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13 March 2019, Sweden | Mutual Funds | News

Stock picking and earnings

After a gloomy end to 2018 the new stock market year has begun very strongly. The US Federal Reserve has taken a softer stance and there are positive signals from the US-China trade talks. The reporting season was largely as expected, with an absence of negative news, and a Fed statement was enough to lift the stock market, say Catella's equity fund managers.

Martin Nilsson and Henrik Gripenvik, who manage Catella Småbolagsfond and Catella Sverige Aktiv Hållbarhet say the now-completed corporate reporting season for the fourth quarter was acceptable. However, it was the first quarter in six that fell short of market expectations when it comes to earnings, although sales at the aggregate level were better.

There were strong reports from the industrial and consumer staples sectors, while consumer discretionary was weaker. Automotive-related companies had a particularly tough time. Henrik Gripenvik says that a slowdown in the car market has been on the cards for a long time, and therefore seems to be no surprise.

"The most positive thing this reporting season was almost the lack of more bad news. It was automotive and China that were weak, which we already knew," says Gripenvik.

Industry dominates the Stockholm stock exchange, including the classic engineering companies. Gripenvik says that Sandvik's report was very much in line with expectations, and the weak elements such as China were known in advance.

"On the upside, its margin growth was a little better. It delivered good numbers while the market expected that this was where early cyclical exposure would hurt. And that didn't happen," he says.

He describes Sandvik's mining arm as quite strong, and it also follows something of its own cycle with plenty left to do when previously sold equipment needs to be replaced.

There is not much debt in Sandvik, can we expect an acquisition?

"They have promised that, but it might unfortunately be too expensive. They are making a thrust in software-related companies to strengthen their exposure to short cyclical in indexable inserts, and these are always companies with high price tags and not much sales. But they have guided for this and people understand that it is something they need to do," says Gripenvik.

In the wider industrial sector, he highlights Electrolux and Husqvarna, which were big losers from the commodity upturn in 2018 but which are now starting to get price rises through.

Heating company Nibe, which no longer fits the small cap fund due to its size, also issued an entirely acceptable report. The company set a new target for sales to increase to SEK 40 billion within four to seven years, which corresponds to annual growth of about 10 percent. Martin Nilsson, who has Nibe in his portfolio, says that this means the company probably needs to make acquisitions.

"What is a something of a shame from a small company perspective is that Nibe is getting so big that it may disappear from our universe at the next re-indexing this summer," says Martin Nilsson.

Nilsson says that other smaller companies in the sector worth watching are Hexpol, Lindab and Indutrade. Lindab reported an increase in operating profit of 45 percent, and Indutrade's report was also clearly better than expected, which caused the share to rise.

Recent times have been more troubling for real estate and construction companies. Nilsson describes the old business model for housing and home construction as broken; consumers no longer want to pay before construction is completed, which raises the question of who provides the capital.

Of the big construction companies, both Skanska and NCC came up with weak reports and lowered dividends, causing their shares to fall sharply. JM's report was more in line with expectations, while the small companies had a tougher time.

Housing developers have had a really difficult time recently, and many of them are also highly leveraged. This could open up opportunities for stronger companies like JM to acquire building land and other assets at attractive prices, but in general the fund managers believe that new building will remain under pressure.

"The oversupply has to be eliminated, through incentives like rent-free and price reductions. This is a painful time," says Martin Nilsson.

Will there be any point this year when it makes sense to pick up one of these companies?

"Maybe, as long as you keep to quality companies. A company like JM, which essentially has no debt and a very strong land bank, plus a strong Norwegian controlling shareholder who is buying shares, would be an interesting choice in that case," says Martin Nilsson.

Real estate companies have been strong at the start of the year and a lot of capital has been allocated to them. Property makes up a large part of the small cap index, over 20 percent, although most portfolio managers are underweight in the sector. Martin Nilsson describes their reports as divided, with disappointments from Balder and Hufvudstaden while Klövern and Kungsleden were strong.

One problem child on the stock market in recent years has been clothing giant H&M, and its fourth-quarter report offered no obvious turnaround, according to Henrik Gripenvik.

"This was unfortunately a low-water mark in terms of earnings. Once again it was mainly logistics costs and high levels of discounting that dragged, even though discounting levels were actually lower than last year," he says, adding that at least the company seemed to have gained better control of its stock.

Things have gone all the better for some of the online retailers in the clothing industry. One Catella Fonder investment has been Boozt, which is a newcomer in online branded clothing. Its report was strong, as was the report from the largest European company in the field, German Zalando.

"Online has provided upside surprises while more traditional retailing has had a tougher time. Zalando was highly shorted leading up to its report and rose over 20 percent when it presented a better margin, beat expectations by 10 percent and provided a good outlook. Boozt grew almost 40 percent year on year, with a margin that was in line with expectations, and guided for sales just under 30 percent higher in 2019," says Martin Nilsson.

Undoubtedly the most discussed sector so far this year is banking, with increasingly many banks in choppy water related to money laundering in the Baltics. The reports for the fourth quarter were mixed, with Handelsbanken and DNB a little better while Swedbank and, in particular, Nordea were weaker. But the issue of money laundering remains hanging over the sector - the question is, for how long.

There was previously a kind of consensus that banking was a good go-to as interest rates started to rise and provide better margins. Do you dare to go there now?

"This will probably hang around like a wet blanket over the sector for a while. Many investors that had exposure to Danske Bank jumped to quality in Sweden and to Swedbank when the holding hit a downhill slope. Then the problem spread there and so on," says Henrik Gripenvik.

Martin Nilsson warns against believing that what has happened is an overreaction and that the trouble will quickly blow over.

"If negative news keeps on coming then it is not an overreaction and the driver persists. It often carries on longer than you think," he says.

In the IT sector they have holdings in Ericsson, which was burdened by large extraordinary expenses and generally high cost levels last year. Henrik Gripenvik says that many in the market believe these problems will persist for Ericsson in 2019, but that does not have to be the case.

"We believe this is wrong and that there is potential for Ericsson to beat the forecasts," he says.

One of Catella Småbolagsfond's more successful holdings is Mycronic, which has long been heavily shorted by foreign hedge funds. This, in turn, has been highly profitable for Småbolagsfond, which has lent shares to the shorters at high interest rates.

"Hedge funds have paid up to almost 30 percent annual interest to borrow them. Unfortunately, they have now begun to close their positions, but it has been fantastic for the fund to gain from both the rising price and on lending," says Martin Nilsson.

On the commodities side, forest product companies generally issued slightly weaker reports for the fourth quarter, burdened by a lot of operational problems, which is often the case during the winter months. Martin Nilsson points out that once the stock market has understood the background to the report figures, such as those for SCA and SSAB, the shares have been able to retrieve initial losses.

Looking ahead for the year, which sectors look best and worst?

"It's on the cards for engineering that companies will start to go into negative organic growth for the first and second quarters. This is probably not entirely reflected in the expectations of analysts, but the market took it on board quite a long time back," says Henrik Gripenvik.

According to the fund managers, it is realistic to count on slightly worse report figures for the first and second quarters this year. If this is not the case, it would be a really positive surprise that would have a significant impact on share prices.

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Henrik Gripenvik

Fund manager
Direct: +46 8 614 25 56
Sweden

Martin Nilsson

Fund manager
Direct: +46 8 614 25 64
Sweden

Mikael Wickbom

Senior Sales Manager
Direct: +46 8 614 25 51

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