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European Opportunities investors hit by widening discount

European Opportunities trust has just published results for the 12 month period ended 31 May 2022. [That is quite a lag for a trust of this size, we’ve seen some results for periods ending 31 July in recent days, we aren’t sure why this one was so delayed.]

During the twelve months to 31 May 2022 the NAV total return was 3.4% (with dividends added back). This compares with a total return of 2.4% from the benchmark, the MSCI Europe index, and a total return on the share price of -0.3%. Since the year end the NAV had fallen by 3.2% from 1 June 2022 to 823p as at 31 August 2022, outperforming the benchmark index which fell by 3.9% over that period. The share price was 704p as at 31 August, a fall of 5.6% since 1 June.

The dividend for the year is 2.5p, up from 2p for the prior year.

4,052,000 shares were repurchased into treasury during the period (with an aggregate value of £31.6m) and a further 963,742 shares (£6.6m) have been repurchased between the financial year end and 9 September 2022. The repurchase of shares at a discount to NAV added a total of £4.3m to the NAV during the period under review and has added a further £1.3m since the year end.

Extracts from the manager’s report

It was pleasing that our performance was generated by stocks in many sectors. Whilst the market experienced a major rotation from ‘Growth’ to ‘Value’, we persisted throughout with ‘special’ companies. These are companies that, in our opinion, can flourish in a range of economic scenarios. For this reason, we do not need to churn the portfolio as market conditions change. Our winners come from a very eclectic range of companies including pharmaceutical, food, technology, oil services, financial trading and crop science. What they have in common is that we consider them to be niche winners in their respective fields. Our losers, too, came from an equally diverse range of companies including technology, genetics, and food companies. What this shows is that the Company’s portfolio is a series of ‘special’ companies in many different areas and not easily classified as ‘Growth’ or ‘Value’. We believe that this wide range of businesses, and their extensive geographic reach, represents good risk mitigation. In addition, we believe that our companies’ relatively strong balance sheets were a factor behind the portfolio’s modest outperformance. As interest rates started to rise, other investors started to appreciate our companies’ better balance sheets.

The biggest single contributor to our performance in the period under review was Novo Nordisk, the Danish pharmaceutical company. Shares in Novo Nordisk, our biggest investment, rose sharply as prescriptions for three of its new diabetes and obesity drugs soared in America. We believe that Novo Nordisk, along with their principal competitor, will dominate these two therapeutic areas for many years. Moreover, the market for the treatment of obesity, presently limited, is likely to expand enormously, not just in North America but worldwide, as health authorities understand the tremendous pharmacoeconomic benefits of these new drugs.

The next biggest contributor to our performance was that of RELX, the global provider of information and analytics for professional and business customers. Growth rates in all divisions (except exhibitions which is still affected by COVID concerns) have picked up, underpinning investors’ confidence that RELX is benefitting from well-established trends. In particular, the company’s risk division is a play on the growth in digitalisation and artificial intelligence. Authentication services for both governments and businesses are increasingly important to counter fraud. RELX is a leader in this area.

Our best performing stock in the period under review was the French company, Gaztransport & Technigaz (‘GTT’). It provides engineering and design technologies for liquefied natural gas (‘LNG’) carriers. It also provides engineering and design technologies for LNG propulsion systems for ships. The reason for the shares’ strong showing is the ‘energy crisis’, as reflected by the EU Parliament’s decision to approve the inclusion of gas and nuclear in the EU Taxonomy. It was our firm view that natural gas would remain an important and growing element in the energy mix, thereby providing GTT with a big and growing market. The war in Ukraine effectively accelerated and increased this opportunity.

Bayer was another important contributor to performance. This German conglomerate has been plagued by lawsuits in the US over the alleged carcinogenic effects of Roundup, its systemic, glyphosate-based herbicide originally produced by Monsanto. To date, the company has set aside approximately $13 billion to settle with most plaintiffs. There is a risk of further costs. Nevertheless, Bayer’s shares have performed well on the back of higher grain prices, which in turn have boosted demand for Bayer’s seeds and agrochemicals. Against a background of rising food prices, we remain positive about the company’s prospects as its technologies are vital to the agriculture industry worldwide.

Deutsche Boerse is the German-listed international exchange organisation and market infrastructure provider. Its shares have performed well as macro circumstances have changed. Higher interest rates and greater volatility are good for their business. Moreover, their exchanges ensure safe and transparent trading, an important driver of their business as financial pressures increase on market participants. We believe that the factors that drove the recent good price performance are likely to endure for the foreseeable future and we have confidence in retaining this position.

Another positive contributor to performance was Mowi, the world’s leading salmon farmer. Demand for salmon in the retail channel increased during COVID-19 lockdowns, in part because of the health benefits associated with eating salmon. This demand has proved resilient as economies re-opened. This has had the effect of raising overall, sustainable demand. As demand for salmon outstrips supply, prices and profitability are squeezed higher. Moreover, compared to other sources of protein like meat, conversion rates are higher with salmon, thereby making the product relatively cheaper than other sources of protein. For these reasons we think this business will continue to prosper in tougher economic conditions.

Finally, we highlight Edenred as one of the positive contributors to our performance. 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. There are multiple drivers behind its high growth rates. One is that digital technologies have allowed the company to develop more services. Further, companies and governments increasingly use these services to provide targeted financial support. Finally, Brazil, its second biggest market, is flourishing on the back of the buoyant agriculture sector, which accounts for approximately a quarter of Brazil’s GDP, when production, processing, and distribution are included.

The worst stock in the period under review was Genus, the world leader in porcine and bovine genetics. Their sales of porcine genetics to the Chinese market fell sharply due to low pork prices, caused by a combination of factors: a supply glut stemming from high slaughter rates (this because of African Swine Fever) and lockdowns. We consider these factors to be temporary. In due course, we expect pork prices to recover; this will catalyse demand for Genus’ services. The company is in the final phases of its gene editing research programme for porcine reproductive and respiratory syndrome virus. If these trials are successful and lead to regulatory approval, it will hugely increase the company’s earnings power. We have retained the holding.

Intermediate Capital Group (ICG), too, was a significant detractor from our returns, having been one of the best contributors in recent reporting periods. ICG is a UK-listed private equity company, investing in private credit and debt. The company’s recent reports have been very strong. The sharp share price reversal is explained by the changing macro conditions, specifically, rising interest rates. Nevertheless, institutions are allocating more resources to the private markets. This favourable trend and the long-term commitment of funds make for high visibility. Accordingly, we have retained the holding.

Infineon shares also retreated in the period under review. German-listed, Infineon designs, manufactures and markets semiconductors. They are a world leader in power semiconductors. Anticipating a downturn in economic activity, the share price fell as it is viewed as a cyclical company. However, we believe that the company enjoys more structural growth than before; Infineon’s prospects are enhanced by its strong position in power semiconductors. Whatever the energy source, power efficiency and savings are clearly of increasing importance and Infineon is well placed to benefit.

Grifols, a Spanish company, is a world leader in the manufacture and marketing of blood plasma derivatives. The weak share price is explained by two factors. The first is that COVID-19 lockdowns and furlough payments in the US had the effect of reducing incentives for potential plasma donors. The second is competition from new anti-FcRn inhibitors which threaten to displace Grifols’ IgG fractionated products. In our view, demand for fractionated blood plasma will remain strong notwithstanding the impact of FcRn inhibitors, and in due course collections will return to normal as harsher economic conditions incentivize blood plasma donors to return. We retained the position.

Worldline, the French digital payments processing company, was another poor performer. There is a clear trend to digital payments. Moreover, as the largest processor in Europe, Worldline should be a winner in this ‘scale’ business.

Grenke shares also slightly detracted from our relative returns. In 2020, Grenke, the German small-ticket leasing company, was assailed by unwarranted allegations about its financial probity. Having received an unqualified audit for 2021, we believe that the company has been thoroughly vindicated. Repairing the unjustified damage to its reputation is taking time. However, we believe that it will now recover strongly. Historically, rising interest rates have been good for Grenke; banks become stricter on lending criteria and the attractions of leasing are more apparent to corporate customers. Accordingly, we retained this position.

Neste, the Finnish-listed company, had a small negative impact on returns. Its principal business is the production and marketing of renewable biodiesel including Sustainable Aviation Fuel (SAF). One of its main challenges is obtaining sufficient quantities of raw materials, mainly used cooking oils, to convert into its high value renewable diesel products. Rising costs of these raw materials explains the shares’ poor performance last year. We decided to retain this holding, indeed we added to it, because we expected its significant advantages to outweigh the cost consideration. We appear to have been vindicated as the business and the shares are now performing well. Neste’s proprietary processing technology allows it to use lower quality waste materials, giving it an advantage over its competitors. Mandates for SAF in the EU are providing good, visible demand growth. We remain confident that the company’s prospects are soundly based.

EOT : European Opportunities investors hit by widening discount

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