Economic uncertainty is creating ‘attractive opportunities’ in Europe

Marlborough European Special Situations was recently named best European small and mid-cap equity fund over five years in the Refinitiv Lipper UK Fund Awards 2023.

Here, the fund’s manager, David Walton, explains why he believes economic uncertainty has created a highly attractive long-term opportunity to invest in quality European companies at lower valuations.

Companies in Europe are contending with a slowdown in industrial activity and reduced spending by consumers, as a result of stubbornly high inflation and rising interest rates.

Inevitably, some businesses will struggle in this climate. However, we have around 4,000 companies to choose from in Europe and we take a highly selective approach. We look for undervalued companies with high-calibre management, relatively low levels of debt and strong drivers for growth. These are companies we believe can continue to increase their earnings, despite a challenging macroeconomic backdrop.

We particularly favour smaller companies because their growth potential is often overlooked by the majority of investors.

One example of a small cap we hold that we believe can maintain its growth trajectory despite the economic uncertainty is Mersen. This is a French company that makes sophisticated components for electric vehicles and specialist equipment used in the manufacture of solar panels. Despite the economic climate, the accelerating switch to electric vehicles and the rapid expansion of renewable energy production are continuing to provide powerful drivers for growth.

The company recently announced around €300m of new investment over the next three years to increase its production capabilities. In addition, it has set aside €100m for growth-enhancing acquisitions.

Mersen is targeting an increase in annual sales of more than 50% over the next five years, from €1.1 billion in 2022 to €1.7 billion by 2027.

Our largest holding in the fund is another small cap, Swiss company u-blox, which designs wireless modules that locate and connect devices. It has just announced first-quarter sales up 20%, on a constant currency basis, and this follows what was already a strong performance in 2022, when sales were up around 50% in the first half of the year.

u-blox is benefiting from increasing sales to car manufacturers and also strong demand in the industrial sector, where businesses are seeking to connect more and more of their machines to the internet. This enables companies to monitor the performance of individual machines and intervene with preventative maintenance work before things go wrong, thus reducing costly downtime.  

We believe u-blox can maintain its growth through a period of economic uncertainty and the company should be very strongly positioned when the economic backdrop improves.  

While we have a bias to smaller companies in the fund, we also invest in larger companies that we believe look undervalued relative to their strong growth potential. As an example, in recent months we have added Danish pharmaceutical company Lundbeck to the portfolio.

Shares in the company had sold off because of concerns about the expiry of patents for several of its drugs, which will open the way for competitors to enter the market with lower-priced generic products.

However, we think this news is now largely priced in, and Lundbeck has a number of very promising new drugs coming to market over the next two to three years, which could more than offset the loss of revenues from patents expiring. One of these new drugs is to treat agitation caused by Alzheimer’s and we believe demand for this could be especially strong.

Lundbeck has a particular focus on neurology, which is a challenging field but one where there is significant unmet need. In our view, this means the company is strongly positioned for continuing growth.

In addition, we have added large-cap German chemicals distributor Brenntag to the portfolio. The company is increasingly shifting its focus from lower-margin bulk chemicals to the distribution of higher-margin speciality chemicals. We believe this a sensible growth strategy.

We have also been impressed by CEO Christian Kohlpaintner, who joined three years ago, and has taken a more dynamic approach to reducing costs, improving margins and making strategic acquisitions.

Looking ahead, although many of our companies continue to report resilient trading, slower economic growth and higher interest rates mean there are clear challenges for European businesses to navigate.

Inevitably, this has had an impact on valuations, particularly at the lower end of the market-cap spectrum. However, it has also created an opportunity to buy quality businesses at lower share prices – and a flurry of mergers & acquisitions highlights that private equity houses and industry buyers are seeing genuine value.

We are eyeing a number of interesting new opportunities among smaller companies and, for investors taking a long-term view, we believe current valuations present a highly attractive opportunity.

David Walton 20/04/23

Capital is at risk. The value and income from investments can go down as well as up and are not guaranteed. An investor may get back significantly less than they invest. Past performance is not a reliable indicator of current or future performance and should not be the sole factor considered when selecting funds.