Man GLG Continental European Growth Fund

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  • 24 mins 48 secs
Rory Powe, Portfolio Manager, Man GLG discusses the Man GLG Continental European Growth Fund, a summary of the portfolio strategy, portfolio characteristics, historical performance and ends with a Q&A.

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RICHARD PHILLIPS: Hello, good morning everyone. My name is Richard Phillips and I would like to welcome you to the Man GLG Continental European Growth Fund conference call with my colleague Rory Powe. The format is the same as usual. Rory will present for about 15 minutes on the activity he’s had with the fund. So with that I’ll just to turn to page, to slide 4 and I’ll hand straight over to Rory.

RORY POWE: Thank you Richard. Good morning everybody. So let me quickly review 2017 with particular reference to the fourth quarter. For the year as a whole it was a satisfactory year. The absolute return of more than 18% - we’ll show you the numbers in detail in a minute - was comfortably above our objective of producing analysed absolute returns of at least 10%. And we’re pleased to say that the fund beat the benchmark, both the FTSE World and the MSCI index. But the fourth quarter was disappointing: the fund underperformed the benchmark by approximately 70 basis points. And in a way the fourth quarter characterises something that was true of the year as a whole, which is that there’s been significant dispersion of performance between names in both our portfolio but also the wider market.

You could argue that our portfolio is a little bit of a microcosm of the wider market when it comes to dispersion. We have been rewarded and we have been punished where we’ve got stocks right and where we’ve got stocks wrong. And I suppose that’s the way we want it. That it is what I would describe as a stock picker’s market. But of course it is a double-edged sword as well: we felt both sides of it in both the fourth quarter and the full year. For the full year, we had a number of material winners, which I think should be acknowledged now. So for example Moncler, the share price rose comfortably above more than 50% in the full year and contributed properly to our performance. It’s one of our biggest positions, so we’re very pleased about its contribution on the back of what we expect to have been a very strong full year. That was the case at the nine-month stage, and we look forward to seeing their full year results in a few weeks’ time.

Christian Hansen also another core position saw its share price rise by over 50%. And there it’s acknowledging very good organic growth of 10% or more with the cultures and enzymes division outperforming significantly. VAT Group, the share price rose 76%. That’s a big position. And Xing, one of our emerging winners, saw its share price rise by 54%. But offsetting that, albeit not completely because as I say the year was satisfactory as a whole, Pandora was clearly a loser; the share price fell 27%. It’s one of our biggest positions over the course of the year; in fact it was our biggest position at the beginning of 2017, and it had a damaging impact on our performance.

I’ll happily answer questions about that in a minute, but essentially the company has struggled in the face of a very difficult retail market in the US, at a time when its range probably suffered from a bit of design fatigue, and it was probably a year when the company relied too much upon promotional activity in that very difficult US market. And it had an impact on its numbers which fell slightly short of expectations. Their revenues were 22.8bn Danish kroner, which is an increase of 12% versus guidance of 23% to 24%. And their EBITDA margin was lower than expected at 37.3% versus guidance of 38%. Not a train crash by any means. This remains an extremely strong company from the point of view of its top line, its profit and loss account in terms of margins, its returns on investor capital, the extent of its free cashflow, the strength of its balance sheet. And we’re very much keeping it as a core position.

Another loser for the year, particularly in the fourth quarter, was Criteo, which we’ve subsequently cut. This was a mistake. It’s one of the leaders globally in retargeting but Apple, with the introduction of its intelligent tracking prevention, ITP, essentially upended approximately 23% of Criteo’s revenues. And what it demonstrates and reminds us of is how in the world of technology innovation from a giant such as Apple can suddenly render part of your business model obsolete overnight. And that was an expensive lesson. So both Pandora and Criteo were negative performers for the full year, but overall it was a good year. It’s worth noting that as a portfolio manager I’m pleased with the way the portfolio was balanced, how we managed to have a good year despite the damaging impact of those stocks, they were offset elsewhere, those mistakes were accommodated in the rest of the portfolio.

For the fourth quarter, the winners were interestingly Pandora, Christian Hansen, Moncler, Aena and Essilor, very good performers. But they were offset by Criteo. I’ve already described what happened there. And it really happened in December when Apple introduced iOS 11.2, whereby they worked around Criteo’s workaround. Again I’ll answer questions on that in a minute, but it was really representative of the death knell for Criteo’s Apple users; again representing approximately 23% of their revenues. Genmab share price was weak on monthly data which showed slightly disappointing sales for Darzalex, their treatment for multiple myeloma, but there we remain extremely positive about the long-term prospects; indeed, we expect the revenues there to rise significantly in 2018.

UX Net-a-Porter was weak. Ryanair hurt us in the four quarter. When the company decided to recognise the unions in December, the share price over December fell by 14%. We used that as an opportunity to add to our position. It remains our number one position today. We don’t see union recognition compromising Ryanair’s cost advantage vis-a-vis its competitors. And we felt the share price decline whilst understandable was an overreaction, which gave us an opportunity to add to our position.

So that’s a summary on slide 4 of 2017, and the numbers are shown in more detail on slide 5, the next slide. For the 39 months that we’ve now been running to the end of December we’ve been running this fund in terms of my team, we’re comfortably ahead of our targets of 10% annualised and three points of relative outperformance annualised. So, despite a poor fourth quarter, we are long-term investors, we’re going to have other poor periods of performance, it is inevitable. We run a concentrated portfolio of today 32 positions. It’s like two less than at the end of the year when it was 34. We’ve got an active share of over 95%; the top 10 positions represent 52% of the fund. I think only one name in the portfolio, which is SAP, can be found in the top 10 names in the European index. So we are sticking our neck out versus the benchmark. That will hopefully bring its rewards; why else would we do that? But it also comes with its risks and we will be periodically punished for taking those risks.

Why on the next slide - slide 6 - do we run a portfolio which is very different to the benchmark? I think the first point I’d make is that we only want to invest in what we consider to be Europe’s strongest companies. And we are uncompromising about that. And just to recap what we mean by that, we’re looking for companies which have formidable advantages in their marketplace, which we think are sustainable for many years, and where there’s no evidence of complacency. Indeed, we need to be impressed by the extent to which these companies are reinvesting in and reinforcing their competitive advantages.

Those competitive advantages need to be combined with a clear five-year roadmap, which enables us to model as accurately as possible what those companies can achieve over the next five years based upon actions they’re taking, initiatives they’re introducing, levers that they’re pulling, rather than rely upon the vagaries of the macroeconomy. And the quantum of that growth is important, more important than the quantum is the sustainability of it. And it has to come with financial strength. We’re looking for companies with strong balance sheets, strong cashflow generation and rising returns on investor capital so that they will continue to reinvest in the opportunity before them. And most importantly the success of these companies should not rely upon the economy. That’s why coming on to the second point this portfolio steers clear of what we call cyclicals and financials. And the reason for that is their fortunes we think rely too much upon the macro picture.

Now the European economy is clearly much stronger today and long may it continue, we think it probably will continue, but we don’t want to put the future of the fund at the mercy of being right about that. Instead, we want to take risk based upon our individual thoughts about individual companies and their idiosyncratic merits. That’s what is important to us. And anyway the economy will always be vulnerable to shocks which none of us can really predict. And despite the strength of the economy we don’t see it being accompanied by much in the way of inflation or pricing power. And many of these cyclicals and financial companies lack sufficient differentiation from our point of view. So we steer clear of those. They may well perform but we just don’t know, and we want to stick to our knitting really on stocks that we do understand.

Alongside this, equally we want to avoid what we rather rudely call expensive defensive names. This would include quite a few of the consumer staples. Companies where their premium valuation is based largely upon their defensiveness, rather than much more than that, and when the economy is recovering, as it is, we think the premium one should pay for that sort of defensiveness should no longer be as elevated as it has been in the past. And if we’re steering clear of cyclicals and financials, let’s not double our bet by being overweight the extreme opposite of those cyclicals and financials by being overweight expensive defensive long duration bond proxies. Because if bond yields do go up materially, again we don’t want the success of the fund to rely upon what happens to bond yields. Given that there is some sensitivity to that in our portfolio anyway, and I’ll come back to that in a minute.

So we’re not in the mood to compromise. The strong economy is welcome, but the competitive forces out there in our opinion remain relentless. And if you don’t have really important barriers to entry you will be vulnerable to competition. So we want to stick to companies with competitive strengths. And that’s why on the next slide - slide 7 - you can see that we’ve got very high weighting in established leaders. The 87% weighting in established leaders is probably close to the highest it’s been since we started running this portfolio 39 months ago. It’s approximately 10 points higher than it was one year ago. And it reflects our view that the strong are getting stronger and scale benefits are really important in today’s marketplace.

It also reflects the fact that we only want to invest in companies that can fend off competition because they enjoy formidable barriers to entry. If we delve a little bit deeper into the established leaders, we’re prioritising what we call business to business entities, where companies are selling or serving other businesses with products and services which are critical to those business customers, and will enable those business customers to do a better job for their customers and produce better returns for their shareholders. If you’re selling to another business, you’re going to get a much more hard-headed approach to the purchasing of your product, which will look at the return on investment that product brings them. And if your product does bring them value, then they will pay up for your differentiated product.

It explains why we have positions in Christian Hansen, where the quality of the culture will have an important bearing on the appearance, the texture, the taste, the shelf life of a yoghurt; why compromise on that when it represents less than 2% of your cost of goods sold. ASM Lithography recently in the last week or so published excellent full year results for 2017, where its revenues grew by more than 33%. Their revenues exceeded €9bn. The semiconductor industry is hell bent upon achieving smaller and smaller dimensions or lower and lower line width as Moore’s law plays its course. And we’re very positive about their positioning for 2018 and beyond as their backlog in the extreme ultraviolet area remains very strong. And SAP, we’re impressed by their organic growth of 8% in their full year 2017.

Their business customers rely upon SAP as your business data is increasingly your most valuable raw material. Loomis offers cash services to banks and retailers, who increasingly want to outsource that to a third party such as Loomis. And Vitrolife is helping IVF clinics improve their success rates through the media they sell to them and the incubation they sell to them. So over 50% of the fund as a whole is in what we call business to business. And if companies in the portfolio are not selling to other business, if they are consumer names, then they must have something that differentiates them. And we can’t think of better examples than Ferrari or Moncler, Carnival the world’s leading cruise operator, Ryanair in terms of low cost travel, Pandora with its upstream and increasingly downstream integration.

So, if we’ve got this high weighting in established leaders, it has not come at the expense of earnings traction, and I’ll show some numbers on that in a minute. And it’s not about us being more defensive. But there is on the next slide because of this traction, or earnings traction that we’re achieving from the established leaders, less need to have a high weighting in emerging winners, which stands at only 13% versus 23% one year ago. There are some other reasons for that. Moncler, halfway through 2017 we promoted if you like to the established leader category. Criteo, as I said earlier, has now been cut outright from the portfolio. So there are reasons for it. But anyway we’re getting a lot of earnings traction from the established leader section of the portfolio. We don’t necessarily need extra fuel from the emerging winners when we have to be cognisant about the risk we’re taking in the portfolio as a whole, and emerging winners do represent greater risk.

Delivery Hero is a core new name. They are similar business model to Just Eat. They’re the leader in over 36 countries globally in online marketplaces for takeaway restaurants; they represent 150,000 restaurants globally. And like Just Eat their revenues are generated by commissions. And this is a company we think can grow at approximately 40% a year, and even though it’s not profitable today because they’re spending a very high percentage of their revenues on marketing, we expect that cost line to come down as percentage of sales for the company to breakeven within our five-year forecasting period. So we’re very pleased that Delivery Hero has joined the emerging winners section. UX Net-a-Porter, this is not strictly relevant to this call, but it’s going to bring the weighting down further. It’s been bid for by Richemont this month, January, and so we’ll probably be saying goodbye to that position, which has been a great contributor to the fund’s performance over the last few years.

On the next slide, I think these numbers, which present the characteristics of the portfolio, acknowledge that as portfolio managers we will pay up for these high quality names which also have good earnings traction. But what we mustn’t do is overpay. We can defend these valuations. By the way as I think you will know our share price targets are based upon our five-year estimates, not 2018 or 2019. But I think it’s important to apply if you like a sanity check to the average weighted multiples for the portfolio for 2018/2019. And we can defend those multiples, particularly given the 16% compounded growth rate we’ve calculated based upon our estimates for the companies in the portfolio for the period 2017 to 2021 inclusive, that five-year forecasting window. We think that’s a creditable number.

But in terms of our total shareholder returns that we’re expecting of just over 12%, that bakes in some derating and assumes really that the multiples in 2021 in three years’ time based upon year five of our numbers, because 2021 is year five, the multiple has come down by more than 10%. So I talked earlier about bond yields. So if bond yields rise first of all we don’t want to be in what we call expensive defensives, but secondly we need to assume that bond yields will rise, and prepare for some derating of our portfolio. But because of the very strong underlying growth we think we can make 12%. Hopefully that’s clear. And then the final slide just shows what we now have to show for MiFID reasons the longer-term performance numbers of the fund. And I hope that you might have some questions, but I’ll hand back to Richard.

RICHARD PHILLIPS: Thank you very much, Rory. So we’ve got a couple here if we can get through these swiftly. The first one is on Ryanair. How is the impact of the rising oil price affecting Ryanair?

RORY POWE: Yes, for the current year 2017/18 year ending March not so far away from now, very limited impact because they’re 90% hedged at a much lower oil price than the current oil price. And indeed in 2017/18 fuel costs per passenger is going to be down quite sharply versus the previous year. But going into the following year, 2018/19 year ending March 2019, the last set of numbers when they published their first half, they publish their nine month numbers by the way next week, they were only 30% hedged. So they will suffer from the higher fuel price in year 2018/19. We’ve got that in our model. We’ve got the current fuel price for the 70% that is unhedged. And so on that basis the fuel cost will, a passenger will probably go back to where it was in 2016/17, so the decline this year will be reversed in the following year.

Now, because we expect revenue per passenger to be up in 2018/19, both based upon higher fares and higher ancillaries per passenger, we don’t expect much in the way of an erosion of the EBIT per passenger. So 2018/19 is another year of earnings growth, relatively muted but another year of earnings growth at the net profit level and the EPS level. And then we’ve got good numbers in the following years, because then passenger growth should accelerate.

RICHARD PHILLIPS: Quickly onto the next one, you said that UX Net-a-Porter has been bid for, is it a fair price or is it a bit on the low side?

RORY POWE: I think, well the bid price is €38. Our three-year target was €48, so we would say it’s a bit on the low side. And we would be accused of looking a gift horse in the mouth because it’s helped our performance in January, but it’s frustrating that we’re forfeiting, the tenure is between €38 and €48 if this goes through. We will see what happens. Unfortunately, Richemont already owns 50% of the share capital, 25% of the votes. Federico Marchetti has already effectively committed his shares to Richemont, Federico Marchetti h being the founder of UX and one of the biggest shareholders of, after Richemont, of UX Net-a-Porter. We will see what happens, and we’ll keep you updated. But I think the probability is, we shouldn’t assume that we’re going to get more than €38, that’s probably a prudent assumption.

RICHARD PHILLIPS: There’s a question on Pandora, which has downgraded its growth target for 2018/22: does the lower growth rate mean or meet the stock selection criteria as a growth manager?

RORY POWE: Yes it does. They’re talking about between 7% and 10% top-line growth. We think the assumptions behind that reset guidance are quite conservative. Even though the margin will fall from over 37% to 35% in 2018 we don’t expect the margin to go below 35%. And there’s substantial scope for share buybacks, more than we’ve seen in the past, which will offer further earnings per share growth on the back of fewer shares. Plus the multiple we think is too low. This is one position where we do expect some of a rerating. If it’s only roughly 10 times now, our target is 12 times out 2021 estimate. So it fulfils our IRR or TSR target of at least 10%.

On Pandora, they seem to be fixing the design fatigue situation. They’re launching something called Pandora Shine on the 1st of March, which will be a gold range. It will be sterling silver covered with palladium, covered with 18 carat gold, and I think that will help rejuvenate the range. That’s a new concept which should have a positive impact. But also they’re continuing to buy out franchisees. They will continue to open directly owned stores, and in the end one reason we’re positive about Pandora is that we think they’re going to close the gap between what they actually book at revenues and what the Pandora brand revenues are. Historically, they’ve relied a lot upon selling to franchisees. They are essentially bringing home the economics that they’ve historically forfeited to franchisees. And I think that’s very exciting. And the brand remains very strong, so we’re sticking with it as a position.

RICHARD PHILLIPS: This is a question on Novo Nordisk, which shares were hit yesterday on its failed acquisition. Is Novo a good example of how important it is to understand that market leaders will not always be market leaders?

RORY POWE: We don’t, I think the questioner knows that we don’t own Novo Nordisk. We sold it over a year ago. But it was a costly position for us. Novo Nordisk is still the leader in diabetes care, and to be more specific it’s clearly the leader by a significant margin in insulin, and we don’t see that very strong market position being threatened. The acquisition they weren’t able to make was an acquisition they wanted to make in order to strengthen their position in haemophilia, which as an area has been relatively difficult for them. And that opportunity has gone away from them because Sanofi has outbid them. But that doesn’t have any bearing on the strong position they have in diabetes care, which will be strengthened with the growing GLP1 category. So insulin plus GLP1 in insulin care I think gives Novo. The reason we don’t own it is because for the insulin business we don’t have enough visibility on pricing. And the fact is that the buyers in the US in particular have become a lot more powerful, and that’s put downward pressure on pricing. But it’s a great company, it remains a great company, and it could return to the portfolio at some point.

RICHARD PHILLIPS: Thank you for that Rory, that looks like an end to all the questions, so thank you everybody for dialling in today. As I said earlier we will be sending you a transcript and a recording of this call hopefully within the next seven days. But for now thank you very much.

RORY POWE: Thank you everybody.