Market commentary, June 11, 2020

European small and mid caps - resilient amid the crisis!

The world economy has been battered by the coronavirus. Small and mid-sized European companies - of which many are entrepreneur-led businesses - could become stronger through the crisis, says Birgitte Olsen, Lead Portfolio Manager of the BB Entrepreneur Europe Small Fund at Bellevue Asset Management.

European small and mid caps have a long and consistent track record of outperformance, fueled not least by their ability to deliver better-than-average, profitable growth. That makes them an attractive investment proposition in today's market environment distinguished by low interest rates and low economic growth.

As the corona crisis unfolds, European small and mid caps are in relatively better position, mainly because of their solid balance sheets, lower debt ratios and historically astute cost management practices. Regardless whether the economy experiences a V- or U-shaped recovery, these companies are likely to maintain their strong earnings growth and show greater flexibility along the way, which should ultimately translate into a positive performance for their shares.

Markets are on a strong rebound, but investors should still not compromise when it comes to quality. Solid balance sheets and cash flows remain important criteria because companies that were in a strong position before the crisis struck will be the only ones that will be able to capitalize on the current situation at the expense of weak rivals and reap the best rewards. The following questions are most relevant with regard to the corona crisis: What is the outlook for demand post-Covid? Is management still investing in the implementation of its growth strategy?

Heavily indebted companies cannot make such investments in the current environment. Instead of focusing on strategy execution, management at these companies is spending more time securing credit lines, drawing up ad hoc cost-cutting measures and protecting company liquidity. The current environment favors small and mid cap companies, especially the entrepreneurs within this segment, which have historically taken a much more conservative approach to financial matters. Many entrepreneur companies even have high net cash positions, which gives them additional leeway to invest in their business or pursue M&A.

Highly resilient healthcare sector
Valuation is and remains one of the key criteria when it comes to investing. The discrepancy between value and growth stocks has become more conspicuous as investors bid up the premiums on growth stocks. Tech as well as healthcare stocks have profited from this. Healthcare has demonstrated resilience to market uncertainties since 2018 and the sector was remarkably immune to the corona crisis, which is reflected in its significant outperformance of the broader market.

Arjo is one such example. This Danish company supplies goods and services to hospitals and homes for the elderly. One of Europe's leading producers of hospital beds, it has witnessed an increase in demand for its beds. Healthcare infrastructure will remain an important topic in the public sector going forward too. Attention is also drawn to a promising new product developed by Arjo called Wound Express, a therapeutic system consisting of a pump and inflatable cuff that is used to treat open sores, which heal poorly in elderly persons, if at all. This innovation marks Arjo's entry into the medtech business and its shares are likely to see an upward re-rating.

In the tech sector, S&T has an interesting profile. This Austrian IT services provider is a specialist for "Internet of Things" solutions across various industries, ranging from manufacturers and the transportation and energy industries to medical and communications companies. Its outlook for 2020 is intact and the company's steady growth, expanding margins and active M&A strategy should likewise lead to a long-term re-rating.

Strong niche manufacturers
Manufacturing companies within the entrepreneur universe that are active in niche markets offer good opportunities. Battery manufacturer Varta, for example, is the global leader for miniature batteries and is likely to profit from structural trends involving small devices such as hearing aids and wireless earbuds. In addition to substantial profit growth, the investment case for Varta is backed by the company's strong cash flows and increased budget for capacity expansion.

Invisio, the global market leader for advanced communications and hearing protection systems in challenging environments, is another case in point. It has a 99% share of the market for special headsets for police officers and military personnel, and the overall penetration rate in its target markets is less than 10%. The corona crisis has not dented its business whatsoever so far this year and we are modeling >20% annual sales growth for Invisio over the next three years. The Swedish firm is poised to harvest the rewards of its past fixed investment and offers further upside potential over the coming quarters.

Summary
European stocks have clearly underperformed their US counterparts. Europe's relatively good response to the pandemic has not made a difference here. Massive stimulus from national governments and central banks gives stocks good downside support and has improved market sentiment since mid-March. The EUR 750 bn recovery fund championed by Merkel and Macron could lay the groundwork for a stronger European Union with a stronger sense of solidarity. This announcement has triggered a rotation into small and mid caps and cyclical laggards, which has led to a slight outperformance by European stocks since the end of April.

For further information:

Bellevue Asset Management AG, Seestrasse 16 / P.O. Box, CH-8700 Küsnacht/Zurich
Tanja Chicherio, Tel. +41 44 267 67 09, tch@bellevue.ch

www.bellevue.ch

Bellevue Asset Management
Bellevue Asset Management and its sister company StarCapital based in Oberursel outside Frankfurt, Germany are part of Bellevue Group, an independent, Swiss financial group registered in Zurich and listed on the Swiss Exchange SIX. Bellevue was established in 1993 and is a leading investment boutique specialized in healthcare equities and traditional as well as alternative investment strategies with assets under management of CHF 10.6 bn.

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