Solid Silver at Sohn

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May 21, 2024
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The Sohn Conference is a long standing charity that raises money for medical research in the format of a series of short pitches of investment ideas with a 12 month horizon. Attendees and Managers are essentially invited to back the ideas and give some or all of their profits to the charity. Originally founded in New York, the conference has expanded internationally and last year saw the 12th Hong Kong conference, and the first since Covid.

We were thus honoured at Tosca HK to be given the opportunity to present this time last year and delighted to see that our pick, Italian Bank BPER, has come a solid second with a return of over 100% in $ terms. To be clear, this was a team effort, the conference came a month before we launched our Tosca Market Thinking UCITS fund here in Hong Kong and the nature of the fund is such that it invests in Themes and Factors, not individual stocks. As such, we took one of our themes - European Financials - and enlisted the help of the Toscafund specialists in London for their preferred stocks in the sector. So kudos to Rob Sheward and Johnny De la Hay for pointing us to Italian Bank BPER.

Of course, at this point we should note that this is not investment advice. Please do your own research and speak to a financial advisor.

However, in the interest of information and (possibly) entertainment, we reproduce below some of the points from out presentation of a year ago.

Our thesis was that we are now in what we refer to as the new ‘New Normal and thus we are looking to invest in companies that have the following characteristics: (from the slide deck)

·  Companies that benefit from ‘normal’ levels of short rates​

· Companies with improved pricing power under ‘normal’ levels of competition

·  Companies that are highly operationally leveraged and  able to deliver significant profit and cash flow growth from modest top line growth​

· Companies with strong balance sheets able to pay our dividends and buy back shares​

·  Companies that are ‘cheap’ and will benefit from re-rating as well as cash flow growth​

We picked European Banks as a sector/thematic that hit all of these criteria. Again from the presentation we pointed to:

·   Net Interest Margins going from 1.5% to 3.5%​

·   Elimination of many ‘Challenger Banks, private credit, private equity that benefited from previous regime

·   Profits coming in not just 40% higher, but 40% higher than consensus expectations.​

·   All European Banks regulated as highly as Tier 1 US Banks

·   European banks had been forced to triple capital and not allowed to pay dividends or buy back shares. Until now.

·   Valuations close to all time lows

We were also ‘fortunate’ in the timing. We already had the underlying story and the sector had delivered a 30%+ return from May 2022 to early March 2023, but the Silicon Valley Bank debacle had led to a widespread correction across all financials such that we saw this as a classic example of an oversold position due to macro/emotional mispricing that would unwind over the following 12 month period. As such this was a second chance at a story that we not only expected to play out, but had already seen evidence of it happening. As we said at the conference, this was not to be willfully contrarian, but was an ‘even better’ story because the valuations reflected the fact that, this time a year ago,

·  ‘Everyone’ hates Europe​

·  ‘Everyone’ thinks the US banks story maps onto Europe. ​

·  ‘Everyone’ thinks an economic slowdown ‘isn’t in the price’​

From the European banks, we picked BPER as the stock we saw with the most upside, and indeed, it has ranked only just behind Banco de Sabadel as the best performer in the sector - 104% in $ terms versus 114% - although worth noting that Sabadel has just been bid for (!) In the meantime, the Net Interest Margin at BPER has gone from 1.3% to 2.6% and dividends have gone from 0.12c to 0.44c

The oversold position due to the macro/emotional mispricing has obviously gone now and the 100% return means a lot of the ‘easy’ value has been returned (although it’s only ever easy in hindsight!), but the Sabadel bid certainly helped the run in BPER, as it showed other banks are prepared to pay up for Bank assets, not just buy back their own shares. As such, investors are realising that the re-rating can be done by the companies themselves and that European Banks really are not the same as the US Banks. Also, a year on, the recognition that diversification away from US Tech is sensible from a portfolio construction point of view is helping form a more positive view on Europe and with Financials the biggest sector in the European index, that means a more positive view on the sector generally.

In our view then, despite this performance, all this suggests there remains good value in the sector -  and even though dividends are highly unlikely to grow 4x again, the thesis about winners from the new New Normal remains intact and in many cases yields are still higher than P/E’s, which is never a bad thing for investors looking to buy a stock. (Still not investment advice!)

As for this year, well, in our Tosca Market Thinking Fund we still like European Financials as a theme, but we also like (inter alia) Robotics, Cyber Security, Global Mining, Japanese wholesale companies, Energy Infrastructure, Global Fintech and Chinese Internet stocks. But outside of the Sohn Conference we don’t take single stock bets….

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