exposed to sentiment around global trade; it is these two features that likely account for a large degree of their observed weakness. There are also areas of the market where demand is holding up very well: software, certain consumer staples and many areas of healthcare. These observations really sum up current market conditions; we have seen pockets of weakness, but no widespread collapse in demand. We also have to remember that the current sluggish demand environment is happening at a time of ultra loose monetary policy. This should prove supportive, especially when combined with currently inexpensive equity valuations.

I am finding opportunities to add to existing holdings and new positions for the watchlist. Over the past year, the company has moved from a position of a net cash balance to a position of modest leverage. I will continue to spend my time trying to identify the best Compounders and Improvers from across Continental Europe. I look forward to updating you in my next report.”

The discount

HNE noted that the company’s shares traded at a discount to NAV of nearly 10% over the year (8.2% at the prior year-end), a higher discount than the peer group average of circa 7%. With only eight constituents, the peer group is relatively small, and includes companies which also invest in the UK. HSE’s view is that the widening discount is not a reflection of company performance, which has been good. Rather, enthusiasm for European equities has been limited due to adverse political sentiments around Europe and Brexit and, in relative terms, HSE says it is under-owned by retail investors.

HNE: Manager’s stock picks deliver for Henderson Euro Trust