Jewellery maker Pandora, medical-equipment maker ConvaTec, mobile phone company Nokia and renewable energy stock Siemens Gamesa all failed to capitalise on a strong return to favour last year but remain among some of the best ideas in the four FE Crown-rated Hermes European Alpha Equity fund.
Managers James Rutherford and Martin Todd said that despite a strong showing for European equities these stocks were left behind by the market last year but could be set for a rebound in 2018.
Last year the MSCI Europe ex UK index outperformed the broader developed markets benchmark MSCI World index by 4.04 percentage points, as the below chart shows, having underperformed it by 9.62 percentage points the previous year.
Performance of indices in 2017
Source: FE Analytics
“While European equities rebounded strongly in the past 12 months as the region’s economic recovery deepened, these four stocks faltered,” the managers of the Hermes European Alpha fund said.
“Stock markets are capricious in the short-term. Unexpected news flow and temporary factors can trigger bursts of share price volatility, but leave the long-term fundamentals of companies intact.
“We saw these stock price weaknesses as short-term disruptions, and therefore decided to retain – or add to – our positions, remaining confident that long-term gains would offset any noise.”
First up is Danish jewellery maker Pandora which lost more than a quarter of its value last year as higher production costs and a weak retail environment in the US dented earnings.
Despite the disappointment the Rutherford and Todd added to the position last year as they believed that the stalling growth is only temporary.
The managers said: “Chief executive Anders Colding Friis acknowledged that 2017 was marred by “hiccups” as product assortments became too repetitive.
“However, in response Pandora outlined a clear strategy which will cut product development time to ensure new jewellery reaches the market faster – a key weakness in the last two years.”
As such, the jeweller expects to generate 50 per cent of sales from bracelets by 2020, compared to 74 per cent last year with 800 new products launched by 2022, up from 400 last year.
Increased spending on manufacturing and a new approach to marketing – particularly digital – should also help, they noted.
“Pandora divides market opinion, but with a price-to-earnings [PE] ratio of about 10x, organic growth of 7-10 per cent and a strong balance sheet, we believe its recovery will continue to gather pace,” the European Alpha Equity fund managers said.
The other recognisable brand on the list is mobile phone manufacturer Nokia, which was hit by disappointing third quarter results that saw its share price skid, as the below chart shows. Indeed, the shares slumped 17.88 per cent in October last year.
Performance of stock over 1yr
Source: Google Finance
At the time, the Finnish company suggested the lacklustre results were a result of robust competition in China and consolidation among wireless carriers.
“We saw reason to look through the near-term uncertainty at Nokia, viewing the challenges as temporary,” they explained.
Engineering problems causing software upgrade delays, the lack of an expected share buyback and weak network sales all contributed to the disappointing results.
There were also cashflow-related issues, which were reversed in the following quarter. As such, since October shares have rebounded, rising by 13.4 per cent.
“After a difficult few months, Nokia enjoyed some welcome respite, bouncing back to post strong fourth quarter results,” Rutherford and Todd said.
“Nokia provided a credible 2020 guidance of 60 per cent earnings per share growth – well above market expectations – as it ramps up investment in new 5G technology ahead of expected orders from phone operators.
“This serves to highlight the negative extrapolation that the market baked into forecasts following a disappointing third quarter, even though issues facing the group were temporary.”
Elsewhere, the pair also continue to favour medical-equipment maker ConvaTec despite manufacturing issues weighing on profits and organic growth last year causing the share price to fall 19.57 per cent over the last 12 months.
“ConvaTec stated that the fundamentals of the business ‘remain strong’, revealing that the manufacturing issues in the Dominican Republic have been resolved,” said Rutherford and Todd.
“Production is now at full capacity and the backlog of orders is beginning to clear. Moreover, fourth quarter results came in ahead of expectations despite manufacturing disruptions.”
The final stock the managers are standing by is Siemens Gamesa Renewable Energy, which was hampered by political uncertainty in the US following Donald Trump’s presidential election success in 2016.
As well as this, chief executive Ignacio Martín announced his intention to leave once the merger was complete and Siemens’ inability to retain senior management was further exacerbated by two profit warnings.
“However, shares in Siemens Gamesa enjoyed a much-needed jolt in late 2017, buoyed by a strong increase in new orders and a cost-cutting plan,” Rutherford and Todd said.
While investors remain sceptical, they said the firm should deliver on revised targets of increasing its earnings before interest and tax margin to 8-10 per cent by 2020.
The managers run the €615m Hermes European Alpha Equity with Rutherford taking charge in 2010 before being joined by Todd in 2013.
Since managing the fund together, it has returned 46.84 per cent – below both the IA Europe Including UK sector average of 53.83 per cent and the FTSE World Europe benchmark’s gain of 53.22 per cent.
Performance of fund vs sector and benchmark under both managers
Source: FE Analytics
Last year the fund underperformed both the sector average and benchmark with a double-digit total return of 12 per cent, compared with a 15.35 per cent for the peer group and a gain of 15.83 for the benchmark.
The fund has a clean ongoing charges figure (OCF) of 0.86 per cent.