Bellevue Entrepreneur Europe Small

European small and mid caps, as measured by the MSCI Europe Small Cap ex-UK, rose 0.2% in September slightly outperforming European large caps (SXXR -0.3%). Following a relative weak start into the month, equities generally rebounded sustained by a combination of 3 factors: 1) a 50 bps cut from the Fed 2) a pickup in US economic data, signalling the unlikelihood of a sharp downturn for now, and 3) significant Chinese stimulus announcements, leading to a surge in local markets and China exposed stocks (Shanghai Index SSE up more than 20%). Europe was less exciting, with the Eurozone flash PMI failing to remain above the key 50 level (48.9 in September from 51.0 in August), impacted by a deepening of the downturn in the manufacturing sector (44.8 vs 45.8) while services remained in expansion territory. In terms of sector performance, chemicals (+5.9%), insurance (+4.3%) and real estate (+3.8%) performed best while energy (-5.4%), healthcare (-2.4%) and technology (-1.8%) lagged the most.

Against this backdrop, the fund increased by 0.5% (EUR / B shares), outperforming its benchmark by 37 bps. This brings the performance to 10.7% for the first nine month of 2024, a 336 bps beat vs the benchmark.

Top detractors in the month were Subsea 7 (-10.1%), Rovi (-10%) and Do & Co (-10.3%). Speculations about Rovi’s CDMO assets sale hit the press, with a Spanish Newspaper mentioning CVC likely to offer EUR 3 bn, at the lower end of the valuation range. Other than the value of the deal, other questions remain unanswered: Will Rovi keep a minority stake? how will the cash be allocated or re-invested, ie is a jumbo dividend possible? The actual market cap of EUR 3.7 bn now discounts a very low multiple to the non-CDMO business. We had reduced our position following a management meeting in early September. Subsea 7 experienced further profit taking related to the probability of a weaker Q3 order flow after a very strong Q2. Also, the oil price has been falling since April due to lower economic growth in China and Europe despite geopolitical uncertainty. A recent meeting with the management left us confident about the general activity levels for both conventional O+G and offshore wind for the subsea contractor. After a strong first half, Do & Co was subject to profit taking despite having published strong quarterly results marked notably by an excellent topline growth of 38%, including +40% in airline catering where the company continues to gain market shares. Operating margins were down 60 bps to 6.6% which remains a very decent profitability level for the sector, particularly as start up costs in the US temporarily weigh on margins.     

Top performers in the month were Fuchs (+14.5%), Nexans (+12.8%) and Sopra Steria (+8.0%). As an early cyclical exposed to global industrials and auto, Fuchs benefited from both the Fed cut and the China stimulus. We feel the company has been overly sanctioned by the recent auto sector weakness, considering Fuchs exposure to first-fill OEM lubricants is only 10%. Nexans maintained its upward trend underpinned by positive newsflow related to the Great Sea Interconnector, a EUR 1.9 bn project aiming at connecting Cyprus to the European electricity network through Greece. While a lot remains to be finalized in this highly complex project, these progresses are contributing to the gradual rerating of Nexans which remains highly undervalued in light of its strong growth prospects. Sopra Steria rebounded as some early cyclicals IT services players showed improving business trends. Sopra’s next growth phase will be sustained by recurring large digitization projects and the ramp up of its high margin consulting activity. At 7.5x 2024 EBIT, the risk reward is attractive.

The European equity opportunity is slowly sinking in. At the same time, European small and mid caps benefit too as the asset class is offering an interesting entry point with valuations below their large caps peers for the first time since 2008. The massive valuation gap with European equities trading at 14x forward earnings, compared to 21x for the S&P 500 speaks for the region. What could be the triggers to a rerating? China seems less bad and we have witnessed some positive macro data. The Caixin China General Manufacturing PMI increased to 51.1 in March, the fifth straight month of growth in factory activity. Copper reached an 11-month high. Also, compared to the Fed, the European Central Bank finds itself in a less complicated situation. The business cycles of the US and Europe have decorrelated a lot in the last 6-12 months and while growth expectations rise in the US, it is the opposite in Germany and a large part of Europe. Finally the March BofA's global fund survey showed the largest increase in allocations to European equities since June 2020. After 3 consecutive years of outflows, it’s time to reconsider European small and mid caps.