BlackRock Greater Europe (BRGE) has announced its annual results for the year ended 31 August 2020, during which the company has provided a strong year of outperformance. According to BRGE, it provided an NAV total return of 16.9%, outperforming its reference index, the FTSE World Europe ex UK Index, which returned 0.7%, while its share price returned 18.0% over the same period.
A positive tax ruling has been a win for revenue income
BRGE’s revenue return per share for the year ended 31 August 2020 was 6.85p per share, which compares with 4.87p per share for the previous year, an increase of 40.7%. A fall in dividend income, reflecting the challenges faced by many portfolio companies, has been offset by the positive outcome on a tax ruling in relation to overseas dividends. In April, BRGE’s Board declared an interim dividend of 1.75p per share (2019: 1.75p) and is proposing a final dividend of 4.40p per share for the year (2019: 4.10p). This, together with the interim dividend, makes a total dividend for the year of 6.15p per share (2019: 5.85p), an increase of 5.1%.
Investment manager’s comments on the portfolio
“Despite this extraordinary level of fiscal and monetary support it is also clear that this volatile financial market episode posed a severe test to any investment philosophy. For us it required a heightened focus on maintaining our long-term approach to investing, thinking like business owners and long-term stewards of our clients’ capital. While there was an atmosphere of panic amongst some market commentators, we were able to lean on our investment process: focusing on well-run businesses with a clearly articulated strategy, high returns on capital, strong free cash-flow generation and options to deploy capital into growth projects at attractive returns. Whilst this process leads us to businesses which are fundamentally durable and resilient, we had to endure a certain degree of loss tolerance in the short term: maintaining positions in many of our world leading more cyclical businesses and avoiding the temptation of reacting to short-term market gyrations by positioning the portfolio more defensively.
“Ultimately, we believe this approach creates the greatest amount of value for our clients over the long term, which is why we made few changes to the general composition of the portfolio during the period aside from opportunistically adding to some of our highest conviction ideas at compelling valuations.
“Large market sell-offs like the one experienced in March also affords patient investors opportunities to initiate positions in world-class businesses such as Atlas Copco, which we see as one of the most attractive industrial businesses in our investment universe. The company sells mission critical components such as compressors used in petrochemical and processing plants and vacuum pumps used in the production of semi-conductor chips and equipment. Its expanding base of installed equipment supports the company’s aftermarket and services business which gives a high level of growing recurring revenues. Overall, the company generates high returns on capital, is extremely cash generative and has a net cash balance sheet, which means it is a perfect fit for this portfolio.
“Reflecting upon how our portfolio companies performed during the last twelve months, we would categorise our holdings in three broad clusters: those most directly impacted by lockdowns and travel restrictions; those which proved their resilience through the skilful stewardship of their management teams; and finally those which have become direct beneficiaries of the pandemic.
“The first category includes some of the Company’s largest detractors over the past year. These include aerospace holding Safran and travel technology company Amadeus IT Group, which both suffered due to widespread travel bans. We thoroughly examined these companies’ balance sheets and cashflows and engaged extensively with their management teams. Even with the postponement of engine deliveries and a reduction in scope within the maintenance business we believed that Safran had sufficient balance sheet headroom and cost levers to pull to get through this difficult period and beyond, particularly since the heavy investment phase in their new LEAP engine is behind them. Management have also proven extraordinarily proactive in reducing costs.
“In the long term we expect air travel to remain a growing industry supplied by an oligopoly of engine-makers, which should allow for durable value creation when traffic patterns start to normalise.
“Amadeus IT Group, which provides IT infrastructure solutions for airlines, travel agents and hotels, was severely impacted by the sudden stop in economic activity. The company took swift action to right size its cost base and to secure a strong balance sheet position. Given its technology leadership, the company has taken market share in this downturn, winning new airlines as well as expanding the product offering to existing clients. Its unique capabilities in air traffic disruption management and ticket changing have proven particularly popular in this context.
“Overall, we consider both Safran and Amadeus IT Group as good examples of businesses that should come out of this crisis with stronger market positions by capitalising on the weaker competitive position of their main peers.
“Two of our emerging European holdings, Bank Pekao and Alpha Bank, saw share prices directly impacted by the crisis as yield curves flattened and investors priced in a credit loss cycle equivalent in scale to the global financial crisis in 2008/09. In our mind, this thesis will likely prove too pessimistic given government support schemes for small and medium sized businesses across Europe. Further, regulation following 2008/09 ensured that banks now have stronger capital positions to survive these challenging market conditions.
“These detractors to portfolio returns were more than offset by companies which were able to prove their resilience, many as a result of strong execution by company management teams. Evaluating management capabilities has long been a core pillar of our stock selection process. While one can assess management quality in various ways, we would suggest that scrutinising an executive’s ability to operate effectively during the largest economic contraction since World War II proves a formidable test in itself.
“In our mind, DSV Panalpina, one of the global leaders in freight forwarding and logistics, constitutes a prime example of strong operational execution. We believe DSV Panalpina has one of the best management teams in any industry across Europe, with an exceptional track record in creating value by successfully deploying capital through acquisitions. This was evidenced further in a recent meeting with management which revealed that newly integrated Panalpina increased volumes in DSV’s German operations by 50% with no net additions in costs. Overall, DSV Panalpina managed to increase operating profits during the second quarter by 63% versus the same period last year by over-delivering on deal related cost synergies and via capturing higher air yields from freight planes that came with their Swiss acquiree. These results not only significantly surpassed market expectations but they are all the more impressive when held against the backdrop of one of the worst periods for global trade volumes we are likely to experience in our careers.
“Royal Unibrew, a company which operates in very different end markets to DSV Panalpina, also benefited from its management team’s excellent stewardship during the period. The brewing and beverage company’s decentralised organisational structure brings them closer to their end customers and allows local management to identify trends for products, brands, packaging and consumption and to react quickly to newly emerging opportunities. This is crucial in an industry shaped by changing consumer preferences and we believe played a significant role in Royal Unibrew being able to reinstate full year 2020 guidance in June 2020, the first beverage company to do so.
“A relentless focus on meeting and exceeding customer requirements has also benefited Sika, one of the global leaders in the development and production of specialty chemicals used in large construction and infrastructure projects. The company’s focus on research and development (R&D) and product innovation make them an indispensable partner to their customers, which in turn allows for a healthy degree of pricing power, crucial in an environment where many investors expected a sharp contraction in demand for its products. As we have learnt since, global construction spend has been one of the few income streams that has shown great resilience and is considered an end market poised to benefit from future stimulus programmes, a trend which has already started to materialise in Sika’s numbers.
“Not for the first time, ASML was among the Company’s top performance contributors for the year. This company dominates its market segment through R&D leadership and unmatched product innovation. ASML is the global leader in cutting edge photolithography systems used in the semiconductor industry. Their Extreme Ultra-Violet machine tools business has amassed a US$10.5 billion order backlog, which means these machines are now sold out until the middle of 2021. At times we like to refer to businesses like ASML as ‘order book’ companies, as its tools play such an integral part in the technology roadmap of clients like TSMC and Samsung that a decision to delay or cancel an order potentially has multi-year strategic implications. This is why ASML has managed to weather this crisis well and why we continue to see a long runway of growth, benefiting from structural tailwinds such as data centre investments, artificial intelligence and cloud computing.
“Another beneficiary of this trend towards digitalisation is Netcompany Group, a provider of information technology solutions and consultancy services. Founder run, we believe this is an exceptionally well-managed company with a strong value creating culture. Rather impressively, customer demand during the crisis remained virtually unchanged with the company maintaining its target of 18-20% organic sales growth for 2020. For us this was the result of many customers continuing to prioritise digitalisation investments and the company executing strongly by servicing clients from remote locations. Netcompany Group benefited further from its diverse client base across the financial, telecommunication, retail, energy and industrial sectors, as well as governments and municipalities. Overall, we see the group’s end markets offering attractive growth opportunities for many years to come.
“The final grouping of companies that warrant comment are those which directly benefited from the pandemic. Our long-standing position in contract drug manufacturer Lonza Group was amongst the top performers over the past year. Its unrivalled market position was highlighted yet again during a recent conversation with the chairman where we learnt that practically all of Lonza Group’s global manufacturing capacity is sold out. This reflects the strong demand it enjoys in the production of biological drugs, as well as in the development of gene therapy and vaccines. The operational performance of the business remains strong, as impressive cost control coupled with the potential disposal of non-core special ingredients assets leaves investors with a highly attractive investment proposition of long duration growth in earnings and cashflows.
“Within the same sector, a position in in vitro diagnostics company DiaSorin contributed equally strongly as it benefited from the crisis due to its role in developing antibody tests for COVID-19. The Italian company develops and manufactures reagents for in vitro diagnostics and creates products for a variety of tests in fields including infectious disease, hepatitis, endocrinology, therapeutic drug monitoring and autoimmunity. The last few months have helped the group raise its profile among US hospital groups since both speed of development as well as accuracy of its COVID-19 tests compare favourably to its much larger US peers, which in itself bodes well for future opportunities to generate new business in a large and attractive market.
“For this Company, portfolio construction remains purposefully designed to tap into a diverse range of end markets and income streams, from consumer goods to the construction industry, to trade related companies, and technology capex. Overall, we follow a high conviction approach that seeks to deliver a diversified stream of alpha for our shareholders, which makes it pleasing to see those diverse sources of performance in portfolio returns for the year.”
Investment managers comments on outlook
“As active investors, we have never believed a positive view on the European economy to be a prerequisite for attractive equity returns in the region. In our mind, the European market remains home to many exceptional businesses that have and will continue to provide compelling investment opportunities regardless of the wider economic outlook.
“That being said, we find ourselves today feeling more optimistic about the outlook for Europe than we have done in many years. The newly established European Recovery Fund marks a structural change in the outlook for Europe and provides a facility for a cohesive response to all future crises. While the Eurozone does not appear en route towards full fiscal union, it is taking a significant step towards stronger fiscal co-ordination when it matters. In our view, this deal sets a precedent. The EU issues debt in a crisis, which is why we expect some common fiscal response to play a greater role in future crises as well.
“As far as this €750 billion European Recovery Fund is concerned, we expect it to direct spending, focused on the periphery, towards a green and digital transition, which should not only lend support to countries most severely hit by the crisis but it also offers the potential to make the region more competitive in a global context over time. We see interest free grants providing necessary incentives for conducting pro-growth reforms. The overall benefit of such actions should be most acutely felt in smaller countries in Emerging Europe, which is a designated part of the investment universe of this Company.
“Finally, while a material improvement for the region’s economic and political stability and outlook, one should refrain from considering these latest developments as a tide that lifts all boats in European equity markets. Structural challenges are likely to remain in some industries and we believe investors will be best served by staying selective. Consequently, we continue to focus rigorously on taking an active approach to stock selection for this Company by identifying and investing in companies with superior business models, strong management teams and growth prospects that enable them to earn an attractive spread over their cost of capital. We believe these wealth creating businesses are the key to delivering strong shareholder returns over the long term.”