MONTHLY LETTER JANUARY 2019
Madrague performed well in the month of January: +1.83%.
The equity markets were a complete opposite to the experience in December. In our last monthly letter we wrote about the worry of a possibility that the FED would make a policy mistake and the effect on global liquidity at a time of macro uncertainties. FED, as usual, had its ears to the ground and signalled a much more dovish tone in January than in previous months. Whether this is good policy in the long run can of course be debated, but in the short run it is definitely market friendly and good for the risk appetite. The general view of Madrague is that we are not overly enthusiastic about policy interventions to prevent normal business cycles. Removing the cost of capital will most likely have a detrimental effect when it comes to the cost of risk to the millennial generation. The 20 to 25 year olds that are now buying their first flat have never experienced (first hand) what a rate increase feels like. Just like my parents and grandparents talked about the perils of war and famine which I could not fully comprehend, these new home owners will start suing banks when they find out that there is a cost associated with borrowing money. For now all is well though. Europe is set for another bout of never ending quantitative easing. Japan will just continue for another quarter of a century and the odd one out, the FED, has 250 basis points to work with before they go below zero. The central bank that is left out of the public discussion is PBOC. China has got more than USD 3trn in FX reserves and the power to change global liquidity. At Madrague we believe economists will start talking about the “Big 4” before the next global crisis. The current “Big 3” are running out of bullets and the marginal benefit of each QE and rate decrease is diminishing. For now the trajectory in the equity market and for risk assets in general is on an upward path, but we still have US/China trade, Brexit, Chinese slowdown, Italy and the Euro to worry about. That is just to mention a few of all the potential pitfalls to a second half recovery in corporate earnings. Downside protection and discipline is paramount in this environment. We do however believe that we will get some clarity on Brexit and trade war in the coming months. This will present opportunities and a market moving on more traditional parameters.
Sectors of note in January:
Hellenic Telecom and KPN were the main contributors to our performance. Hellenic bounced back from very depressed levels in December. The company is trading on the wrong multiples given historical track record and resilience to the macro environment it operates in. We did not change our position in January. KPN jumped towards the end of the month on the back of speculation that Brookfield is looking to take the company private. We believe this makes sense and slightly increased our position. A take-out price would most likely be at least 20% above the current price. The caveat with going hostile against KPN is that the company has the possibility to issue golden shares which makes a take-over virtually impossible. The “Stiftung” that are in control has not yet commented on what its position is. The last one to try a take-over of KPN, Carlos Slim and America Moviles, left the battle field both bruised and battered. Madrague is not a merger arbitrage fund, but at this valuation we are of the opinion that the company offers upside on a stand-alone basis.
Basic resources: +0.6%
Long positions in SSAB and Boliden were the main contributors. With improved economic sentiment and supportive commodity prices our long positions outperformed the general market substantially. SSAB has been a victim of the macro worries of late and will generate 60% excess of market capitalisation in free cash flow in the next 3 years if we the market prices are held steady. On the negative side was our short position in SCA. This position was profitable for the fund in the last quarter of 2018. The proposition is that the increased pulp prices in China has generated superprofits for SCA and that capex in the segment would result in higher capacity, lower prices for pulp and therefore lower profits for SCA in the near future. The trade war pre-empted the capacity increase. All positions are unchanged except for smaller adjustments due to extreme price movements.
The biggest contributors were our short position in Henkel and our long position in Elkem. Henkel issued a profit warning (they claimed it wasn’t a profit warning, but there is no other way to phrase it) in January. The company said it needs to invest more to keep the organic growth at the guided level. In plain English: more money spent for the same amount of sales equals lower margins. We shorted more Henkel on the day of the announcement as we believe this is a watershed when it comes to how the equity market should price the company. Elkem rose on the back of a generally better economic sentiment. We did not change our position in the company.
Our long position in Ambea and our short position in Getinge did all the damage in January. Getinge published the Q4 2018 numbers that were a bit short of expectations. The company however announced a small dividend (1% dividend yield) which got the market thinking that the likelihood of a capital raise was much lower than anticipated. We don’t really agree with that conclusion, but the stock went through our stop loss limit so consequently we bought back the short. We keep monitoring the company for a possible re-entry point. Ambea on the other hand was under pressure due to rumours of competitors having problems in Finland and possible indigestion after the purchase of Aleris Care. Madrague is of the opinion that the Aleris Care purchase is strategically correct and offer great upside potential if the acquisition is executed according to plan. We continue to be invested in Ambea.
Gross exposure was increased from 110% to 139% in January as the market volatility decreased and performance was good. We also increased net exposure from 26% to 34%. 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