March comment

Madrague had a tough month in March: -0.9%.

Equity markets continued to climb the wall of worry in March. We are being inundated by acronyms to describe the equity rally so far in 2019. FOMO, fear of missing out, and TINA (there is no alternative) are maybe the most common ones with AMO (already missed out) the latest addition to the list. The underlying meaning is generally the same; you don’t believe in the equity markets at these levels, the economic cycle is coming to an end, but you need to buy equities because underperformance is pushing you in that direction. Be that as it may with positioning as correlation between reported positioning and equity direction is very poor. What we do find interesting though is that there is an enormous focus on when we will enter the next recession. Europe is, as always, the dog when it comes to GDP growth and this cycle is not different. US growth expectations have been holding up quite well whereas the Eurozone has been revised down gradually in the last couple of months. An interesting angle here is the stimulus in China combined with a de-icing of the bruised relationship between US and China caused by the trade war. A big beneficiary from an improved economy in China would be Europe in general and Germany specifically with chemical and auto companies at the forefront. Our thesis with long deep cyclical companies valued close to replacement cost did not bear fruit in March but we believe this is just a blip in the recovery of those valuations.

Sectors of note in March:

Media: +0.2%

The biggest contributor was MTG which spun off Nordic Entertainment Group (NEG). Pre the split we have argued that the sum of the parts have been underestimated in MTG. As the relative valuation between the two companies was realized we sold out of the NEG position and kept the long position in MTG. Another positive contributor in the sector was our short in Mediaset Italia. The company continued to underperform and we did not change our position in March.

Basic Resources: +0.1%

Best performers were our long position in Rio Tinto and a short position in SCA, the pulp and paper company. Rio benefitted from a strong iron ore price. The commodity continued to grind higher after the Vale dam disaster in January. The market is not willing, for good reasons, to price the spot price into the earnings model, but we find that even the forward curve is being heavily discounted when we value Rio Tinto. The discount is too big so we continue to be long. In March we entered into a new long position in Norsk Hydro. The company is one of the biggest aluminium producers in the world. It has endured quite a lot of hardships in its production facilities in Brazil. Firstly because of the issues with the Brazilian government in the case of its Alunorte refinery which has been operating at half capacity since the beginning of 2018. Secondly the company was hit when Vale’s Brumandinho tailings dam burst in January. We believe that Norsk Hydro should fare well in the Brazilian investigation how to limit these kind of disasters in the future. Our understanding is that Norsk Hydro only operates downstream and centreline tailings dams which are safer and won’t be decommissioned in the near future.

Business Service: -0.4%

Airlines, with a long position in Norwegian Airlines (NAS) and a short position in Lufthansa were the biggest detractors coupled with a long position in G4S in March. On the positive side was our long position in Deutsche Post. Our long position in NAS was pressured by the rights issue that was completed in the beginning of the month. This was the second rights issue within a year. We have underestimated the balance sheet challenge and the operational challenge NAS has been facing. With hindsight the company should have been more willing to talk to IAG when it was exploring a take-over. In March both the Chairman Bjorn Kise and the founder and CEO Bjorn Kjos stepped down. This should open the company once again to further merger talks. Lufthansa was even weaker than NAS due to pressures from the Boeing 737 Max disasters and an oil price that continue to grind higher. We covered our short in Lufthansa to leave our airline positions with longs in NAS and Ryanair going into April. Deutsche Post appreciated so quickly in the middle of the month as we were looking to scale into the position that we decided to sell out of the position we bought and wait for a better entry point.

Telecom: -0.2%

Our short position in Swisscom and our long position in Veon did most of the damage. Our long position in Hellenic Telecom performed well and was the biggest positive contributor for the month. On one of the last days in the month Telenor placed 5.7% in Veon. This means that it has decreased its holding from 33% to 9% since it lost the struggle for power with Mikhail Fridman. We believe that Veon on EV/EBITDA of 3.0 is completely undervalued, consequently we increased our position when Telenor sold. Our positions in Hellenic and Swisscom were left unchanged.

Gross exposure was increased slightly from 180% to 188% in March. We also increased net exposure from 36% to 39%. 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