MONTHLY LETTER SEPTEMBER 2018
September Sector Comments
Madrague showed a small positive result in September: +0.28% which takes the year to date figure to +0.71%. Sectors of note in September:
Capital Goods: +0.4%
We have a fairly balanced long and short exposure in the Capital Goods sector so the performance is all down to relative movements. Main longs include Caterpillar, Weir Group, Sandvik and SKF. On the short side we have Wartsilä, Assa Abloy and Hexpol. In September the shorts in Wartsilä and Assa were the biggest contributor together with the long position in Caterpillar. We believe that the market is pricing Wartsila with too much “safe non-cyclical” growth compared to what it should be. Wartsilä is a good and well-managed company where expectations for growth through scrubbers are overly optimistic in our opinion. Assa Abloy has changed leadership lately and on top of that it has started to take charges in China due to weakening market conditions. The write-downs will most likely continue and the valuation premium the company currently enjoys should also narrow. Caterpillar, the yellow goods company, has already been sold down on worries about the global economic cycle in general and a Chinese slowdown in particular. We believe valuation is compelling for a company which has basically named the segment it operates in. At a conference in September (we did not attend, but read statements) Caterpillar also reiterated its stance that a “significant” part of their business is in the early or slow to recover part of the cycle. If the company is correct it should enjoy good growth in the coming quarters. All the above positions were still in our portfolio by the end of September.
Basic Materials: +0.3%
Our long position in SSAB and our short position in SCA accounted for the lion’s share of the performance. Apart from just being long SSAB we also have a spread where we are long the SSAB B shares vs. a short in the A shares. This spread is trading at 25% which is on an extreme level according to us. The spread used to be justified by the poor liquidity in the B shares, but that argument is not (as) valid anymore. Liquidity has been vastly improved in the last couple of years so the sole remaining argument is a 10 to 1 voting right advantage to the A shares. With the same right to earnings and dividends we find it strange that pension funds etc. that very seldom use their voting rights anyway settle for a 3% dividend yield instead of a 4%. The market is supposedly rational and we have the wisdom of the crowds, but we are of the opinion that the difference is due to complacency and laziness. We have long argued (in the face of market bullishness) that SCA is too expensive given where, SEK/USD is and where pulp prices are. In September SCA finally came off a little bit, but we do find the company way too expensive at EV/EBIT 22 times next year’s estimates. We continue to be short SCA, long SSAB and long SSAB B shares vs. the A shares.
In September Transocean made a bid for Ocean Rig where we had a very small position. Ocean Rig is unlevered and quite easy to do the math on. Given how difficult the rig market has been in the last couple of years we have opted to go for rig companies with less gearing as valuation has become an asset play rather than an earnings game. Utilisation is very low and a lot of the contracts over the past years have been on cash breakeven or even below as rig-owners have tried to stay alive until the next investment cycle by the oil majors. It is easy to make the case for increased spending as the reserves have decreased the last few years. Couple that with an oil price above USD 80 and we should have a booming oil service market. It hasn’t happened. Maybe the oil majors are as careful this time around as they were careless with spending in previous cycles (i.e. they have learned) or it is just that they are unsure about the length of the current up cycle because of the rise of Electric Vehicles and the environmental debate. Unless we find a substitute in the near future there is a real risk that we are in for another oil spike in the next couple of years. Our positioning in the sector is very light though. We sold out of the position in Ocean Rig on the day of the bid and, to mention a few, only have small long positions in Subsea7, PGS and Magseis.
We have one of our biggest single positions in the Chemical sector: Elkem. We have written about the company in a few of our recent monthly letters. Silicone companies have been hammered since this summer irrespective of their end markets. Elkem is no exception. Couple the connection to China through both owners and factories with the worries about the economic cycle and we have a stock that the market loves to hate. We think it is wrong, but it was expensive in September. We are short Covestro which have enjoyed super-margins on the TDI/MDI products in the last couple of years. Covestro is just in the phase where it will see their margins collapse and profits demerge. We continue to hold all of the mentioned positions.
We marginally increased our gross exposure from 145% to 152% in September. Our net exposure was unchanged at 48%. Our option protection shows the same characteristics as always, i.e. a gap move down 5-10% and we would have zero net exposure to the equity markets. As always, you are more than welcome to contact us should you have any comments or questions on our investments or the views expressed in this letter.
Chief Investment Officer