European Opportunities (EOT) has published its annual results for the year ended 31 May 2024, during which it provided NAV and share price total returns of 15.5% and 16.5% respectively, which compare to a total return of 17.3% from its benchmark, the MSCI Europe Index, of 17.3% (all in sterling terms). The manager notes that stock picking is the key to the trust’s performance and this was hampered by the negative sentiment around small and mid-sized stocks. Since the year end, EOT’s NAV per share has remained flat at 1,008.8p (as at 31 August), underperforming the benchmark index which increased by 0.7% over that period. The market price of the company’s shares on 31 August was 900p, a reduction of 0.7% since the financial year end.
Performance has been challenging but board expects vindication long term
EOT’s chair, Matthew Dobbs, says that, whilst EOT’s NAV total return has outperformed its benchmark over the ten years to 31 May 2024, its three and five year NAV total returns have been below the benchmark. Dobbs says that the board is painfully aware of the disappointment this entails for shareholders and, through intense engagement with the investment manager, is persuaded that the consistency of commitment to a differentiated, high conviction approach will be vindicated in the longer term. Since launch, EOT has generated an annualised net asset value total return of 11.1% and an annualised share price total return of 10.4% as at 31 May 2024.
Dividend and revenue income
EOT focuses on capital growth so dividends are a secondary consideration and there is no income objective. Consequently, the revenue per share, and therefore the dividends paid, have fluctuated from year to year. Due primarily to transaction activity in the portfolio involving the disposal of a number of high-income generating securities and the reduction in the size of EOT (through the tender offer and buybacks), there has been a sharp decline in the revenue return per share to 0.3p per share in the year under review (3.3p in 2023). It has generally (but not exclusively) been the board’s policy to pay a dividend covered by the revenue return per share of the year to which it pertains. However, in view of the scale of the decline in the year, the importance of income to many shareholders and EOT’s ample revenue reserves, its board has decided to recommend a final dividend of 2.0p (3.5p in 2023).
The dividend will be proposed at the Annual General Meeting and be payable on 25 November 2024 to shareholders on the Register of Members on 8 November 2024 (the record date). The ex-dividend date is 7 November 2024.
Discount management and 2026 tender offer
The discount on the company’s shares was 10.2% at the year end (2023: 10.9%) and the average discount for the year was also 10.2% (2023: 14.4%). The year end discount was wider than the 7.8% average on that date for the investment companies’ universe as a whole (excluding VCTs) and wider than the average of the company’s peers in the AIC Europe sector of 6.7%.
In January 2024, EOT implemented a tender offer at close to NAV for 25% of the shares in issue which was fully subscribed. The board has also announced proposals for a further performance-related tender offer for up to 25% of the shares in issue in the event that the company’s net asset value total return does not equal or exceed the benchmark total return over the three-year period ending on 31 May 2026. The company will also put a continuation vote to shareholders at the 2026 AGM in accordance with its three-yearly continuation vote cycle.
In the meantime, the board believes that the most effective means of minimising any discount at which the shares may trade is for the company to deliver strong, consistent, long-term performance from the investment portfolio (in both absolute and relative terms). However, wider market factors inevitably impact the rating of the shares from time to time. A total of 33,365,814 shares were repurchased during the period under review (with an aggregate value of £302.2m, inclusive of £222.7m purchased in relation to the tender offer in January 2024). This compares with 4,126,242 shares bought into treasury in the previous financial year. A further 630,919 shares (with an aggregate value of £5.6m) have been repurchased since the financial year end (as at 9 September 2024).
Gearing
EOT’s net gearing level was 8.4% (2023: 8.9%) at the year end and, subsequent to the financial year end, EOT renewed its multi-currency revolving credit facility with The Bank of Nova Scotia, London branch with a maximum drawable amount of £85m available until September 2025 (2024: £85m) and credit approval for an additional ‘accordion’ amount available upon application for a further £50m (2024: £50m). There was £60m drawn down as at 31 May 2024, unchanged as of the date of the annual report.
Investment manager’s review – index performance
“Despite political turmoil in Europe and disappointing growth rates, European equities advanced in the period under review. Moderating inflation in the EU, where the annual inflation was 2.6% in April 2024 compared with 8.1% a year earlier, has prompted cuts in interest rates. Between 2022 and 2024, European interest rates rose rapidly; the ECB’s refinancing rate went from 0% in 2022, peaking at 4.5% in 2023. With the cooling in the rate of inflation, the ECB lowered its refinancing rate in June this year, but it remains, at 4.25%, higher than at any time since 2008. Nevertheless, anticipation of a period of rate reductions provided support for European equities.
“The brightest element behind the strong equity market performance was the impact of Artificial Intelligence (AI). Whilst principally an American phenomenon, European technology stocks, too, were lifted by the opportunities this will bring. The benefits of AI were recognised in other sectors, where proprietary Intellectual Property (IP) can be leveraged with AI. Notwithstanding the productivity gains from these technological advances, corporate earnings growth in Europe (MSCI Eurozone) is modest. Earnings in 2023 declined slightly, whereas consensus aggregate earnings for 2024 anticipate about 3-5% growth. As in the US, much of the growth is coming from Technology and Communication Services. For the markets more broadly, rising real wages are squeezing corporate margins.”
Investment manager’s review – EOT’s performance
“Whilst the Company’s total NAV return was 15.5%, we were disappointed not to outperform the Benchmark during the period under review. As ever, stock picking is the key to our performance. This was hampered by the negative sentiment around small and mid-sized stocks, a part of the market to which our portfolio has a greater than average exposure. We believe that many small and mid-sized companies are significantly undervalued. In some cases, these have attracted private equity interest, underpinning valuations. We still regard this as insufficient and are disappointed to see our holdings, notably Darktrace, taken out of the public market at unsatisfactory prices. We had anticipated years of progress at Darktrace and are disappointed to forego that eventuality.
“The Company’s relative performance was impacted by an underweight exposure to the banking sector. Banks performed strongly during the period as higher rates, strong fee momentum, moderating cost inflation headwinds, lower regulatory costs and benign credit costs all fed through to better-than-expected earnings reports. This has fed into dividend distributions and a modest re-rating (off a low base).
“Whilst we recognise the cyclical tailwind during the period under review from rising rates and continuing low levels of non-performing loans, our structural view of the European banking sector remains unchanged. Specifically, we generally avoid business models dependent on high levels of leverage to generate returns above their cost of capital. Through multiple cycles European banks have proven consistently unable to generate returns above their cost of capital on a sustainable basis, which precludes our involvement in the sector. The significant asymmetric risk to the downside in periods of challenging macro (which can result in equity issuance or even effective/actual bankruptcy) reinforces our aversion to the sector.”
Investment manager’s review – positioning
“We continue to invest, as we always have, in ‘special’ companies that, in our opinion, can flourish in a range of economic scenarios and which are well protected from competitive pressures. We believe that our portfolio is well positioned to navigate macro challenges. Europe’s low structural growth is a major challenge. Europe’s real GDP has only grown at 1.5% pa in the past decade, below the US at 2.3% pa, and below the wider world at 2.7% pa. This is mitigated in our portfolio by the greater extra-European revenue exposure of the portfolio. The STOXX Europe index derives approximately 41% of its revenues from Europe, 24% from North America and 21% from Asia-Pacific. The respective ‘look-through’ share of revenues for your Company are 39% and 35% for Europe and North America respectively; emerging markets account for 20% of sales on the same basis.
“Consumer spending has been remarkably robust since the outbreak of COVID, on the back of huge public spending support. A squeeze on consumer spending looks inevitable at some point. Accordingly, the portfolio is tilted away from consumer facing stocks and is instead more heavily weighted towards companies which provide goods and services to other companies and governments (often described as B2B). Therefore, we expect the earnings of our investee companies to be less cyclical, more robust and to grow even as consumer spending declines. Perhaps the most obvious example of a sector that is uncorrelated to consumer spending is the Defence sector. We initiated new positions in Thales and BAE Systems, to capture the seemingly inevitable increase in Defence spending.
“Our companies typically have more IP and value added across the portfolio. The corollary of this is that Return on Invested Capital (ROIC) tends to be higher than average. Another characteristic of the Company’s portfolio is its high active share. The active share at the period end was 91.4% (2023: 92.5%), being defined as the sum of the absolute value of the differences of the weight of each holding versus the weight of each holding in the Benchmark, divided by two. Our investee companies also tend to have relatively low debt levels, which is partly due to their low capital intensity and high cashflow generation, and partly a function of the predominantly ‘organic’ growth strategies.
“The development of the energy market is another important consideration in our positioning. Oil prices, in sterling, rose 10% in the period under review. More significantly, Europe’s commitment to the ‘Green Economy’, not matched elsewhere in the world, is a threat to Europe’s industrial competitiveness and has led to ‘offshoring’, that is to say, moving businesses outside Europe to reset costs lower. This is the opposite of the US experience where their vibrant energy sector has led to the ‘re-shoring’ of industry. Europe is vulnerable to energy costs; the green transition is not likely to reverse its long record of economic underperformance. For these reasons Europe is a difficult area in which to invest. A meagre allocation to European equities disproportionately affects mid and smaller stocks, stocks which form the bulk of our portfolio. Investor indifference is mitigated to a certain extent by Private Equity interest.”
Investment manager’s review – contributors
“Yet again, the biggest single contributor to our performance relative to our Benchmark in the period under review was Novo Nordisk, the Danish pharmaceutical company. The company reported strong profit increases over the last twelve months. Its GLP-1 drugs, for diabetes and weight management, have gained significant traction in many markets, most importantly, the United States. A body mass index (BMI) over 30 is considered obese by the World Health Organisation. The anti-obesity part of their business is extraordinary: an almost completely new opportunity, one, moreover, that is relevant to the estimated one billion people worldwide with a BMI of over 30. Moreover, clinical trial results were very encouraging with concomitant labelling improvements. Semaglutide, the GLP-1 active ingredient in Ozempic and Wegovy (respectively the diabetes and weight loss drugs), has been found to have additional beneficial indications. The most important, though not the only one, is cardiovascular (CV) disease. Weight loss is not only good in itself; it also reduces the risk of other diseases such as diabetes and CV disease. Clinical trials show that semaglutide’s therapeutic effects go beyond the benefits that come simply from weight loss. The pharmacoeconomic (measuring costs and outcomes) case for GLP-1 drugs is building; arguably, the case for Semaglutide specifically, with its CV indication, is even better.
“Being our biggest investment, the strong performance of the shares (up 66% in the twelve months under review) made a big contribution to the portfolio. Novo Nordisk’s weighting was 13% of total assets at the beginning of the reporting period; at the end it was 14.2% of total assets. We sold c. £71.4 million of shares during the period under review to keep the weighting down. Nevertheless, this is clearly a very significant position. Our confidence in Novo Nordisk is not simply the excitement about its new blockbuster drugs and the massive latent demand worldwide for anti-obesity drugs. What makes it a great investment, with a weighting to match, is the visibility of its prospects. There is only one other serious competitor at present. It will take years for others to pass through clinical trials and launch new competing products. In the interim, Novo Nordisk is constantly developing more advanced products itself. It has an impressive manufacturing scale, and distribution reach, and enjoys a distinguished heritage in China which is a significant advantage as it addresses that market. Transparency of Novo Nordisk’s pipeline and those of its competitors, coupled with the need for regulatory authorisation, means that it is relatively easy to monitor threats to the company’s leading position. The nature of this business is such that we are likely to get plenty of warning of any material threats.
“Another significant contributor to our performance relative to our Benchmark was RELX, one of our long-standing, major investments. The company is clearly a winner from Generative AI, one factor behind the higher growth rates reported in two areas of the company’s business, Risk and Legal. RELX has for many years developed algorithms which might now be described as AI. RELX has the necessary ingredients for success, data sets and domain knowledge, which should help maintain good growth rates. The Exhibitions business has also rebounded very strongly after COVID-related lockdowns.
“Shares in Darktrace soared following an offer for the company from a private equity firm. We invested in Darktrace when it came to the market in April 2021. Although the exit price (at more than twice the price of the Initial Public Offering) marked a successful investment for us, it is disappointing that the adverse and often unreasonable commentary that blighted its time in the public markets effectively forced Darktrace into private ownership. We had anticipated many years of growth with Darktrace, which operates in a niche area of cybersecurity.
“The global alternative asset manager, Intermediate Capital Group (ICG), which provides investment finance across the capital structure, was another good performer. Just as public markets are squeezed by capital outflows, so the private markets are relatively buoyant. ICG is a beneficiary of this and with its emphasis on private credit markets is less vulnerable to a downturn than pure private equity.
“Experian was also a contributor to our performance. As a leading credit bureau in the biggest market, the US, Experian has been vindicated with its differentiated strategy. By developing a consumer-facing credit platform, the company successfully navigated the slowdown in the traditional market for credit bureaus, serving the banks. It also has a strong business in Brazil which is growing rapidly, and where the outlook is good.
“Camurus, a new investment, was also a strong performer. Swedish-listed, Camurus uses its proprietary, extended- release technology to develop long-acting pharmaceutical drugs (typically using existing approved, active pharmaceutical compounds), addressing the needs of patients living with severe and chronic diseases. Their medicines are developed in-house or in partnerships with international pharmaceutical companies. These long-acting medicines aim to improve chronic disease management both in terms of efficacy and treatment administration, but also in terms of reducing the treatment burden. The company’s first product is a once-weekly or monthly medication for the treatment of moderate to severe opioid use disorder (OUD) and is particularly effective in the prevention of withdrawal symptoms caused by stopping the use of opioids for pain management therapy. The medicine has been launched in the US, Australia, the UK and Finland. Initial reports of the markets’ acceptance are very encouraging. The opportunity is huge owing to the large addressable market
“Prysmian reported a string of good results. Its leading position in the manufacturing of electrical energy cables means that it is a beneficiary of the energy transition. The share of electricity in final energy demand is likely to increase, which might be described as electrification of energy, and for this grid stability and resilience is prerequisite. The initial driver for this transition was the increase in renewable energy. The rapid increase in demand for data centres, itself partly driven by the surge in AI, has intensified the urgent need to upgrade electricity networks and to overhaul and modernise the electric grid, especially in the US.
“Deutsche Boerse was another contributor. Its various transactions platforms continue to perform well: ‘higher for longer’ interest rates in Europe have boosted profits; its power trading platform is proving to be very successful and volatility in financial markets is a boon to their activities.
“The continuing demand for Liquified Natural Gas (LNG) has underpinned the success of Gaztransport et Technigaz (‘GTT’). There is no doubt that LNG will continue to be an important, indeed growing, part of the energy mix. New sources of natural gas are being developed in the world. The transport of that gas with LNG carriers is almost certain to increase. As a leading technology provider of solutions for transporting LNG, and other liquified fuels, GTT is clearly a beneficiary of this trend.”
Investment manager’s review – detractors
“Edenred had a significant negative impact on our relative returns. Although a good long-term performer, the share price stalled on concerns about regulatory changes in its main markets, France and Brazil. However, we do not think that these concerns amount to a serious threat to Edenred’s position as the leader in specific purpose benefits. We maintained the holding.
“Genus also detracted from our performance relative to our Benchmark during the period under review. Results were impacted by the weak performance in the Chinese market and by delays in the application process for approval for gene-edited pigs. We are confident that they will obtain approval, which will transform their fortunes. Accordingly, we retained the position.
“Dassault Systèmes has an excellent long-term record. However, the shares performed poorly in the period under review. The short-term growth rate has moderated, impacted by the slowdown in clinical trials post COVID, which in turn has dampened growth in their life sciences business. Nevertheless, we remain very positive about Dassault Systèmes’ strong position and prospects for growth. Automotive-related demand is robust and likely to improve as cost efficiency becomes ever more important with the development of Electric Vehicles (EV). Aerospace and defence demand is another growing opportunity. Moreover, Generative AI is already driving growth. We retained the shares.
“Grifols was another significant detractor, as allegations around accounting and governance damaged the company. The company has addressed these concerns, obtained a clean bill of health from the Spanish regulator, published unqualified accounts, appointed a new external CEO and reduced debt. There is considerable scope to improve operating performance, underpinning our confidence in this holding.
“Worldline shares have performed badly. Nevertheless, we saw value in the shares and increased the holding.
“We sold the holding in Neste following a series of disappointments. We lost confidence in management and its ability to navigate the challenges of the demand, supply imbalance in the biofuels and renewable diesel markets.
“We also sold all our shares in Bayer, a chronic underperformer that also detracted from performance in the period. We were unimpressed by the new management and do not believe that they are tackling the company’s challenges successfully.
“S.O.I.T.E.C also detracted from our returns relative to our Benchmark. The business has proved to be more cyclical than we expected with high smartphone inventories dampening demand for their products. Furthermore, it has not succeeded in getting widespread adoption of its unique silicon carbide splitting technology. Whilst acknowledging that progress is slower than we had hoped, we still believe that the company’s technology will gain extensive acceptance and retained the shares.
“Finally, we note the negative impact of Genmab shares on the portfolio. Whilst its standing as a leader in the production of antibody therapeutics is not in doubt, its ability to monetise its technology leadership is a concern. Nevertheless, we decided to keep the position, believing that in due course the company will be properly rewarded for its impressive technology.”
Investment manager’s review – Portfolio activity
“During the period under review, we raised approximately £325.5 million net cash. We sold about £605.7 million of stocks and reinvested around £280.3 million, representing a turnover ratio of 71% of the Company’s average net assets during the year (2023:28%). Takeover activity within the portfolio, the funding of share buy backs and the tender offer in January 2024, for which we had to raise approximately £222.7 million, accounted for most of this activity. We reduced the number of holdings from 31 to 27. There were four new investments and eight complete sales during the period under review.
“The biggest sales in the period under review were of three troubled holdings, Merck KGaA, Neste and Bayer. Merck’s pharmaceutical business announced disappointing clinical trial results. We sold because we saw better opportunities in other stocks. The sale of Neste followed a series of disappointments with the management’s performance. Poor execution and poor communication undermined our confidence in the company. There is also some evidence that European governments are backing away from earlier biofuels commitments, representing a setback for Neste. We decided to sell all our shares in Bayer as we are not convinced that the new CEO’s plans will work. The cultural challenges, not to mention litigation overhangs, need to be addressed and overcome at Bayer.
“We also made outright sales of Borregaard, Elkem, Wolters Kluwer, OHB Technology and SUSE. The last two companies were sold following offers from private equity firms. We sold Borregaard because profit growth failed to match our expectations; we sold Elkem as reported profits disappointed and Wolters Kluwer on valuation grounds.
“We took new positions in, Camurus, CTS Eventim, Thales and BAE Systems, the biggest new position being Swedish-listed Camurus.
“We initiated a position in CTS Eventim, which is Europe’s leading promotor of live entertainment, and the number one provider of ticketing services in Europe. It also operates some of Europe’s most renowned venues, a few of which it owns. Demand for live entertainment is growing. CTS Eventim’s continues to develop its ticketing services, gaining market share and expanding geographically.
“We made two small new purchases in Thales and BAE Systems. Both companies will benefit from increasing European defence spending. They also stand to benefit from more defence spending in other parts of the world, notably Asia. Moreover, both companies cover the fullest range of defence which, nowadays, is not simply Land, Sea and Air, but also extends to cyber and space. Competence across all these areas is thought to improve the value proposition of each offering. Thales, the French multinational company that designs, develops and manufactures systems, devices and equipment for the aerospace, defence and security sectors is a leader in cyber security and data protection. Increasing demand for their products and services is evident. BAE Systems, the UK-listed defence and aerospace company, is gaining business in the US and also looks well-placed to grow in Asia where there is clearly increasing long-term demand for defence solutions.
“We also increased commitments in a number of existing holdings. We bought more shares in Genus following setbacks in the process of obtaining FDA approval for its gene-edited pigs. We expect them to get approval and expect this to transform the company’s fortunes. We also bought more shares in BFF Bank after a sharp fall in the share price, a fall caused by a regulatory enquiry by the Bank of Italy. We expect the bank to recover fully in due course. The decision to buy more shares in Oxford Instruments followed the appointment of a new CEO who has refreshed the strategy. The clarity, credibility and accountability of this strategy is encouraging. We also bought more shares in Bachem, which should benefit from the surging demand for peptide manufacturing, and Prysmian which is flourishing on the back of increasing power demand.”
