European Opportunities results overshadowed by Wirecard – European Opportunities has published results for the year ended 31 May 2021 and they don’t look good. Over the period, the trust returned 1.2% in NAV terms and 0.1% in share price terms. This compares to a return on the MSCI Europe Index of 24.6%. The dividend was cut from 3.5p to 2.0p. The discount widened from 7.9% to 9.0% and is 12.6% today. 6,228,471 shares were repurchased into treasury during the period (worth around £44.2m) and a further 832,000 shares (£6.3m) have been repurchased since the financial year end.
The chairman points to encouraging recent short-term performance – since the year end; the net asset value per share had increased by 14.7% to 945.74p between 1 June and 31 August 2021, outperforming the benchmark index which rose by 5.4%. The share price increased by 14.9% to 862p between 1 June and 31 August.
The Wirecard debacle fell into the early part of the trust’s accounting year. What had been the trust’s largest holding was sold on 18 June 2020 on the day that Ernst & Young said it would not sign off Wirecard’s accounts. For the period under review, Wirecard had the biggest negative influence on returns. However, other factors were at work.
The manager says “Whilst the demise of Wirecard, a matter which we have covered extensively in previous reports, is an element of the explanation, it is not the only reason. Simply put, our portfolio did not participate in the most buoyant investment themes during the period under review. Investors’ confidence that debts can easily and cheaply be refinanced was a significant reason for the market extending the valuations of loss-making, more speculative companies. These included many new electric economy companies engaged in activities such as the production of green hydrogen and ‘circular economy’ stocks. Although there is great enthusiasm for these new businesses, they are not yet proven. Technical challenges and high costs are likely to stymie the widespread adoption of some of these new ideas. Other areas of strong market performance were metals, and infrastructure and building materials stocks, beneficiaries of the massive stimulus packages in the US and Europe. To put it another way, lower value-added, capital-intensive businesses have significantly outperformed higher value-added, more capital-light businesses.
Our strategy has always been to invest in companies with structural growth, low capital needs and high value-added…. We clearly misjudged that Covid-19 and related policy responses would be a boon to stock markets. We saw Covid-19 as a threat to economies, raising costs and fostering indebtedness. It might be that, as Keynes put it, investors indulged in ‘spontaneous optimism rather than mathematical expectations’, a bout of what he described as ‘animal spirits'”.
Stock drivers of returns
“The biggest single contributor to our performance in the period under review was Intermediate Capital Group (ICG). It invests in private equity, credit, and debt. Around the world, institutions are allocating more resources to the private markets. This favourable trend and the long-term commitment of funds make for high visibility and underpin our confidence that the company will deliver good returns for the foreseeable future.
Arrow Global Group (‘Arrow Global’) was the next biggest contributor. The share price rose sharply after an offer was made for the company; a takeover has been agreed.
Genus was another significant contributor. The company is a world leader in porcine and bovine genetics. There is increasing demand across their major business lines and in all the main global markets. A particular opportunity is in China where there is a realistic prospect that Genus will increase its market share tremendously in the medium term. There is an even bigger prize, the introduction of gene editing for one of the main porcine respiratory diseases. Trials for this proprietary technology are well advanced. There is a realistic prospect of success which will open a significant commercial opportunity. We have reinforced the holding.
The move to the digital economy, bolstered by the roll out of 5G, has been a boon to the semiconductor industry. Accordingly, Infineon has made a positive contribution to performance. Its strength in power semiconductors plays well with the new electric economy. Where electric power efficiency is concerned – automotive, hand-held tools, wearables and other 5G applications – Infineon has world-leading positions and should benefit further as 5G applications gain ground.
Dassault Systemes, a holding since 1996, was another positive contributor. Its continuing success in CAD/CAM with core aerospace and automotive customers, has been complemented by successfully developing new verticals in, notably, life sciences and city planning. The scale of their ambitions is impressive; and they have the necessary ingredients to achieve much more.
Another long-standing holding, and our biggest position, is Novo Nordisk. It made a modest positive contribution to our performance. Nevertheless, we do not believe that the strength of Novo Nordisk’s business and its fine prospects are adequately reflected in its valuation presently. The company enjoys a globally dominant position, together with one competitor, in the treatment of diabetes. This is a favourable position addressing a worsening diabetes pandemic. In addition, the company has approved ‘best in class’ drugs for severely obese patients. This is a big and growing market.
Edenred also made a positive contribution. This French company processes and promotes ‘specific purpose money’, operating schemes for governments and corporates which want to give benefits to employees for specific purposes. A typical example of their activity is the administration of food voucher schemes for corporates, their original core activity. The move from paper-based vouchers to digital vouchers is good news for Edenred; as is the rise of ‘virtual canteens’ in place of corporate canteens.
The biggest single ‘hit’ to performance was Wirecard. We sold the entire holding on the day that the fraud was reported by the company in June 2020. We have written extensively about this issue in previous reports.
The marked underperformance of bioMérieux shares is due to the company’s warning that Covid-19 related demand in the US has fallen sharply. However, the future success of bioMérieux is about much more than Covid-19. They fulfil many other diagnostic needs including the reliable, fast detection of pneumonia, meningitis, and influenza. We are firmly of the view that there is a structural increase in the need for diagnostics to tackle infectious diseases and to reduce antibiotic use. Accordingly, we have retained this position.
In September 2020, Grenke was assailed by an investigative financial research group which accused the company of “widespread fraud and predatory practices”. As a precaution we sold the holding. The company initiated a series of audits which have taken nearly nine months to complete, an indication that these audits have been exceptionally thorough. Over this nine-month period the company released interim findings of these audits, all of which confirmed our view that the company’s management was honest and that the allegations were without foundation. Thus, we decided to take a new, small position in Grenke. The company’s financial auditors duly announced an unqualified audit for 2021. Although, in our view, the company has been vindicated, it has been damaged by the unwarranted allegations. We believe that it will now recover strongly.
Deutsche Boerse was also a negative contributor to performance. It prospers most when there is uncertainty in financial markets and when interest rates are higher. Neither condition was apparent in the reporting period. However, we can easily imagine a more favourable backdrop for Deutsche Boerse and have retained the position.
Experian, the world’s biggest credit bureau and credit analytics company, made a slightly negative contribution. This is a major holding in the portfolio, a reflection of our confidence that it is a high-quality company which we expect to deliver good returns whatever the macroeconomic conditions. Results and guidance are encouraging. We attribute the shares underperformance to the concern that the Biden administration will disrupt the existing, favourable industry structure. We do not believe that this is a likely eventuality because Experian’s business is already well aligned with policymaker objectives: greater consumer protection and control. Indeed, what sets Experian apart from its peers is that it has established a successful direct-to-consumer credit business. It remains a core holding.”