Monthly Letter April 2018

Growth and Earnings Picking Up After a couple of poor months the main equity markets in Europe and the US (we are not particularly fond of the developed markets expression as it infers that quite a few Asian markets would be less developed than our old world markets) recouped most or all of their losses for the year. We are a bit surprised how fast this recovery took place given some of the worries that plagued the markets during the sell-off have not gone away.

We are thinking of a potential trade war, higher bond yields, the end of quantitative easing etc. One theme we wrote about in our last monthly letter was the rebasing of equity prices due to higher volatility and then a continuation of the upwards trend until the end of this cycle is visible. At this stage we are not seeing the end of the cycle. Earnings are being revised up which is a very rare feature indeed. The normal earnings “snake” is starting at an optimistic level most of the time and then as reality sets in expectations become more and more muted. The last month we had upwards revisions for MSCI Europe combined with growth momentum improving. Growth in the EMU region is expected to increase from 1.7% in Q1 to 3% in Q2. We believe it makes sense that upward revisions are being reflected in equity prices. Madrague had a very good month in April: +4.17% which takes the year to date figure to +2.46%. Sectors of note in April:

Business Services: +1.8%

The outstanding best position for the fund in April was our long position in Norwegian Airlines (NAS). On the 12th of April IAG (owner of British Airways) announced that it had taken a 4.61% stake in the Norwegian company. IAG also stated that it is looking to initiate talks with NAS and may make an offer for the entire company. We were long NAS because of its low operating costs, modern fleet and a consensus belief in the market that NAS balance sheet has too much leverage. The company is highly geared, but it has two very potent assets that it can monetize: the stake in Bank Norwegian and the order book of new planes which is deep in the money. The gearing when it comes to a potential bid from IAG works really well when you are an equity holder. Even after the 50% increase in the share price the equity value only constitutes c20% of the enterprise value of the company (i.e. if IAG believes an increased enterprise value of 10% can be justified it would increase the equity value by 50%). We believe that IAG has bought themselves a seat at the consolidation table with their purchase. NAS has confirmed that it has drawn attention from other airlines as well. We continue to be invested in NAS and did not realize any of the gains in April. It seems that industry players are seeing more value in NAS than the equity market has been willing to pay for.

Telecom: +0.8%

Biggest contributor to the telecom sector was our long position in Hellenic Telecom. As we have mentioned HTO quite frequently in our monthly letters we focus on Telia and KPN instead this time. Both are long positions that combined contributed as much as Hellenic. We entered our long position in Telia on the day of their Q1 report. The report in itself was “ok” and rendered upgrades in the 2-5% range on an EPS basis. What made us pull the trigger and invest though, was the commitment to better capital discipline. Telia has sold non-core assets in the last year. Combine that with a new buyback program, raised dividend and that it backed off from buying TDC when the price tag was considered too rich. The communication now was very much to our liking: capital not used in the company is to be returned to shareholders. KPN is a company we have followed closely for a long time as it is the incumbent in the Netherlands where Tele2 came in as a disruptor. This theme has now played out and we believe that KPN with a new CEO is on the road to changing the company in the right direction. The competition is fierce in the Netherlands, but we are convinced that KPN at this valuation is pricing in a lot of difficulty ahead. We continue to be long and did not realize any of the gains in April.

Retail: +0.5%

Biggest contributors were our long position in Richemont and a short position in ICA. Richemont performed well as the general market recouped its losses year to date. ICA on the other hand came in with a weak set of Q1 numbers. The report in itself was not encouraging for anyone being long. Profitability in the Baltics and their pharmacy division resulted in downgrades in the magnitude of 3-5% on an EPS level. The bigger issue and the reason for our short thesis is that ICA is facing big structural issues with increased competition (LIDL among others) and a company structure that is not suited for online retailing. Stores being owned by the floor manager are great when you have a segregated market and want to incentivise the “crew” as much as possible. This, unfortunately for ICA, works the other way when you move in the direction of online retailing and centralisation of warehouses and distribution centres. ICA is a great company, with great history and with even greater challenges ahead. We continue to be short even after the recent sell-off.

We kept our gross exposure broadly unchanged from 145% to 147% in April while we decreased our net exposure slightly from 50% to 42%. 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.

Lars Frånstedt
Chief Investment Officer

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