This document is solely for the use of professionals and is not for general public distribution. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested. Is there still a case for European Small Caps? Richard Brown Investment Specialist, Pan European Equity
A hope rally where next? EPS expectations 30% 25% 20% 15% 10% 5% 2013 EPS growth estimate 2014 EPS growth estimate MSCI Small Cap Europe total return (RHS) 17.1% 23.4% 7.4% 170% 160% 150% 140% 130% 120% 110% 100% 0% 90% Jan 12 Apr 12 Jul 12 Oct 12 Jan 13 Apr 13 Jul 13 Oct 13 Jan 14 Source: JPMorgan, IBES, Henderson Global Investors, 24 January 2014 1
Valuations it will get uncomfortable Valuation (Small and mid caps) 15-year average 15-year peak Current Upside to 15-year average Upside to 15-year peak P/E (trailing) 17.1x 20.5x 19.1x -10.6% +7.6% P/E Yr+1 13.9x 16.5x 16.0x -13.2% +2.7% P/B 2.3x 3.0x 2.4x -6.7% +23.2% Source: Henderson Global Investors, JP Morgan, IBES, as at 31 January 2014 Excludes tech bubble multiples 2
Current P/B (x) Valuation low versus other regions and large caps 4,5 4,0 US large cap 3,5 3,0 US small cap Global large cap Europe large cap Asia large cap 2,5 2,0 Global small cap Asia small cap Europe small cap 1,5-25,0-20,0-15,0-10,0-5,0 0,0 5,0 Upside to historic P/B average (%) Source: Henderson Global Investors, JP Morgan, as at 31 December 2013 3
Europe Economic data improving Manufacturing PMIs 70 70 60 60 50 50 Eurozone 40 Germany Italy France UK 30 2006 2007 2008 2009 2010 2011 2012 2013 40 30 Source: Bloomberg, as at 31 January 2014 4
The cycle Back testing results using four complete cycles Phases of the economic cycle* and investment style preferences Merrill Lynch Style Cycle Neutral value vs growth. Overweight rising momentum, high risk and small caps vs large caps. Overweight growth vs value, rising momentum, high quality, low risk and large caps vs small caps 1 2 Positive economic growth Negative economic growth Extended expansion Slowdown Recession Recovery Recession Recovery 3 4 3 4 Overweight value vs growth, high quality and low risk. Neutral large caps vs small caps. Overweight value vs growth momentum, low quality, high risk and small caps vs large caps Phase 1 Rising and accelerating; Phase 2 Rising and decelerating; Phase 3 Falling and decelerating; Phase 4 Falling and accelerating Source: Merrill Lynch, MSCI, IBES, Henderson Global Investors, as at September 2008 Note: Merrill Lynch European Quantitative Strategy - Back testing period January 1992 to January 2004 * Economic cycle based on the Merrill Lynch composite macro indicator 5
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 M&A - where is it? M&A volume (Euro millions) 1.600.000 1.400.000 Deal volume ($bn) > 10bn 5bn to 10bn Deal volume ($bn) 1.200.000 1.000.000 800.000 600.000 400.000 200.000 1bn to 5bn Deal number > 10bn 5bn to 10bn 0 100 200 300 Deal number - 1bn to 5bn 0 50 100 150 Source: Henderson, as at 13 February 2014 European M&A volumes Deal value and deal number refer to last twelve months in Western Europe 6
Q1 2007 Q2 2007 Q3 2007 Q4 2007 Q1 2008 Q2 2008 Q3 2008 Q4 2008 Q1 2009 Q2 2009 Q3 2009 Q4 2009 Q1 2010 Q2 2010 Q3 2010 Q4 2010 Q1 2011 Q2 2011 Q3 2011 Q4 2011 Q1 2012 Q2 2012 Q3 2012 Q4 2012 Q1 2013 Q2 2013 Q3 2013 Q4 2013 Euro (Bn) Corporates have the cash to reinvest Cash on balance sheets 1000 900 800 700 600 500 400 300 200 100 0 Source: Factset, Henderson Global Investors, as at 31 December 2013 7
Why European small cap Superior earnings growth Valuation not a barrier 35% of small caps are down >50% since peak Attractive versus other regions Russell 2000 +32% since June 2007 MSCI EMU small cap -15% since June 2007 Small caps the beneficiary of the M&A cycle Source: Henderson Global Investors, JP Morgan, as at 31 January 2014 8
European small cap Where is the value?
Domestic Europe no secret EPS revision ratio for exposure baskets 1,8 Domestic EU exposed US exposed 1,6 EM Industrials exposed EM Consumer exposed 1,4 1,2 1,0 0,8 0,6 jan/11 apr/11 jul/11 okt/11 jan/12 apr/12 jul/12 okt/12 jan/13 apr/13 jul/13 okt/13 Source: BofA Merrill Lynch European Investment Strategy, 31 December 2013 10
mei/02 sep/02 jan/03 mei/03 sep/03 jan/04 mei/04 sep/04 jan/05 mei/05 sep/05 jan/06 mei/06 sep/06 jan/07 mei/07 sep/07 jan/08 mei/08 sep/08 jan/09 mei/09 sep/09 jan/10 mei/10 sep/10 jan/11 mei/11 sep/11 jan/12 mei/12 sep/12 jan/13 mei/13 sep/13 What's important in 2014? Correlation 0,7 0,6 Average pairwise Correlation - MSCI Europe 0,5 0,4 0,3 0,2 0,1 0 Source: Datastream, Henderson Global Investors, as at 12 February 2014 11
What's important in 2014? Gartmore strategy Contribution to tracking error (%) 70,00 60,00 50,00 40,00 30,00 20,00 10,00 -- Stock Style Industries Countries Currencies Source: Henderson Global Investors, as at 20 January 2014 12
Why go active in small cap 1000 900 36 34 942 40 35 800 700 30 600 22 25 500 20 400 300 200 100 0 Number of companies Average number of analysts covering the stock (RHS) 4 56 >100 >20 5 to 20 100m to 5bn 116 6 15 10 5 0 Source: Bloomberg, Henderson Global Investors, as at 12 February 2014 13
okt/10 jan/11 apr/11 jul/11 okt/11 jan/12 apr/12 jul/12 okt/12 jan/13 apr/13 jul/13 okt/13 jan/14 Anti-consensual stock picking Gartmore Eurofins Scientific analyst recommendations (+178% HPR*) Pandora stock price DKK Buy Neutral Sell Total 400 Initiation (Oct 10) 3 1 3 7 At sale (Oct 12) 7 4 2 13 350 300 Oerlikon analyst recommendations (+183% since purchase) 250 Buy Neutral Sell Total Initiation (Nov 11) 2 4 1 7 Now (Jan 14) 7 4 2 13 200 150 Initiated position Pandora analyst recommendations (+320% since purchase) 100 50 Buy Neutral Sell Total Initiation (Jan 12) 4 5 1 10 0 Now (Jan 14) 9 2 1 12 Source: Henderson Global Investors, Bloomberg, as at 23 January 2014 HPR = Holding period return The above example is intended for illustrative purposes only and is not indicative of the historical or future performance of the strategy or the chances of success of any particular strategy. Henderson Global Investors, one of its affiliated advisors, or its employees, may have a position mentioned in the securities mentioned in the report. References made to individual securities should not constitute or form part of any offer or solicitation to issue, sell, subscribe or purchase the security. 14
Where next? Sacyr Spanish commercial property Gerry Weber Mature German consumer Meyer Burger Solar equipment orders returning Faiveley Rail equipment orders returning Gamesa Wind power remains 15
Restructuring Management taking action Oerlikon (Disposals Focusing on high growth Asia exposure) Pandora (Returning to core market) Fugro (Disposals) EFG International (Disposals and cost cutting) Tessenderlo Chemie (Disposals Focus on high margin businesses) Nobia (Cost savings) FLSmidth (New CEO/CFO) Safilo (HAL) Clariant (Divestments/ acquired sud chemie) C&C Tennents/US Cider Kuoni Divestments Uniqa (Austrian insurance) Gamesa (Wind turbines) 16
mrt/06 aug/06 jan/07 jun/07 nov/07 apr/08 sep/08 feb/09 jul/09 dec/09 mei/10 okt/10 mrt/11 aug/11 jan/12 jun/12 nov/12 apr/13 sep/13 jun/11 aug/11 okt/11 dec/11 feb/12 apr/12 jun/12 aug/12 okt/12 dec/12 feb/13 apr/13 jun/13 aug/13 okt/13 dec/13 Restructuring Oerlikon CHF 120 Oerlikon share price 100 80 60 40 20 0 CHF 16 15 14 13 12 11 10 9 8 7 6 5 4 3 Solar business disposal How do they spend the money? Natural fibres disposal 2012 disposals c.chf250m Source: Datastream, as at 20 January 2014 The above example is intended for illustrative purposes only and is not indicative of the historical or future performance of the strategy or the chances of success of any particular strategy. Henderson Global Investors, one of its affiliated advisors, or its employees, may have a position mentioned in the securities mentioned in the report. References made to individual securities should not constitute or form part of any offer or solicitation to issue, sell, subscribe or purchase the security. 17
Restructuring Nobia Revenue decline offset by cost cutting 18.000 Revenue (SEK million) 16.000 14.000 12.000 10.000 8.000 6.000 4.000 2.000 42 41 40 39 38 37 36 35 34 33 0 2009 2010 2011 2012 2013 2014 32 Source: Henderson Global Investors, Bloomberg, as at 31 December 2013 18
Market summary high liquidity, low growth Core assumptions 1) Low GDP growth 2) Stubbornly low inflation 3) Low interest rates 4) Expect earnings to recover 5) Long drawn out recovery over a number of years Therefore: Small caps a good place to be Still 23% below peak P/B Leverage on global growth (2.2x on average) Source: Henderson Global Investors, JPMorgan, as at 31 January 2014 19
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