Man GLG Continental European Growth Fund

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  • 27 mins 36 secs
Rory Powe, Portfolio Manager, Man GLG, discusses the Man GLG Continental European Fund and its performance so far in 2018, the European equity universe, established leaders of the fund, portfolio characteristics and ends with a Q&A.

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WARREN SHIELS: Conference call with Rory Powe, Portfolio Manager, and myself Warren Shiels, Director within UK retail sales. On this call Rory will provide an update on the performance of the fund. He’ll cover Q1 and also year-to-date performance numbers. He’ll then cover some of the key stocks, and discuss the established leaders and emerging winners he holds, which we hope you will find useful. I’ll now hand over to Rory.

RORY POWE: Thank you Warren and good morning everybody, so if we go straight to the fourth slide and discuss performance in 2018 so far. I’ll start with the first quarter. The fund finished Q1 in absolute territory, despite the fact that equity markets were down in the first quarter. So it was a positive absolute and relative three-month period for the fund. Equities struggled. You had the stronger than expected increases in wages in US in February, and therefore the rise in bond yields that followed that, and more concerns about tightening. And that seems to be proved now with the Federal Reserve on track to raise rates probably by four times in the calendar year 2018. The Italian elections took place in March, and we saw the populous parties achieve a majority, and we’re now seeing the consequences of that. The oil price went up a lot this year. And also during the first quarter the economic numbers from Europe were relatively weak after a strong 2017.

So all of these factors contributed to lower stock markets, but thankfully the fund finished in positive territory. We’ll look at the numbers on the following slide in a minute, but in terms of what was behind the strong relative performance, it was stock picking. In fact the sector profile of the portfolio didn’t do it any favours. It had a very marginally negative contribution. So all of the positive contribution came from stocks, and I’ll go into a bit more detail on those names when I talk about the year so far. Where, in the first five months of 2018 the fund remains ahead of its benchmark, indeed the gap has widened thanks to strong performance so far in Q2, and better absolute performance because equity markets have recovered partially in the second quarter. But the fund from a stock picking point of view has done well. In contrast to the first quarter, the sector profile has now made a positive contribution.

If you were to break down the reasons for the outperformance for the year so far, it’s over 75% of the alpha has come from stock picking and close to 25% has come from the sector profile. In the second quarter, we’ve benefited from the fact that banks have been weak, where as you probably know the portfolio has zero exposure. So we’ve also benefited from the fund’s exposure to consumer durables, and also to software stocks. To be honest these sector points I’m making are not really behind our thinking. As you know, this is a stock picking fund. The sector profile is the consequence of the bottom up, but I have to acknowledge the fact that we’ve had a sector tailwind in the second quarter. But thankfully the bulk, over three quarters of the alpha has come from stock picking. And then if I highlight the names behind that.

I’d first of all make this point. The list of contributors, effectively share prices or equities in Europe year to date are approximately flat, and yet over two thirds of the portfolio is in positive share price territory. And that really is heartening I think that the number of names that have contributed to the fund’s outperformance in the first five months, it’s a long list. But the names that stand out are for example Montcler. At the end of last year Moncler was our second biggest position, over 6% of the fund. The share price is up 62% year to date, so it’s made about three points of absolute performance for the fund, and we have to acknowledge its contribution. It had an outstanding set of full year results for 2017 when its revenues hit €1.2bn. At constant exchange rates its revenues grew at 17%; that’s all organic growth. And it achieved an EBITDA margin of 34½%.

So above the already high margin of 2017 and it’s followed that with very strong first quarter numbers for 2018, where the revenue growth accelerated to 28% in the first quarter. And the retail business, which accounts for 75% of the business, enjoyed growth of 35%, with approximate growth in like for likes or same store sales of around 20%, compared to a very good already 14% last year. So the Montcler brand today is at the top of its game, and interestingly they’re in the process of launching a number of new capsules, one of which was launched last week, which is Montcler Fragments, so this company is not resting on its laurels.

The second name I would highlight would be Ferrari, which also published a very strong set of full year numbers for 2017, where its EBITDA hit €1bn, a strong increase in the margin, and the company is confident that it can double that EBITDA number in five years’ time in 2022 to approximately €2bn. And we’re witnessing a company where the strength of the brand, the design and engineering is now clearly evident in the numbers of the company in the form of the top line. Interestingly in their first quarter they had strong volume growth of approximately 6%, a very positive mix, not least due to the contribution of the 812 Superfast. And even though the LaFerrari Aperta will see a drop off in sales in the next quarter or two to close to zero, the 812 Superfast on the one hand and the Portofino should, and also the 488 Pista should contribute to a positive mix, which I think has surprised people, and it probably explains the strength of the share price, which is up 45% year to date.

Yoox Net-a-Porter has been a big contributor as well. It’s one of our biggest emerging winners, and Richemont bid for it early on in 2018. So year to date the share price is up 30%. We’ve now sold that position; it’s no longer in the portfolio. Ryanair was a difficult name for us in the fourth quarter of last year, and yet the share price is up year to date by approximately 6%. ASM Lithography up 25%, [Orterly? 0:08:02] about 32%. [Outerley? 0:08:06] was a name that was a drag on our performance last year, and it’s very pleasing to see it come back in 2018, not least because of the fact that their passive business has seen a strong acceleration in its top line, and an expansion in its market share.

So that’s pleasing, but on the negative side Pandora again has been a negative contributor. The share price is down quite sharply since the beginning of the year. Their first quarter numbers were really the reason for this. Even though they were only just shy of expectations, there was evidence of weakness in China, which is an important pillar of their future growth strategy. With the Pandora position, we have kept it. We believe that the thesis is still intact, but we have, I have misjudged this company in the last two years. I’ve not been sufficiently prescient in anticipating the design fatigue the company has suffered, which they’re now fixing, but it takes a while to fix that, and also the difficulties in the US retail market. And it’s caused the fund harm, both this year and last. And I of course take complete responsibility for that. It’s been a very disappointing name.

Eurofar has also been a poor performer, but let’s put that into context. If it’s cost the fund 60 basis points this year, all of our top 10 contributors this year have made more than 60 basis points. So a slightly slowdown in Eurofar’s organic growth, and at a slightly disappointing margin doesn’t give us cause for concern about the case for the company.

Just to capture what I’ve said in numbers, if we turn to page 5 where you can see the numbers. And I think the problem with these webcasts is we tend to concentrate on very short term time periods; whereas we are long term in our approach. We set ourselves the aim of delivering annualised returns of above 10%. We’ve just done that just in the last 12 months. But on an annualised basis for the three-year period and since we took over the running of this fund on the 1st of October 2014 we’re well ahead of our objectives, both absolute and relative. Our relative objective to remind you is to be above the benchmark by at least 300 basis points on an annualised basis on a three-year rolling period, not every year.

So I’m pleased to report for this webcast satisfactory numbers, both for the year to date 2018, but also the last three years, and also since I became the Portfolio Manager on 1st of October 2014, but there’s no point though lingering for too long on these numbers if we don’t deliver in the next three to five years. And so it’s appropriate I think to turn to the next page, and just look at the backdrop first, and then look at the positioning in the portfolio after that.

As far as the backdrop is concerned, 2017 was a very strong year for the European economy. It probably surprised most people with the extent of its recovery. But that has faltered in the first quarter. For example GDP growth for the Eurozone region expanded sequentially by 0.4% in the first quarter compared to 0.7% in the fourth quarter of last year. You probably saw last week the ECB downgraded its growth forecasts for 2018 from 2.4% to 2.1%. Now it’s probable that the negative influence on the European economy in the first quarter were temporary caused by things like bad weather, industrial action, outbreak of influenza, bad timing of Easter and factors like that, and therefore the ECB is not in panic mode; indeed it’s announced that it will end QE at the end of this year. It will taper from October through to December at €15bn a month, but it’s going to end QE.

But I think acknowledging the fact that the economy has slowed down, and before anybody jumps to conclusions as to whether it’s temporary or not, the ECB particularly when it looks at the inflation numbers. If you strip out the impact of fuel for example, underlying inflation at the moment in Europe is about 1.1%. So interest rates are not going to go up according to the ECB before late summer 2019, and that’s been pushed back. And it’s been pushed back because also talk of trade wars, the situation with Italian politics as well, none of these are going to contribute to an acceleration, indeed they might contribute to a deceleration in growth, but at least I think we’re going to have very benign monetary conditions.

I think our stance remains very clear, which is to be uncompromising about quality, to not own stocks in the portfolio which rely upon the vagaries of the macroeconomy. Our job we think is to identify companies who can be successful despite the economy, not because of the economy. And the fact that the region does struggle economically means it’s likely to remain unfashionable in the context of the world. And that is a good thing, because as stock pickers we want to find attractive situations which are uncrowded and where the pack is hunting elsewhere. And before I’m a bit more specific about the position I think it’s useful on the seventh slide to present the universe in the form of a spectrum, where on the left-hand side you can find the cyclicals, the financials. I’ve deliberately put value in inverted commas, because we’re all interested in value. But I think just as a broad brush name to describe that end of the spectrum, value is not the wrong word. Lower price to book values, lower earnings multiples. The problem I think with that end of the spectrum from our point of view, it is too reliant upon the macroeconomy. There’s today a shortage of pricing power out there.

I think if we do see higher input costs in the form of higher raw materials on the one hand and higher wages, we’re beginning to see higher wages in Germany, I think a lot of companies are going to struggle to pass those on to their end consumers, and therefore you’re more likely to see margin pressure than you are an outbreak of pricing power or inflation, and so we’re really not interested in that end of the spectrum. But equally if you take the other extreme of the spectrum on the right-hand side, it’s another area we broadly want to avoid, because in our opinion there’s inadequate organic growth to be found in that extreme end of the spectrum. And if we’re wrong about the European economy, if we’re wrong about pricing power, if inflation does come back, if bond yields do rise materially, then those bond proxy type positions will perform poorly most probably. And we want to limit the sensitivity of the portfolio as a whole to the ups and downs of the macroeconomy, and instead we want the performance of the fund as much as possible to rely upon the individual merits of each company, and their ability to succeed regardless of the economy good or bad. And that’s where our focus lies.

The fund focus in the middle, we try to differentiate ourselves by not being at either end of the spectrum, instead concentrate on companies which really have two things. One very powerful competitive advantages that we think are sustainable for many years and two that being converted into a robust expansion in the economics of those companies over the next five years. Our forecasting period is 2018 to 2022, the next five years, and we want to invest in companies which are going to bring home the benefits of their competitive positioning. A lot of these companies sit in relatively niche areas, and they are at odds with I would say what you would expect from the index or from the universe as a whole.

On page 8, we talk about, we always talk about our portfolio in terms of established leaders and emerging winners. The established leader weighting today is at an historically high weighting of 89%, which I think is higher than it’s really ever been since we’ve been running this fund in the last over three-and-a-half years. To remind you we always want to have at least 50% of the portfolio in established leaders, and the elevated weighting today reflects I think our understanding that in many cases, not all cases, the strong are getting stronger. And advantages gravitate to companies that have scale in the field of innovation, have scale in the field of downstream distribution, have scale in the form of purchasing power, and as long as these companies are paranoid about defending their market position, and keep reinvesting and reinforcing in their competitive advantages so that they can capitalise upon those in the long term, then we find these companies attractive.

With one or two exceptions, I’ve already mentioned Pandora. We were very pleased with the reporting season in terms of the portfolio, both for the full year 2017 and the first quarter of 2018. We’ve been on the whole positively surprised by our companies and how well they are delivering, even though our focus is on what they can achieve in five years’ time and beyond. I’d make the point that SAP is now our biggest position. I’ll happily answer questions about that later if you want me too. There’s probably not time now to go into detail as to why that is, and we’re pleased with its contribution to the fund so far.

The emerging winners weighting is thus quite low at only 11%. Yoox Net-a-Porter has gone. We’re very grateful to its contribution to the fund’s performance in the last three years. I think on the last webcast I mentioned the fact that Delivery Hero is a relatively new position. We held it going into 2018. The share price is up 27% this year. It’s been an important contributor, and we’re happy to keep it. Puma is a new position. You might wonder why isn’t it an established leader, given it is an established brand, but it’s got a lot of catching up to do vis-à-vis the giants in its sector, firstly, and in terms of its profitability. We see good headroom for the revenues to grow at approximately, well at least 10% a year over the next five years, and for the margin to move towards 10% over that period, and therefore very good earnings traction from that position. We’re also looking at some new names at the moment. So maybe the low weighting of 11% emerging winners might go up, but maybe not significantly in the next few months. We will see.

So I think that really covers it. I’ve probably spoken for too long. On the tenth slide we give you a snapshot of the portfolio at the end of May in terms of the underlying earnings growth that we believe based upon our estimates 14%. It still says 27 to 21, we have roughly half the portfolio on 2022, half the portfolio on 2021, we’re in the process of rolling forward to 2022. The multiple for 2019 has actually risen since this end of May number. We’re more like at 23 times now 2019, because the fund is in positive territory in June. But we tend to, we still focus on 2022, our five-year number.

The market cap has steadily risen; it’s €23.8 billion is the average weight of market cap. The median market cap if you’re interested is €7½bn. So this is still a portfolio which is very different to the index. I think our active share is over 95%. And so with our share price targets, and allowing for a small amount of derating in the multiples between now and three years’ time, because our share price targets are based upon where we think the share price will be in three years’ time based upon on our year five estimates, we think we can achieve an IRR of at least 12% with this portfolio today. And just to remind you our objective is to keep that above 10%. And then we have some performance numbers, which we have to show you on page 11. Thank you.

WARREN SHIELS: Rory, the first question we have is what’s the mix within the portfolio between global companies and European-centric companies?

RORY POWE: Thank you for that question. The weighting today in companies that I would describe as global is now over 80% of the portfolio. So I think with this fund investors in it are I think capturing our iteration of what we consider to be Europe’s strongest companies, and these are more often than not global in their scale and reach. So we’re not big fans of the European domestic economy. I half-jokingly say to people they want strong economic growth, they should invest in Vietnam not in Europe. The reason I think to invest in Europe is because of the strength of its companies, which are often global in their scale.

WARREN SHIELS: Thanks Rory. In regards to Ferrari, model pipeline appears to be speeding up, can this have a negative long-term consequence, and might Ferrari adapt to the trend towards EV?

RORY POWE: The pipeline today at Ferrari looks excellent. And if you take the current range, with the exception of the GTC4Lusso it is fully sold out for 2018, and most of the models are sold out for a good chunk of 2019. And what’s also encouraging is that the V12 cars, for example the 812 Superfast are performing very well, and that is good for the mix. And even though the Portofino’s a V8 it will start to, well it is starting to sell in the second quarter. So you wouldn’t have seen Portofino in the revenues in the first quarter of 2018. This is I think a good example of Ferrari being successful in the GT category, where versus sports cars they’re relatively underrepresented. And we are excited about the prospect of Ferrari launching their equivalent of a sports utility vehicle in the next few years, which will clearly be in the GT category. And we’re confident that unlike maybe the Lamborghini or the Bentley or the Porsche versions of this, this will be a premium product versus their other products, and also positive for the mix.

As far as E vehicles are concerned, Ferrari has a long history with hybridisation in Formula One, and also using its kinetic energy retrieval system KERS in Formula One. And Formula One loses Ferrari money, which is weird to say. It’s not published but approximately, probably approximately €100m which is about 3% of the revenue. So if you were to regard it as marketing cost, 3% of revenue, then that’s not bad. Montcler for example spends 7% of its sales on marketing. But also the leverage they can get off it in terms of research and development is significant. And from 2019 onwards, next year onwards Ferrari will start to launch hybrid versions of new models, so that by 2022/2023 probably all of its range will have a hybrid version. In terms of pure EV it’s too early to say, but no doubt they are looking at that very closely.

Ferrari isn’t a part of Formula E today for example, so I think the priority is hybridisation. Hybridisation will help contribute to probably lower KGs of CO2 emission per grams of CO2 emission per kilometre, but not at the expense of performance. And one thing that impresses us about Ferrari at the moment is its pricing power. The length of its order book would argue maybe that they’re not using enough of their pricing power. Personalisation is a good example of where they get more pricing power, but also hybridisation and the improvement in performance that will come from that will also probably enable them to charge a premium for it. So we’re very positive about it.

WARREN SHIELS: Rory, thanks for that, and we’ve got time for one more question. How far down the market cap scale will you look, and what’s the market cap of the smallest company in the fund as an approximate?

RORY POWE: The answer is today, I’m going to just pause a second to answer that question. The smallest market capitalisation is just under €1bn. So that sort of answers your question. We did have a number of positions where the market cap was €200-300m market cap, which we sold because either we had misgivings about the business compared to when we bought them, or we’ve just concluded that they just lack the scale to be in the portfolio. And if the median is approximately €7½bn, I think that demonstrates that we’re still very active in the mid and small cap echelons of the market. But all ideas really need to be scalable.

WARREN SHIELS: Thanks Rory, that concludes the Q&A session for the update. Thank you very much for your questions. I appreciate there’s a few questions that have come through we haven’t had a chance to answer, so your sales representative will speak to Rory and will come back to you on those. I’d like to remind everyone that there will be a recording and transcript of the call made available in approximately seven to 10 days’ time. In the interim if you would like more information on the strategy, or have any questions and follow up to this update, which is not available on our website, please contact your sales representative at Man GLG. Finally on behalf of myself, Rory and the Man GLG Continental European team we would like to thank you for your continued support and for listening to this quarterly update. Thank you.