Four holdings in the European Alpha Fund missed out on a share of the spoils in 2017 – a vintage year for European equities – as they were pummelled by temporary pressures. We looked beyond this volatility, maintaining our focus on the companies’ prospects for long-term growth. As these pressures begin to ease, we ask: have these stocks turned a corner?
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. This is illustrated well by the performance of current holdings Pandora, ConvaTec, Nokia and Siemens Gamesa in the last year.
While European equities rebounded strongly in the past 12 months as the region’s economic recovery deepened, these four stocks faltered. 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.
Since the turn of the year, these stocks have regained positive momentum.
Pandora: regaining lost charm?
Danish jewellery maker Pandora lost more than a quarter of its value in last year due to a lack of product innovation, the weak retail environment in the US, and higher production costs. Earnings expectations fell gradually throughout 2017, and a corresponding fall in the price-earnings (P/E) multiple saw Pandora underperform the benchmark index by 30%.
Despite a disappointing year, we looked beyond the recent weakness, retaining – and adding – to our position in Pandora. This stemmed from our belief that the decline in the company’s growth expectations is temporary. We therefore found its recent Capital Markets Day (CMD) and our subsequent meeting with management reassuring.
Management clearly identified areas of weakness and outlined plans to achieve growth going forward. Chief executive Anders Colding Friis acknowledged that 2017 was marred by “hiccups” as product assortments became too repetitive1. 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.
Achieving a more balanced offering is also integral to Pandora’s growth plans. The jeweller expects to generate 50% of sales from bracelets by 2020, compared to 74% last year. It also announced plans to launch 800 new products by 2022, up from 400 last year.
Meanwhile, investment in manufacturing will begin to pay off, enabling the group to reduce lead times to deliver new products to stores by 50% to four weeks. Moreover, a revised approach to marketing, which includes expanding the digital marketing efforts to increase traffic to its online ‘estore’, should help the brand regain momentum.
Pandora divides market opinion, but with a PE ratio of about 10x, organic growth of 7-10% and a strong balance sheet, we believe its recovery will continue to gather pace.
ConvaTec: convincing convalescence
The second half of 2017 was a tumultuous one for medical-equipment maker ConvaTec, as manufacturing issues weighed on profits and organic growth.
The company was struck by hurricanes in the Dominican Republic, where it makes its advanced wound-care products. This disrupted shipping lanes in the Caribbean, resulting in backlogs and the loss of some orders. The unfortunate timing of the logistics problems, which occurred one year after it became London’s largest initial public offering in 2016, exacerbated the share-price reaction.
The departure of the group’s chief financial and operating officers last year also heightened the uncertainty about the company’s performance. Despite this torrid run, we retained our holding in ConvaTec, viewing the production issues as temporary. And our view was reflected in the company’s full-year results, which dispelled any lingering concerns.
ConvaTec stated that the fundamentals of the business “remain strong”, revealing that the manufacturing issues in the Dominican Republic have been resolved. 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.
Looking ahead, the company pointed to higher investment this year and left earnings expectations unchanged. Management also reasserted its belief that margins can expand “materially” in the medium-term, and organic growth should return to 4-5% over the same time period.
ConvaTec remains in a strong position across its four divisions – advanced wound care, ostomy care, continence & critical care, and infusion devices – in a capital-light, high-margin, oligopolistic industry which benefits from structural tailwinds. Nevertheless, market sentiment towards the company is weak, which is reflected in the company’s valuation at its current P/E of about 16x – a 10x discount to its closest peer. It is still early days in the stock’s recovery, but we are confident that our patience in ConvaTec will pay off.
Nokia: a 5G-driven rebound?
Disappointing third-quarter results weighed heavily on Nokia last year, prompting a sharp slide in its share price. At the time, the Finnish mobile-telecommunications company attributed the lacklustre results to 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. Moreover, our long-term positive investment thesis held true.
First, cash flow in the third quarter was poor due to a timing-related issue which impacted inventory delivery. This would later reverse in the fourth quarter. Second, engineering problems caused delays in delivering software upgrades – an issue which has since been resolved. Furthermore, expectations of a share buyback failed to materialise (however, hopes for one never formed part of our original investment thesis). And finally, weak network sales reported in the third quarter were widely anticipated as the benefit of full-scale rollouts of 5G is not expected until 2019.
After a difficult few months, Nokia enjoyed some welcome respite, bouncing back to post strong fourth-quarter results. Network and technology sales both came in ahead of expectations, by 4% and 69% respectively, and earnings before interest and tax beat forecasts by 19%. Nokia ended 2017 with €4.5bn in cash, significantly ahead of expectations.
Network margins were lower compared to the third quarter, as Nokia began to trial 5G networks with clients. We view this development as positive and a signal that the implementation phase of 5G rollout has begun.
In addition, Nokia provided a credible 2020 guidance of 60% 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. And what’s more, it highlights that opportunities can arise when problems are temporary, rather than structural, in nature.
Siemens Gamesa: new generation
Siemens Gamesa Renewable Energy’s first year as a merged entity has been hampered by political uncertainty, US tax reform and the introduction of a competitive auction-model in India, which resulted in price erosion throughout the industry. Moreover, management problems at Siemens Gamesa also hurt sentiment. In April 2017, Gamesa 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. The group’s first CMD as an enlarged entity earlier this month also bolstered optimism in the stock, as it outlined its cost-savings plan.
Under the plan, Siemens-Gamesa is targeting cost savings of €2bn by 2020 through digitisation and manufacturing automation. We were also encouraged by the level of detail provided on efficiency plans as the group seeks to drive down the localised cost of energy in both onshore and offshore wind-power generation. This suggested that the group is well positioned for a recovery.
Siemens and Gamesa were technology leaders in their own right before they merged last year. As an enlarged entity, they can now use their combined strengths to bring leading turbines to market. In November, the group announced 6,000 job cuts to “strengthen the group and consolidate its position as a market leader”2.
The group set a target to increase its earnings before interest and tax margin to 8-10% by 2020. But double-digit revenue growth in both onshore and offshore wind-power generation, coupled with a growing services business, suggests forecast margins should be higher. While conservative targets are understandable following the travails of 2017, at 15x FY1 earnings per share, investors remain sceptical. Nevertheless, we believe Siemens-Gamesa is well placed to over-deliver on these revised targets.
Volatility passes, fundamentals endure
Bouts of volatility triggered by transient factors can spook the market into irrational sell-offs.
We aim to not be driven by emotion, but instead examine adverse issues influencing a company’s performance. We seek to understand the nature of these issues – for example, whether they are structural or temporary – and whether we can see a clear road to recovery. This requires discipline and patience, and ultimately helps us look beyond short-term turbulence and keep an evidence-based faith in the ability of our holdings to outperform.