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Unearthing Europe’s hidden disruptors

Hermes European Equities

Home / Perspectives / Unearthing Europe’s hidden disruptors

Chi Chan, Lead manager, Hermes Eurozone
24 February 2017
European Equities

Famous ‘blue-sky’, pre-profit stocks may excite investors, but they also pose significant challenges. With extraordinary price-to-earnings multiples unsupported by cash flows, the appeal of these disruptors can be tempered by their financial viability. It is worth remembering that not all innovators make headlines, and here we profile two companies capitalising on long-term change in their respective industries.

The lure of ‘the next big thing’ is understandable. Visionary companies like Tesla have the potential to generate enormous returns if they can harness and monetise innovative ideas. However, these stocks also carry considerable risks. Their value is often intangible and unsupported by near-term earnings, accompanied by dizzying price-to-earning (P/E) multiples. Investors’ holdings may also be diluted in further rounds of fundraising.

On the other hand, stocks in apparently dull industries have the potential to shine over the long term. While their industries may not epitomise the technological zeitgeist, they can still be disruptive. Finding the businesses that are responding innovatively to challenges such as the globalisation of supply chains and the demands of e-commerce can provide ample rewards for investors.

We have invested in companies focused on warehousing and packaging that are capitalising on the changing needs of their end clients. Their products or services may not claim to be the next big thing, but they do offer compelling long-term returns.

KION Group
Warehousing and forklift trucks may seem out of place in the new economy, but the evolving needs of e-commerce and general retail mean that the emerging innovators in this space are reaping rewards. Kion Group, the second-largest manufacturer of forklift trucks in the world and a leading automated systems provider, is one such company.

The company has already enhanced its automated systems capabilities by acquiring Egemin Automation and Retrotech, which provide automated material-handling systems and warehousing systems integration. Kion also recently acquired Dematic, one of the market leaders in warehousing systems and automation. These acquisitions have enabled Kion to provide an automated 24-hour service, a function that is becoming increasingly important for warehousing operators responding to the demands of e-commerce, which include increasingly rapid dispatch times. We believe Kion’s commitment to responding to this change will fuel future earnings growth.

We first invested in the company in October 2015 for one of our strategies and have recently added a position in the business to another of our portfolios. While its shares initially languished at a P/E multiple of about 12x given the market’s assumptions of the business’s cyclicality, they have since re-rated after its long-term growth prospects became clear. Kion currently trades on a 15.8x P/E multiple and 5.1% free cash flow yield for 2017.

Source: Bloomberg

Smurfit Kappa
This Ireland-headquartered company provides cardboard packaging globally, leading the market in Europe and also running strong operations across Latin America.

The previously fragmented packaging industry has been consolidating. The globalisation of the fast-moving consumer goods producers, from which Smurfit draws 60% of its operating volumes, creates a need for packaging suppliers that can provide worldwide support and to higher technical specifications. Larger operators like Smurfit have the revenue base to invest in packaging innovations and in more efficient packing equipment.

Smurfit’s global presence enables it to draw on its experience in one region to provide innovative solutions for clients in another. For example, its packaging solution for watermelons was drawn from its method for transporting another client’s footballs. This customisable service proposition also helps to establish longer term relationships with clients.

The company has recently developed technology enabling it to show customers how their packaging designs will appear on various supermarket shelves across the world.

Source: Bloomberg

Choose your disruptors
When investors discuss innovation, it is often Tesla, Facebook and other famous disrupters that dominate the conversation. Yet stocks such as these, with unproven business models, have carried significant risks for investors in the past and many continue to do so. By considering the companies that are disrupting or capitalising on the benefits of established industries, investors may find that they can access growth fuelled by innovation – coupled with reliable prospects for future earnings – without taking on the same level of financial risk.

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Chi Chan Lead manager, Hermes Eurozone Chi Chan joined Hermes as an analyst in 2009 and is now lead portfolio manager of the Hermes Eurozone strategy. Prior to this, in early 2004 he joined Execution Limited as a senior telecoms analyst with lead responsibility for companies with an aggregate market cap in excess of €200bn and established a reputation for interesting and commercial analysis. Previously he was at Credit Suisse First Boston, initially supporting the inception of the global value-based research group (the predecessor to HOLT) before being recruited internally to join the highly-rated pan-European telecom team. Chi started his career at the financial services practice of Ernst & Young where he qualified as a Chartered Accountant after graduating from UMIST in 1997 with a BSc in clothing engineering and management.
Read all articles by Chi Chan

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