BlackRock Greater European outperforms

BlackRock Greater European outperforms – Over the year to 31 August 2019, its NAV increased by 6.3%, outperforming the World Europe ex UK Index which rose by 4.8%. The share price increase was even better, rising by 7.9% over the same period. The dividend was increased slightly from 5.75p to 5.85p. Some of that is being paid out of capital after a fall in revenue for the year.

Extract from the manager’s report

Sberbank was the top performing position in the portfolio over the period. We had initiated the holding on the expectation that the earnings revision cycle was underestimated by the market. Following easing of sanctions towards Russia and realisation of improving earnings the stock rallied. As it reached what we deemed to be its fair value, we exited the position.

Within the consumer space, positions in Royal Unibrew, Ferrari and Adidas were all notable contributors to performance. Royal Unibrew is a new position initiated in the Company during the year, which operates in consolidated markets for both brewing and beverages. We like Royal Unibrew’s decentralised structure which allows for on-the-ground managers to respond quickly to trends for products, brands and packaging and make capital allocation decisions which support the realisation of strategic and financial targets. This has translated
to an attractive return on invested capital (ROIC) of circa 25% for the business.

Shares in Ferrari performed well as the company continued to execute on its long-term targets to double earnings before interest and taxation (EBIT) by 2022 from 2017 base levels. Their most recent results saw EBIT ahead of consensus and Free Cash Flow targets upgraded, with the latter aided by this year’s supercar, the Monza. We believe Ferrari’s plan to double EBIT is more than achievable as they use their brand exclusivity to push through pricing increases on car models and ancillaries which will lead to EBIT margins of circa 38%. This compares very favourably to typical high-end car brands and, importantly, we believe it will be sustainable in the long-run.

The Company also realised strong performance from a holding in aerospace engine maker Safran. Safran has executed strongly on the ramp-up of its new LEAP engine, maintaining its dominance in the narrow body plane market. In addition to building for new deliveries, the business has enjoyed accelerating growth in their aftermarket civil business which is supported by the strong aerospace cycle as demand for air travel continues to grow. The aftermarket business is highly cash generative as aircraft come in for servicing on regulated schedules. This gives management the confidence to predict high-single-digit revenue growth for this portion of the business out to 2025, providing a level of resilience for earnings with any potential slowing in the aerospace cycle.

A long-standing position in Novo Nordisk was also a notable contributor to Company performance. Novo has a dominant diabetes drug franchise which has grown at a mid-single-digit rate in recent years. Further growth is being fuelled by the launch of new products, such as their injectable GLP-1 which has shown to have better cardio vascular and weight loss outcomes than competitor products, driving strong rates of adoption amongst the patient population. We expect Novo to file their oral GLP-1 towards the end of 2019, which will be sold into a US$12 billion addressable market at what we feel is likely a more attractive price point than the market is expecting. Novo’s clean accounting, sound corporate governance and strong capital allocation have made it a core holding within our portfolio.

From a sector stand point, the Company continued to exhibit a lower allocation to European financials and in particular European banks. This benefited relative returns as the banking sector saw downwards earnings revisions based not only on the cyclical pressure of low rates, but harsh competitive dynamics which have been further heightened by recent regulatory changes such as the Payments Service Directive II. With this regulation, and falling customer loyalty in a digital age, we believe the banks will suffer yet further competition from more nimble fintech players and thus continue to see key measures of profitability fall. Where we have invested in European banks we have looked for those operating in more consolidated markets with better pricing dynamics and higher Returns on Equity. Regrettably, our position in Danske Bank, which is fundamentally better positioned than the majority of European banks, detracted from returns as news headlines hit of Anti-Money Laundering scandals in their Estonian division. This led to reduced profitability in the financial year as management acted to donate all profits from this division. We opted to sell the position as guidance for future earnings was revised down.

Whilst the Company generally benefited from its consumer goods sector allocation over the year, relative returns were dented from not holding a large benchmark position in Nestlé. Nestlé realised strong returns over the period, in part fuelled by its ‘bond like’ characteristics which put the shares in high demand as both equity and fixed income markets exhibited a higher level of volatility. We recognise the strengths of the Nestlé investment case, with a resilient portfolio and some areas of attractive growth, such as pet food. However, in a highly concentrated portfolio which exhibits strong competition for capital, we have struggled to find a place for the shares over the last year, given its relative size in the index and the long-term conviction we have in the company’s ability to deliver above-market levels of growth.

Within the Emerging portion of the portfolio, a position in Bezeq Telecoms detracted from performance. We entered the position in anticipation of a regulatory change that would allow the industry to improve returns and increase investment in the Israeli telecom infrastructure. A series of delays at the political level culminating in two elections has interrupted this reform and put increasing pressure on returns and share prices. We maintain the position into the September 2019 election in the hope that regulatory reform may yet bear fruit.

A holding in marine and energy exposed engine manufacturer Wartsila also detracted from returns over the year. We had held the business based on a supportive outlook for both their energy and marine services operations, which
were meant to be complemented by re-acceleration of growth in its high margin aftermarket business. We decided to sell the position as it became increasingly clear clients in Europe were delaying investment decisions on power generation projects due to uncertainty introduced by wholesale changes to the energy mix. At the same time, the outlook for the marine side of the business deteriorated as slower trade led to customers pushing out maintenance or replacing high margin spare parts purchases with lower cost alternatives.

BRGE : BlackRock Greater European outperforms

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