In Anglo-Saxon countries the stock market has long played a prominent role in corporate thinking, necessitating a reasonable respect for shareholders. In continental Europe, the culture was a little different: the traditional go-to cash raising destination was the bank.
Globalisation has, of course, changed this dynamic but old habits die hard, says Chris Garsten, fund manager at Waverton European Capital Growth Fund, which invests in European equities.
“Growing sales and level of profit with little regard to the capital tied up is still the primary objective for the majority of continental European management teams,” he says.
“We want to invest in companies where the interest of management teams is aligned with that of shareholders.”
Garsten says such shareholder alignment – where surplus cash flows are returned to investors via dividends or share buybacks – is only found in about one third of continental European companies.
His €167.6m fund remains underweight on France, for example, despite President Emmanuel Macron’s pro-market reforms because some corporates in the country, in Garsten’s view, have yet to fully grasp the importance of prioritising shareholders.
The Nordics, however, are different. “Nordic companies are in the vanguard of European companies focusing on maximising shareholder value,” Garsten continues.
This preference is reflected in the fund’s equity holdings. More than one third – Sweden 17.9%, Denmark 7.7%, Finland 6.4% and Norway 5.3% – are invested in the Nordics.
The fund has owned shares in Topdanmark, Denmark’s second largest insurer, for about five years.
After a brush with bankruptcy in the late-1980s, Topdanmark’s management vowed that if the company survived it would repatriate all profits to shareholders via share buybacks.
“It has been good to its promise,” Garsten says.
Over the last two decades, Topdanmark has bought back and cancelled about 80% of its share capital and its share price has increased roughly twenty-fold.
“This phenomenal shareholder return has been achieved with relatively little sales growth, totally killing the misconception that sales growth is important. The key is how much cash is generated and what management does with the cash flow,” Garsten says.
To put the Topdanmark’s performance in context, German insurance giant Allianz has made minimal returns over the last decade. Diluted earnings per share were lower in 2017 than they were in 2007.
“A clear commitment on cash flow repatriation makes it easier to pick long-term winners and Scandinavian companies are good at this. If one can lengthen one’s time frame to five to ten years then huge market inefficiencies can result, because so few investors are willing to look that far out,” says Garsten.
The fund has held stock in Swedish snuff manufacturer Swedish Match for more than 15 years for similar reasons. “It’s tremendously profitable company with a history of returning excess cash to shareholders,” Garsten explains.
“Not only has Swedish Match’s dividend yield been high, but over the last ten years the share count has reduced from 274 million to 176 million. Sales revenue has risen by 30%, but earnings per share has more than doubled.”
Most chewing tobacco is banned in the European Union. However, snuff – or ‘snus’ – remains resolutely popular in Sweden and the country received a dispensation from EU rules when it joined the bloc. Swedish Match sells its products in more than 100 countries and its biggest market is the United States.
Norway is the largest salmon producer in the world and the demand for farmed salmon has risen steadily in recent years because of overfishing in the Atlantic. However, the industry has suffered from bouts of severe oversupply leading to in very volatile salmon prices and similarly volatile share prices.
The last few years have seen the Norwegian salmon industry adjust to another challenge: a rise in sea lice – a naturally occurring parasite that attaches itself to fish – which have wreaked havoc with salmon stocks.
However, the sea lice infestation has, in Garsten’s view, actually been “good” for the industry.
“Tight regulation has constrained production resulting in higher salmon prices and operating margins,” he says. “Scandinavian shareholder discipline, means the excess profits have been returned to shareholders, largely through dividends.”
The European Capital Growth Fund owns shares in Norwegian seafood group Marine Harvest.
The fund recently invested in Finnish mining equipment supplier Metso.
“Depressed commodity prices have led mining companies to cut capital spending to the bone and Metso has seen its turnover nearly halve since the 2012 capex peak,” Garsten says.
“However, operating margins have held up amazingly well at 8-9%, having been supported by a focus on high margin service revenues and prudent management. It has no net debt. Years of cost cutting has left the mining equipment fleet ageing, now at a record average age of ten years. Thus, the mining capex cycle only has to turn up very modestly, encouraged by firming commodity prices, to make future new equipment orders very likely.”
“New technology should add some icing on the cake. Metso’s new rock crusher, which cuts operational costs by 10% and enables 10% higher uptime compared to traditional crushers, is a key product area that it claims offers one of the biggest technology changes for 30 years.”