MONTHLY LETTER JUNE 2019
Madrague showed a small gain in June: +0.20%.
After two months of roller coaster driven by the trade war, sentiment has changed in the markets. It seems that consensus is now going for a truce between US and China. Good old times won’t be rolled back, but for now it seems the investment community will take the stance that logistics, trade and growth won’t be damaged irreparably. At Madrague we would agree with that interpretation. What we do need to adapt to though is a new world where it is quite possible that we are in the midst of the dissolvement of the western block and unity. The current President of the US might make the US great again in the short run, but it looks quite likely that it will trigger actions from both allies and foes alike. China, Russia and other countries with world dominance in mind should of course never be trusted, but we will be watching the EU and UK preparing themselves for tough trade negotiations with the US with the aim of lessening the dependence of the USD and US trade. It won’t be an exercise done overnight and we doubt we will hear politicians in power to vent those thoughts in public. It would be poor judgement (even if we see those tactics by other leaders currently) to speak out loud, but it would be even worse crisis planning not to have a plan B when you see allies changing course even if it might only be temporary and gradual. The move towards 3 major economic areas with 3 main currencies seems to be on its way. Tony Blair might be correct that Europe needs to cooperate if it wants to be a power on the global stage, but we struggle to see the current EU moving towards fiscal union and taxation possibilities of individuals in respective member countries. Both Asia and the US have an advantage in the current political set-up. When it comes to investment implications we believe that companies with less fixed assets, track record of cost control and flexibility in logistics will be the winners. Just a matter of identifying them ahead of the crowd.
Sectors of note June:
Positive contributors were long positions in Skanska and Cramo while our short positions in LEG Immobilien and Vonovia also showed a positive absolute return. Cramo has as we write this letter just completed a split of the company. The two main business areas became two separate listed companies: Cramo, the rental equipment business and Adapteo, the modular space rental business. The rental equipment market is deeply cyclical and tied closely to the construction market whereas the modular space rental is a property company with shorter life span of the assets. Cramo is a well understood company where the market has assigned a multiple since long. The interesting part in the split is Adapteo. The company has 75% of its sales to the public sector with an average duration of 3 years. Extensions are made in more than 70% of the contracts with a payback of a module at 5 years. The market is growing and we believe the market will assign a lower yield requirement for the company and hence a higher earnings multiple. LEG and Vonovia shorts paid off when Berlin rent cap was voted through the parliament. You can of course argue that rents should be set in a free market and politicians should not meddle, but the practice is common across the globe and one of the disadvantages of property is that you can’t move them if you find yourself at the receiving and of the whims of the ruling political party.
Long positions in Veon and Hellenic Telecom outperformed our short positions in Swisscom and Tele2. We have been invested in both Veon and Hellenic for a few years now. Our opinion is that both companies are still materially undervalued after you adjust for the countries they operate in; Russia and Greece mainly. Hellenic has started to re-rate to a certain degree. This is partly due to a better risk sentiment in Greece and partly due to investors starting to appreciate the operational improvements in the company during the Greek crisis. Veon on the other hand is still a very distrusted company and the recent bounce in the stock price can be mainly attributed to the settlement with the Egyptian tax authority and the last placing from Telenor reduced its stake in Veon to below 10%, a very manageable final placing will be done at a later date. Swisscom has benefited from the safe haven status of Switzerland as some sort of bond proxy. We can understand the logic, but don’t agree with it. The company trades on c17x 2019 earnings with limited growth and increasing competition, mainly from Sunrise. It is just the wrong price and the valuation has been stretched like so many other companies deemed to be a safe haven. In Tele2 the synergies from the acquisition of Comhem has been accounted for by the market and we also see further competition mainly from Three Sweden on the mobile side. We continue to hold the above mentioned positions.
In the Auto sector all our positions are in the service part of the sector. In June our long positions in Valeo and Faurecia outperformed our short position in Autoliv. This is a sector that has been hit by a perfect storm the last couple of years. Emission scandals, climate debate, China/US trade war and electrification have scarred valuation and earnings dramatically. We have maintained fairly small positions during this period as we do not believe we have a particular edge on the issues mentioned. Hence it is one of our smallest sectors, but the knowledge we continue to accumulate in this transition period will pay off when the dust settles. Both companies’ valuations reflect the issues at hand and our belief is they are on the right path even though many challenges remain. All mentioned companies are still in the portfolio.
Capital Goods: -0.3%
This is a sector where we have very little net exposure, but one of our largest gross exposures. In June the defensive rally in the equity markets hurt us as Assa Abloy, Atlas Copco and Hexpol outperformed our long positions in Alfa Laval, Trelleborg and Weir Group. We have entered both Weir and Trelleborg fairly recently as we see possibility of turnarounds. It is not uncommon with those types of positions to underperform when we experience a bull market with very little trust. We continue to hold the mentioned positions.
We increased our gross exposure from 143% to 156% in June. We also increased our net exposure from 29% to 37%. 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