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FE Alpha Manager Cosh: The European recovery is now embedded

13 July 2017

BMO Asset Management’s Sam Cosh describes the outlook for European smaller companies and highlights some of the stocks he is backing over the long term.

By Rob Langston,

News editor, FE Trustnet

After a period of underwhelming performance, European domestic-focused stocks are likely to lead markets going forwards as the regional economy continues to strengthen, according to BMO Asset Management’s Sam Cosh.

The FE Alpha Manager said “the European recovery is now embedded” noting that the eurozone PMI has been in expansionary territory for some time and that Q2 figures were the strongest they have been in six years.

Cosh said: “If we look at those leading indicators in the context of other developed markets, Europe really does stand out positively with the highest PMI versus US, Japan and UK.”

He said the recovery has now begun to filter through to companies’ earnings, with improvements being seen on company balance sheets.

“What has led European recovery is the global sector, the exporting sector,” he explained. “The momentum has been with the global exporters, the quality businesses. The domestic sectors have done badly.”

Cosh, who oversees three European smaller companies funds, said European markets had been led by global-facing stocks, but could see domestic stocks start to perform better.

“Our arguments is that it is difficult to see the global sector continuing to lead,” Cosh said. “We would expect the earnings leadership to be much more balanced from here with domestic sectors delivering better performance going forward.

“This is interesting for us as European small cap investors because European smaller companies are more domestically focused than their large cap counterparts.

“We would expect a domestic recovery to accrue from here more strongly and European small caps would benefit disproportionately from that.”

The European small cap sector has been one of the top performers of 2017 so far. During the first half of the year the average IA European Smaller Companies fund rose by 16.24 per cent.

Performance of sector in H1

Source: FE Analytics

Below, Cosh highlights three European small cap stocks he holds


Lectra

The first stock is French firm Lectra, which Cosh describes as a family-owned business combining both hardware and software.

“They make machines and computer systems which they sell to the auto manufacturers and the fashion industry,” he said.

“It allows the automation of processing of materials. Effectively they cut leather and material for those industries but they do it in a faster more efficient way which means less waste than competitors.

“They have a very high market share of over 50 per cent, they also have very high recurring revenues which are 60 per cent of total revenues. That’s a combination of licensed sales for their software but also spare parts for their machinery.”

He said that earnings have been depressed as the firm has undergone a significant investment in its sales and marketing as well as investing in a new product.

“We were able to buy this at a really attractive valuation. The shares have performed extremely well and what we’ve seen is a significant earnings upgrade and better growth prospects than the market appreciated on an initial view.”

 

Metall Zug

The second firm is Swiss conglomerate Metall Zug, which Cosh said is “still under the radar of most investors”.

The firm is split into three separate divisions: household appliances, infection control and wire processing markets.

He said: “What attracted us to this business initially was the good returns they achieved historically but also the very strong balance sheets.

“We quite liked that it was a family-controlled business as they tend to allocate capital with a view to long-term returns rather than to any short-term stock market moves.”

Cosh said the firm was a leader in the Swiss household appliance market where it sells high-end appliances and has a 43 per cent market share.

He explained: “They sell these to people that build and rent out flats and one of the key reasons people will buy these flats because of the quality of the kitchen and appliances in there.

“The reason why apartment owners use Metall Zug is because it has a very strong service element to it. They are well-embedded in a very strong market. We would say it gives them a very wide moat and it is difficult to be challenged.


“This company only really operates in Switzerland but there are prospects for them to expand over the long term and use the strong brand to sell into other markets.”

The firm is also one of two global market players in the wire processing business, which is a key supplier to the auto industry. Meanwhile, the infection control business – which provides services to hospitals – is undergoing a restructure.

Performance of Metall Zug over H1

Source: Swiss Exchange

Cosh said the infection division is supported by the other two strong divisions and despite recent performance believes there is more earnings growth to come.

 

Vidrala

The Spanish bottling business is a recent investment, which Cosh described as a “durable franchise business, which is very well positioned.

“They are the lowest cost producer in Europe and the most efficient operator,” he said. “On its own that’s attractive. It generates good returns on capital and I think those returns will compound over the long term.

“There are also other additional attractions to the business. It recently made two acquisitions to consolidate itsmarket position and will get some very attractive synergies from these businesses.

“As the industry goes through some consolidation, they companies tend to improve market returns and the players in the market get better profits.”

 

Coor

Finally, Coor is a Nordic facilities management business recently listed. Cosh said the company provides services that are increasingly being outsourced.

He said: “We think this industry is seeing structural growth as companies focus on core businesses and reduce costs by outsourcing to third party providers who are more efficient than they are.

“What attracted us to this company was yes, we think it will benefit from growth in outsourcing in Nordics but we think within that the growth of integrated facilities management will outstrip that of facilities managers as companies decide to hand out facilities not to separate players but to one integrated provider.”

He added: “It’s a lovely business model as there is very little capital needed in this business. Capital intensity is very low plus it has negative working capital requirement it gets paid ahead of its suppliers.

“Cash flow generation is superb. We get really good visibility on revenues because it’s long-term contracts. Also, the company listed relatively recently and valuation is very attractive.


Cosh  - who manages the European Assets Trust, F&C European Small Cap ex UK and F&C Eureopan Small Cap funds - said the one of the biggest challenges for European investors has been the artificially low interest rate environment, but with talk of rate rises increasing he now sees that changing.

“I think the most challenging thing as an investor in European companies over the last three years is that the interest rate environment has helped create a clouding around some areas of quality and indeed the so-called bond proxies.

“We like good businesses but we’re not prepared to pay up to them as we think valuation is an important component of future returns.

“We shied away from the obvious quality areas and had to look a bit harder for these businesses.”

Cosh added: “Having a balanced portfolio, as we would describe it, has been challenging particularly in the first half of last year.

“Having said that there are 2,500 companies out there, there are always areas where we can find these businesses.”

 

The European Assets Trust, the largest of the funds managed by Cosh, was up by 30.17 per cent during the first half of the year compared with a 32.35 per cent gain for the average IT European Smaller Companies trust. Over three years the trust is up by 38.79 per cent gain against a 54.26 per cent rise in the Euromoney Smaller Europe (ex UK) benchmark and a 59.29 per cent gain for the average trust.

Performance of trust vs benchmark & sector over 3yrs

Source: FE Analytics

The trust has no gearing and is currently trading at a 0.2 per cent premium, according to data from the Association of Investment Companies. It has an ongoing charges figure (OCF) of 1.1 per cent.

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