Unveiled margin pressures in Europe despite H1 results confirming economic recovery

During July, the Fund outperformed its benchmark by +0.38% and managed to report a small gain of +0.03% on an absolute basis. Year to date, the Fund posted a positive return of +17.66% on an absolute basis, outperforming its benchmark by +10.99%.

Monthly Fund Commentary
31 Aug 2017

During July, the Fund outperformed its benchmark by +0.38% and managed to report a small gain of +0.03% on an absolute basis. Year to date, the Fund posted a positive return of +17.66% on an absolute basis, outperforming its benchmark by +10.99%.

During the month, markets moved sideways as half year results proved to be less convincing than those of Q1. In spite of accelerating top line growth in the Investment Adviser’s universe, Q2 results have so far failed to trigger a noticeable earnings revisions. The number of working days in Q2 and increased raw material costs were the factors regularly cited as putting pressure on margins.

As stated in the July commentary, the fundamentals of the Investment Adviser’s less crowded positions allowed to overcome some of the short term market pressures. Granges was the largest monthly contributor to the performance, followed by Norma and Mersen. Granges, one of the Fund’s largest positions, delivered convincing H1 results, thereby confirming the Investment Adviser’s investment case based on recurring and sizeable value creation potential for shareholders (Free Cash Flow Yield >10%). Norma, the Fund’s largest position, and Mersen both upgraded their full year guidance prior to releasing their half year numbers, triggering a sizeable uplift in their stock prices in the first half of July.

At the other end of the spectrum, Tarkett, Spie and Metall Zug were the three main detractors. The Investment Adviser’s view on these three companies has not changed. The number of positions increased by one during the month as the Fund initiated a new position in Ebro Foods in Spain.

Ebro Foods ranks number one in the rice market and number two in terms of pasta production worldwide. It operates mainly in Western Europe (35% market share in France through Panzani) and North America (23% pasta market share in the US through New World Pasta). It is also the leader in Spain (rice), Portugal (rice), Germany (pasta) and Canada (pasta). Ebro mainly focusses on branded businesses. It is marketed under different labels in different countries.

The key strengths of this €3bn market cap Spanish company are: 1) a strong position in the branded rice market to support a high pricing power and the ability to anticipate volatile input costs, 2) the positioning of the pasta business in the US and French markets that allows for strong synergies with the rice structure and 3) a low level of leverage that allows the Company to consider external growth opportunities or increase shareholder remuneration. A weakness can be found in the strong market position of its main competitor Barilla, whose strategy focusses more on sales than on profit, acting as a hurdle in case of raw material price movements.

Based on the Investment Adviser’s own proprietary model, Ebro Foods has a very sound balance sheet with < 1x net debt/EBITDA for the end of 2017. The Company trades on 10x EV/EBIT (2018 estimate) and 15x P/E (2018 estimate), translating into a 6% Free Cash Flow Yield; together depicting reasonable multiples for such an anti-cyclical business.

 

The views and statements contained herein are those of Pascal Investment Advisers SA in their capacity as Investment Adviser to the Fund as of 10/08/17 and are based on internal research and modelling.