2018 Third Quarter

Welcome to this third newsletter of the Sustainable Dividends Value Fund. The fund started at the first of January this year, however, the Sustainable Dividends Value strategy exists already quite a bit longer. Since the start of 2016 I have been investing this way, and as we speak ten quarters are behind us. Like in the previous newsletter I’d like to touch upon the recent market developments and the performance of the fund. Of course I will spend some time on what worked and what didn’t work in the most recent quarter. You will get an overview on how the fund currently looks like, and I will finish the newsletter with my investment case on Tomra. This stock is in the portfolio and has drawn quite a bit of attention recently due to the growing plastic waste problem in the world. Tomra is a company that is very much able to tackle this problem. Please enjoy the read!

Market developments
The second quarter was characterized by volatile, but increasing equity markets. Investors were not too much distracted by the threat coming from governments that are looking to raise trade barriers. And also the slowly, but surely rising interest rates in the US didn’t shy away investors. Neither did the European Central Bank announcement of the end of the quantitative easing program in Europe. Especially this last event was expected by quite a few investors. European equity markets increased by 4% in the second quarter. The stocks in the Sustainable Dividend Value Fund added on average just over 5%, which brought the share price of the fund to 100.60 euro. In the graph on the next page you will see the performance of the strategy since the start in January 2016. As a comparison the return of the MSCI Europe Index was pictured in the same graph. During the period shown the strategy returned 32% to its investors, while the MSCI Index gained 12%.

What worked and what didn’t?
Like in the previous quarter I’ll start with the latter category. Continental was the stock with the worst performance in the portfolio during the second quarter. Taking into account the dividend that was paid during the quarter, the value of our investment in the German company fell by almost 11%. This is the consequence of the looming threat of import tariffs on German cars by the US government. It could lead to less car exports from Europe to the US. However, it is likely that German car manufacturers will instead manufacture the same cars in the US. As a result they will still need the car parts from Continental. Continental also designs new technology for electric vehicles and self-driving cars. You need to think about for instance camera systems and sensors, that will allow the development of self-driving cars. Of course, this is not something that will happen tomorrow, but investors with a somewhat longer horizon should feel comfortable holding Continental. Another German stock in the portfolio, Schloss Wachenheim, lost 6% in the second quarter. The producer of sparkling wines published decent numbers over the first nine months of its 2017/2018 book year. Higher grape prices could be the reason for the negative share price development. However, expectations are that the price increases for grapes will be compensated by somewhat higher prices for wine.

Winners in the portfolio
Much more fortunate were the developments for Swedish Biotage. The share price of the manufacturer of medical equipment rose with 58% during the quarter. Main reason was the good set of results over the first quarter. Investors saw profits increase by some 20% versus the same period last year. And management is expecting further profit increases in the quarters to come. An important catalyst for the profit growth is the fact that the company has changed its distribution model. Biotage has opened up sales offices in quite a few countries already. As a result margins have improved significantly. It also helps that the stock has been added to the Swedish midcap index. More analysts and investors are following the company, resulting in a nice increase in the share price. Another winner in the portfolio is British Bloomsbury. The share price of this publisher of academic literature as well as consumer books rose 32% after the report of better than expected results on the 2017/2018 book year. These results allowed a dividend increase of 12% versus last year. And management is also excited about the current year. Sales of bestseller writers J.K. Rowling and Sarah Maas are again above expectations.

What does the fund look like?
By far the largest part of the fund assets are invested in companies of which we expect that they will grow profits and dividends in the coming years. The assets are invested in 22 different companies in seven European countries. By choosing stocks in 14 sectors we make sure there is enough diversification in the portfolio. We have a clear preference for sectors that generate stable cash flows. Some sectors were on purpose not chosen in the fund. Banks, for example, are suffering from the ever-increasing regulation of the sector. In general, this is not in their advantage. Pharmaceutical companies are very much depending on the development of new medications. This is hard to predict, making the future cash flows uncertain at best. And stocks of technology companies seem to be very expensive at the moment. As a result, their dividend returns are often very low. On the next page you’ll find the ten biggest holdings in the fund and their weights in the portfolio.

Global market leader
Finally I would like to share one of my investment cases with you. The fund aims to invest in companies that can help to make our society more sustainable in the long run. Tomra certainly does so. This company is global market leader in the field of reverse vending and sorting machines. Tomra has an installed base of more than 80.000 reverse vending machines globally. These machines receive empty plastic and glass bottles from consumers and in return pay them the deposit. But also industrials on a large scale use machines made by Tomra. The company sells sorting machines to amongst other food manufacturers, mining companies and the waste management sector. Tomra has a global market share of 75% in reverse vending machines and depending on the type of machine 25% to 60% in sorting machines. Therefore the company is truly a market leader.

Recycling in the spot light
During the annual conference in Swiss mountain village Davos earlier this year, eleven multinationals launched a remarkable initiative. Their aim is to reduce the growing mountain of plastic waste in the world. The idea is to make sure that, as of 2030, every plastic bottle sold, will be compensated by another bottle being collected and recycled. That would imply that the amount of plastic in the world no longer grows. Admittedly, 2030 is still far away. But, in order to make this happen, we should start investing now. The Netherlands, Germany and the Nordic countries are ahead of other countries when it comes to collecting and recycling plastic. Expectations are that from now on more and more countries will introduce collection systems and start sorting plastic. The European Union introduced subsidies for countries improving recycling earlier this year. The Australian state of New South Wales started collecting plastic bottles on December 1st last year. Tomra supplied the necessary equipment to do so. The United Kingdom announced some kind of deposit system for bottles just a few months ago. And Tomra is talking to the UK government about the possible use of Tomra machines. This could lead to large new orders for the company over the coming years.

Record order book
The increasing attention for recycling does also show in the numbers that Tomra presented in their half year report. The division that produces sorting machines had a very good first half. The order book grew to a record high, which is some 50% more than a year ago. The expectations of a large potential for growth of the market for sorting machines, in combination with the high market share of Tomra, does allow for some more positive reports in the years to come. A sustainable business model is very important for my investments. The companies that the fund invests in should produce goods that will be in demand for many years to come. This certainly seems the case for Tomra, given the growing global attention for environmental issues. But other selection criteria are equally important. The balance sheet is one of them. Therefore it is good to know that Tomra has very little debt on the balance sheet. The healthy financial situation also appears from the Altman-Z score. This score predicts the likelihood of a company going bankrupt within two years. A weighted average of five statistics gives the investor a very nice indication of the financial power of a company. A score above 3 means a safe situation, and a score below 1.8 means high alert for investors. Tomra has an Altman Z-score of 9, which indicates a pretty good financial health for the company.

A growing dividend
Next item we focus on is the dividend policy. The management of Tomra targets to pay 40 to 60% of the profits to the shareholders each year. Over the last seven years the dividend has been increased every year. The average increase was almost 15%. This is an impressive number and shows that management is very much aligned with the shareholders of the company. When it comes to sustainability Tomra is without doubt an interesting investment. The produce machines that help us improve society. And they also continuously work on improving their own production process. As an example they reduced their CO2 emissions by 25% over the last few years.

Risks and valuation
Like with every investment case, we need to have a look at the risks attached to the investment. The biggest risk for Tomra is political risk. If for instance a country like the Netherlands would decide to abandon the collection scheme for empty bottles, this would significantly reduce the demand for Tomra’s machines in the future. However, given the huge growth in attention for the waste problem, this seems an unlikely scenario. On the contrary, expectations are that more and more countries will introduce similar schemes. Currency risks are also important. Most of the time, sales of Tomra are denominated in euro or US dollar, while a large part of the costs are in Norwegian crown and New Zealand dollar. An appreciation of these two currencies will have a negative effect on profitability. Finally we should have a look at the valuation of the stock. We compare the expected cash flow for the next few years with prices being paid for companies in the machinery sector. My target price for Tomra, based on future cash flows, is 230 Norwegain crowns. This is more than 30% above the current share price. The dividend return of Tomra is about 1.5%.

I sincerely appreciate your support on this journey to grow the Sustainable Dividends Value Fund. We have only just begun and a long road full of interesting investment opportunities is ahead of us. More information on the fund can be found on this website. Feel free to email (simonvanveen@sustainabledividends.nl) or call with any questions you might have.

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