MONTHLY LETTER OCTOBER 2018
Madrague had a very difficult month in October: -5.65% which takes the year to date figure to -4.98%. We are of course very disappointed with this performance and are, as always, prepared to go through performance and thoughts on the market in general and our positions more specifically.
Sectors of note in October:
One of the few positives in October was our Pharma sector. Our long position in Capio coupled with a short position in Ambu were the main contributors. We have been long Capio for more than 3 years. It has been a volatile ride with pricing pressures in France, debates about profits in health care sector in Sweden and the start of the digitalisation of the sector with doctors on line to name a few factors that have affected valuation and profitability. Since the beginning of the summer the company has been looking to focus the company more on the Nordic region and the on-line business. In July Ramsey Health Care made a bid at SEK 48kr for Capio. We were always of the opinion that the bid undervalued Capio. In October Ramsey raised their bid for Capio to SEK 58kr: a level that leaves limited upside for a competing bidder. Consequently we sold out of our position close to the bid level. In Ambu we put on a short in September. This materialised quicker than we had anticipated when the stock continued its slide after a capital markets day that failed to inspire further buying. The company is very hard to value and expectations are sky high: consensus believes that earnings per share will double from 2018 to 2020 yet the company trades on 47 times that 2020 expectation. We see a multitude of risks to those earnings even if they are more balanced now that the stock has halved in value since the middle of August. We closed our short in October, but continue to monitor the company with an inclination to be short.
Business Service: -1.4%
The sector which has over the years been our best sector continued the abysmal performance of the last couple of months. There were a few themes that got seriously damaged in October: our long positions in Ryanair and Norwegian Air were both very weak. At the start of the month Ryanair issued a profit warning that shaved almost 15% off the market value. We believe this move to be excessive and increased the position slightly on that warning. Norwegian on the other hand we reduced our position by more than 60% which leaves our net exposure to the sector reduced. Apart from the profit warning from Ryanair the sector took a hit from higher oil prices and the general global growth worry that hit the entire market. The other big hit came from the gaming sector where our long positions in Jackpotjoy and Playtech cost 50bps of performance. We cut our entire position in Playtech and kept the Jackpotjoy investment as we believe it is less at risk from regulatory changes and also has a long history of steady growth even through tough economic cycles. We reduced our gross exposure in the sector from 18% to 10% of AuM in October.
The entire reason for the poor performance was our long position in Elkem. We have written about the position in a few previous monthly letters when the stock has been performing very well. The quick recap: company has benefitted from tight supply of silicones in the Chinese market which has resulted in very favourable pricing of the material. As the trade war between US and China intensified Elkem acknowledged that they had started to see lower prices and some caution in the market from their customers. This was not a huge surprise to anyone following the market, but we are of the opinion that the company in their conference call did a very poor job of explaining how they manage the business. They also showed a lack of understanding when they were pressured on how they phrased the outlook. It might seem like a trivial issue for someone outside the financial markets, but when you feel like you are reading tealeaves rather than listening to company management there is clear room for improvement. We halved our position in Elkem in October due to p&l protection, overall risk reduction in the fund and the more uncertain outlook for the industry. Short positions in Covestro and Akzo Nobel only partially made up for the very poor performance of Elkem.
The biggest draw down came from our long positions in Rambus and Philips. Rambus’ IP has a technology that improves the speed of semiconductors. We would argue that the market is not giving Rambus the credit it deserves neither for the technology nor for the cash flow it produces. We reduced our position with a third while at the same time reducing our short in the Philadelphia Semiconductor Index by a quarter. We cut our entire long position in Philips as it went through our stop level.
Due to the increased market volatility and poor performance we reduced both the gross and net exposure in October. Gross exposure was reduced from 152% to 122% in October. We reduced our net exposure from 48% to 44%. 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