MONTLY LETTER AUGUST 2019
Madrague had a very tough month in August: -3.6%. Both relative and absolute performance in the equity markets were heavily influenced by the sharp drop in bond yields across the globe. It is a very selective capitulation though; predictable cash flows were re-priced to the upside while the cyclical spectre was treated with utmost distrust. It is almost as if the equity markets are pricing in a recession in more cyclically exposed companies and a muddling through scenario in staple companies. With interest rates way below nominal growth in OECD countries we believe that there is a lot of yield capital being allocated from bonds to assets that are showing small positive yields. With algorithms and quantitative trading models taking more than 60% of the flow in equities the flow is directed in the path of least resistance. Follow the crowd until the crowd changes direction. Something has to give way and to our mind it is either a recession which is indicated by the bond market or a re-pricing of the cyclical equity part of the stock market. The GDP multiplier, i.e. the increase in GDP, you get for each rate cut or bond purchase, from the central banks is very low at the moment. What is needed to revive GDP, if you are a believer in government intervention, is fiscal stimulus. To let the economy go through a recession seems to be totally out of the question nowadays. Growth until the election seems to be the mantra across the globe.
Sectors of note in August:
Biggest contributors were our long positions in Hellofresh and Entertainment One. Short positions in WPP, and RTL were also positive net contributors in absolute terms. On the negative side was our long position in MTG. On the 23 of August Hasbro announced a cash offer for Entertainment One of GBP 5.60, a 26% premium to the previous day’s closing price. We sold out half of our position as the stock traded c7% above the offer. The prospect of an alternative bidder like Disney made both us and the market think that Entertainment One should trade above the offer from Hasbro. Hellofresh came out with a Q2 2019 report that surprised the market on the upside. Revenue +37% year over year and EBITDA being solidly on the positive side. The company was on the way to break even on the EBITDA level already towards the end of 2018 before it decided to expand into new geographies and acquire GreenChef. This delayed the breakeven and unnerved investors. The company traded on 0.7 times EV/sales vs. peers at 2x. we continue to be long and still see substantial upside.
Our long position in Ambea reported a good set of Q2 figures. The Norwegian market which has caused some problems showed signs of starting to turn around. We think Ambea has a very good management with great control of operations and a clear path to integrating their newly acquired business from Aleris. Problems at local competitors have caused a de-rating which we think is undeserved. The stock is too cheap given the risk profile and we continue to be owners.
Business Service: -1%
Prosegur Cash was the biggest negative contributor. When Alberto Fernandez won the primary election in Argentine the Peso fell by c30% and the Argentine stock market by c36%. The risk of a return to nationalization, currency controls and defaults rightfully scared the markets. Our long position in Prosegur Cash is built on a business which is shunned by the market as cash is a declining business. That is true in Sweden and a few other parts of the world, but for the rest of the world we still have a long time of cash handling left. With this sentiment we have a company with fewer competitors and a quite nice situation when it comes to competition. With Argentina being c25% of EBIT, the hit would be c7.5% for Prosegur. The share price is down c22% since the election and we think this is a clear over-reaction. We added a little to the position in August.
Short positions in ICA and Royal Unibrew were the biggest negative contributors of our short positions. On the long side British American Tobacco (BAT) and XXL suffered the biggest drawdowns. Both ICA and Royal Unibrew announced better than expected earnings results. Our short case in ICA rested on high cost to migrate customers to their digital platform with conflicting agendas between the shop-owners and the ICA holding company. The company is executing better than we have expected and it also showed better than expected organic sales growth. We closed the position even though we found it a bit expensive. We also cut our short in Royal Unibrew on the back of the reported result. When it comes to XXL, news of intensified competition from Intersport and dubious sales practices which are being investigated by Norwegian Consumer Authority made us close the position.
The biggest negative contribution came from our best position so far in 2019: Ovzon. The company has performed very well year to date, and we consider the negative performance in August to be profit taking despite positive news. We made no changes to the position. Our long position in Nordic Semiconductor (NOD) was also a negative contributor. The move in NOD was due to sector rotation and not to any company or sector specific news. We kept the position unchanged.
We decreased our gross exposure from 148% to 132% in August. We kept our net exposure unchanged at c40%. 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