BlackRock Greater Europe (BRGE) has announced its annual results for the year ended 31 August 2021, which its chairman, Eric Sanderson, describes as having been a very successful one, with regard to excellent absolute returns and also relative to BRGE’s reference index, which he says has resulted in significant demand for BRGE shares. Since the end of January this year, BRGE has either either reissued shares from treasury or issued new shares at a premium to the net asset value (NAV) per share to the aggregate value of £89,004,000 up to 2 November 2021. Over the year ended 31 August 2021, BRGE’s NAV per share returned 49.4%, outperforming its reference index, the World Europe ex UK Index, which returned 27.4%, while BRGE’s share price returned 56.8% over the same period (all in sterling total return terms). More detail on this performance is provided below.
Investment manager’s comments– portfolio developments
“We are pleased to report that the overall shape of the portfolio has changed very little and shares in our Company have continued to deliver for shareholders despite all these significant events influencing markets over the course of last year. This adds credence to our approach of ignoring macro narratives and instead focusing on long duration growth in earnings and cashflows to drive returns for our shareholders.
One segment of the portfolio that exemplifies long duration value creation are our holdings in the European semiconductor industry including ASML, BE Semiconductor and VAT Group – all amongst our top performers over the period under review. These companies service different parts of the semiconductor value chain and are dominating their respective niches, affording them a healthy degree of pricing power. As is now well documented, the strength in demand for semiconductor components has left many end users in short supply. In fact, one of the reasons we were attracted to these companies in the first place was that the equipment they produce ultimately serve a broad range of end markets that should lend themselves to high, sustainable and value accretive growth. More specifically, demand is coming from areas like high performance computing, artificial intelligence, smartphones, 5G rollouts, gaming and accelerated servers, as well as the continued build-out of data centres and cloud infrastructure.
In addition, the semiconductor content in electric vehicles (EV) is five to six times larger than in traditional combustion engine cars which makes decarbonisation of transport another important driver of demand. In the first instance, semiconductor components are required for the interconnectivity in cars and ensure efficient power management of battery stacks. On top of the electric drivetrain, there is also higher semiconductor content coming from solutions like ADAS (Advanced Driver Assistance Systems – applications such as Lidar, Radar and other safety features) and Infotainment (wireless internet, Bluetooth, touchscreens etc.). Lastly, the semiconductor industry will benefit from continued innovation in the auto industry, like the nascent development of autonomous driving. As a simple rule of thumb, we can say that the more sophisticated and customised the car, the higher the content of semiconductor chips and sensors. Whilst traditional European car manufacturers rarely meet our investment criteria, we can gain exposure to the accelerated adoption of EVs via companies that ultimately act as enablers of one of the largest industrial transformations we are likely to experience in our careers. The good news here is that this process has only just begun and has a long way to run. In this context, we would note that semiconductor stocks are still only 4% of global market capitalisation whilst energy – a sector disadvantaged by the energy transition – still accounts for more than 5%, again pointing to the potential for long duration value creation.
Long duration value creation also often resides within organisations that are founder led, with an entrepreneurial culture, large addressable markets and a product offering that enables disruption and change. One of the best aspects of our jobs as stock pickers is to find those hidden gems early and to grow with them over long periods of time. An example of such a company is Danish-listed IT service provider Netcompany Group. This business helps both public and private sector clients to digitise their operations across four main markets in Denmark, Norway, the UK and the Netherlands. While digital transformation of our economies was a process well under way even before the pandemic, developments in 2020 forced many of Netcompany Group’s clients to accelerate investment into information technology (IT) infrastructure that helped connect businesses with employees and clients alike. Its services have applications as diverse as a customs office looking to develop more efficient ways to collect taxes, helping local authorities to manage schools, or making Copenhagen airport one of the most technologically advanced in the world. Private sector clients also provide many different use cases for its services. In the financial services, logistics and utilities industries, Netcompany Group helps clients to modernise their IT stack with data analytics or to move their IT infrastructure into the cloud. Overall, this is a capital light business model generating high margins and attractive returns on invested capital which combined with high growth – even in 2020 this business grew 20% organically – makes for a powerful recipe for value creation.
Another key investment that has been generating value for our shareholders over prolonged periods of time is Swiss listed Sika, a global leader in construction and industrial chemicals and one of the Company’s top performers over the past year.
The company provides solutions for sealing, insulating, bonding and protecting load-bearing building structures, which are typically used in large infrastructure projects. We see Sika as an innovation powerhouse with a diversified and innovative product portfolio, as well as a well-invested distribution network across the 100+ countries in which it operates. In other parts of the group, Sika also holds a leading position in the supply of noise dampening material and high strength bonding agents used in the manufacture of EVs. With 50% of group sales coming from refurbishment and modernisation spend, Sika appears well positioned to capture some of the post pandemic global infrastructure spending, including investment initiatives coming out of the European Green Deal and the European Union (EU) Recovery Fund. Sika’s management team has an excellent long-term track record in creating shareholder value and we expect them to continue to deploy capital in a way that allows for further margin expansion and for return on invested capital to move higher over the coming years. Finally, adopting a blue-sky mindset, we are keenly monitoring Sika’s research and development initiatives in developing a process to recycle concrete – one of the most carbon intensive industrial processes – which provides further potential upside to an already strong stand-alone investment thesis.
Elsewhere within industrials, the Company enjoyed a strong performance contribution from logistics and transport group DSV Panalpina (DSV). DSV did an excellent job integrating the Panalpina business acquired in 2019, which helped the company grow volumes and earnings with little net additions in costs. Furthermore, DSV announced its next acquisition, buying Kuwait-based Agility’s logistics business in a US$4.1 billion deal in March this year, becoming the third largest freight forwarder globally. Agility is roughly 25% of the size in volume of DSV and we expect this deal to be highly earnings accretive post synergies.
he Company also benefited from strong stock selection within the health care sector where long-term holding Novo Nordisk, a global leader in diabetes care, contributed strongly once again. Shares moved higher following US Food and Drug Administration (FDA) approval for its weight management drug Wegovy. At present, 80% of Novo Nordisk’s business relates to diabetes drugs and we see the potential for its obesity franchise at only 6% of group sales to deliver high margin and long duration growth for many years to come. In addition to sector leading growth, Novo Nordisk offers high returns and best in class cash flow conversion, with any excess in capital being returned to shareholders. Dental implant manufacturer Straumann also traded strongly; in this case we see upside to market expectations stemming from their opportunity to take market share in China which remains a largely under-penetrated market.
The largest relative detractor was German software group SAP. Depressed business spending and delayed decision making by major clients led the company to publish weaker than expected results, as well as a cut to its revenue and profit forecasts. In this context, SAP updated its medium-term targets, essentially pushing out a long-awaited improvement in operating margins by up to two years. We had expected the management team to potentially update its strategic targets in light of COVID-19, however, we were left surprised by the extent of revisions to forecasts. Having reviewed the investment case in detail, we decided to exit the position.
Similar to 2020, some of our travel related holdings including Amadeus IT Group and Safran were amongst the bottom performers for the year. This was the result of weakness in air traffic volumes, with the timing of a more sustained recovery in air travel remaining uncertain. Whilst markets had hoped for travel to recover more quickly, we do not expect a structural change in consumer behaviour over the medium term and believe travel will recover strongly once restrictions are removed.
As mentioned above, overall portfolio changes were limited, with turnover for the period of 20% pointing to an average holding period of five years. Dislocations in markets, whatever form they might take, afford the patient investor opportunities to add to existing holdings, or at times create entry points in exceptional businesses at sharply reduced valuations. In the early part of 2021, a severe rotation in markets created such an opportunity to add to one of our long-term favourites, Swiss listed Lonza Group (Lonza), as its shares lagged the cyclical value rally materialising at the time. We used this share price weakness to top up our position as we remained confident that from an operational perspective the business was firing on all cylinders. As a contract manufacturer of high-end drugs, Lonza operates in a highly attractive market niche, holding the dominant market position globally. If anything, the predictability of this business’ earnings and cashflows materially improved over the course of the first half of the year, as Lonza disposed of its more cyclical specialty ingredients operations. The remaining part of the group enjoys exceptionally strong demand fundamentals, creating multiple opportunities to redeploy cash at returns on capital close to 30%, a compelling proposition. Lonza’s competitive advantages stem from the complexity of the production process, where few peers can match its offering. This is cemented by high barriers to entry given that all production facilities have to be certified by the FDA. Overall, we expect Lonza’s biologics business to grow in the mid-teens every year for the next ten years, with positive pricing given the shortage of capacity in the market.
Other notable changes included additions to existing holdings in Hermès, Kering, Amadeus IT Group and DSV. Equally, we used the strength in financials during the early part of the year to take profits in Sberbank, Alpha Bank and KBC, all of which had enjoyed strong share price performances on the back of vaccine induced recovery euphoria. Overall, we remain very selective in financials as the banking industry remains dogged by the persistence of the low rate environment, as well as fierce competition, leading to a generally tough operating environment.
With strong investment performance and significant share issuance, the Company is much bigger than it was a year ago. The additional funds have been invested in existing holdings and in a small number of new holdings. The number of companies in which we now invest is 44 compared to 38 a year ago.”