2019 – Third quarter

Looking back and looking ahead
The Sustainable Dividends Value Fund had a rough ride but ended the second quarter on a positive note. The last few weeks of June saw some nice gains on most stock exchanges, prompting the major indices back to their highs of early April. And fresh all-time highs were set in the US during the first two weeks of July. May was by far the most difficult month to swallow for investors during the first half of this year. The political chaos surrounding the Brexit discussions in the UK didn’t help the sentiment on stock exchanges. On top of that president Trump added some fuel to the fire when it comes to the trade war with China. He carried out his threats and introduced tariffs on some 200 billion dollars of goods coming from China to the US. And tariffs on an additional 300 billion dollars of goods are still looming. Although it seems that the US economy is doing well so far, Americans do feel the consequences of the trade war with China. How else is one to explain the continuous attacks on the FED president Jerome Powell. According to Trump, he should lower interest rates sooner and faster, from current levels between 2.25% and 2.5%|

Consequences of the trade war
The Chinese get some severe beatings in their fight with the Americans. According to calculations by the International Monetary Fund in Washington, the tariffs should have a negative impact of 1%point on the national income of China. The United States will also suffer, but initially consequences should be less severe. The leaders in Beijing are currently contemplating to limit the export of rare earth metals to the US. If that should happen, there is no telling where it’ll stop. However, we haven’t reached that point yet, but some 18 months since the start of the conflict global trade is hardly growing any longer. The impact on Europe, and especially Germany, cannot be ignored. So far, the Germans have managed to escape a recession. However, the industrial production is going down and leading indicators aren’t pointing to a turnaround yet. Purchasing managers are expecting a further contraction and new orders have fallen by 8.5% compared to the same time last year. That is the biggest decline since the crisis year 2009. Mind you, not all is bad in Germany, as both the services sector and the consumer spending are doing well this year.

Developments in Europe
Surprising enough French managers are full of confidence. After the heavy protesting by so-called ‘yellow jerseys’ last year, we now see some kind of catching up. Italy, on the contrary, remains vulnerable. The Italian coalition government did back down in the budget discussion with the European Commission, but there is no stability within the government. All across Europe people will be eagerly watching the most probable election of Boris Johnson as the new UK prime minister at the end of this month. After that we might have some clarity whether or not he will steer the country to a so-called ‘hard Brexit’. British consumers are very confident and are already preparing for a tough battle between their government and the European Commission. The newly elected chairmen of the European Commission, European Council and ECB will have a hard nut to crack with the UK leaving the EU.

Performance of the Sustainable Dividends Value Fund
The Fund did show a positive return in the second quarter of 1.5%. However, this was slightly less than the 3% return of the MSCI Europe Index. Over the first six months of the year, the Fund gained 14.3% versus 16.2% for the MSCI. The strong performance of European blue-chip stocks did help the markets so far in 2019. Most stocks in the Fund did see their prices increase further during the quarter. Dutch TKH, manufacturer of a long list of cable-related products was the best performing stock. Over the quarter, the company added no less than 32% to the share price. During the Capital Markets Day in May management significantly increased company targets for both margins and returns for the next few years. Italian operator of toll roads ASTM also positively surprised its investors. Shareholders gained some 19% on their investment, as management of the company announced to simplify the organisation structure. In this case more clarity means more appetite from investors to buy the shares of the company.

Taking profits in Tomra
Some stocks in the portfolio couldn’t profit from the positive sentiment on the market. Irish Total Produce (-12%) was one of them, despite no relevant news items being reported on the stock. Expectations are for significantly higher profits at the half year results in August, coming from the integration of American Dole. German Schloss Wachenheim lost 9% of its share price after rather ‘light’ first quarter results. Although the producer of Sekt saw its sales increase by 6%, profits declined by 3%. The reason is increases in input costs, that so far haven’t been fully compensated by higher consumer prices. During the quarter we took some profits in Tomra, the manufacturer of reverse vending and recycling machines. As the share price had gone up almost 50% over the last 12 months, the weight of the stock in the fund had become too big.

What does the fund look like?
By far the largest part of the fund’s 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 most stocks of technology companies seem to be very expensive at the moment. As a result, their dividend returns are often very low. Below you’ll find the five biggest holdings in the fund and their weights in the fund.

Fjord1: Electric Ferries
Like every quarter we discuss one of the stocks in the Fund in our newsletter. Norwegian Fjord1 operates ferries between a large number of towns along the Norwegian fjords. The Norwegian countryside isn’t very densely populated, and traffic isn’t very busy. However, the Norwegian government very much cares about the accessibility of the cities and towns along the coast and therefore pays companies like Fjord1 to operate the ferries. These companies have multi-year contracts with local governments, leading to sustainable cash flows. Furthermore, they make additional income from ticket sales and selling food and drinks to the passengers. About 90% of the revenues of Fjord1 is coming from predictable cash flow based on government contracts. Predictability of future cash flows is an important criterium for selecting the stocks in the Fund. Next to that we care a lot about the sustainability, or ‘green’ image of a company. Fjord1 is investing a lot of money in electrifying their fleet of ferries. This means that the existing ferries need significant modification or replacement by new ones. A few years down the line, we expect the dirty diesel engines to have disappeared from the Norwegian fjords. This is a nice example of a making a positive contribution to the sustainability of our society.

Management is shareholder
We have some additional selection criteria, that a company should adhere to before we decide to invest in its stock. One of those is the balance sheet. As Fjord1 is currently involved in a large investment program to electrify its fleet, debt has increased substantially. However, there are enough assets on the balance sheet to compensate for that debt. On top of that, management aims to lower debt levels again over the coming years. Next we note that it is important that the management is aligned with the shareholders of the company. This seems to be the case for Fjord1. Management of the company owns together some 59% of the shares outstanding. They will for sure act in the interest of shareholders. Then we move on to the dividend policy. Management targets to pay out 50% of annual profits as dividends to the shareholders. As Fjord1 is about to grow its network of ferry services over the coming years, we expect them to grow profits and dividends as well.

What could go wrong?
This wouldn’t be a proper investment case without looking at the risks of an investment. In the case of Fjord1 we will mention the most important risks. The long-term contracts with the Norwegian government offer some certainty regarding the future, however, going forward the company will be in the bidding process for quite a few new contracts. As we do not know the returns on those new contracts, some uncertainty remains. On the cost side the company is depending on the price of electricity for the new ferries, and the price of diesel for the old ferries. For the newly ordered ferries we should take into account the risk of cost overruns or delays. And finally, for investors in the stock there is of course the currency risk that comes with investing in a listing in Norwegian Krones on the Norwegian stock exchange.

Valuation
To determine the proper valuation of a company, we tend to look at recent transactions in the market, that involve comparable companies. Over the last few years several ferry services companies have been bought and sold. In 2017 for instance, Funnel – the company servicing the British Isle of Wight – was sold to a British pension fund at 15 times the cash flow. And last year Scandlines – the ferry service company operating between Germany and Denmark – was bought by infrastructure investors at 14 times the cash flow. When comparing these prices with the valuation of Fjord1, then we notice a significant undervaluation of the stock. Fjord1 currently trades at 7 times the expected cash flow in 2020. When the company would be bought at market multiples, one would expect to see the share price double, to say the least. But even without a take-over, we expect the share price to go up, as the company continues to grow. And meanwhile the company pays a handsome dividend to its shareholders. We expect to receive some 5% dividend annually. More information regarding Fjord1 can be found in the annual report via the link below:
https://www.fjord1.no/eng/Investor-Relations/Annual-reports-and-press-releases/Reports

Outlook Statement
With on average just 1% return over the past 3 years European stocks are very much lagging other regions like for example the US. The significant increase in profits for European companies over the last few years does not show in the share prices yet. If we look at popular valuation metrics like the Price/Earnings-ratio or the Dividend Yield, it appears that European equities have become cheaper over the last few years. Both in absolute terms, as well as compared to American equities. This should make European equities an interesting investment for the next few years.

New participants
We warmly welcome our new participants in the fund. More and more often we can share our story with interested investors, which means lots of nice conversations. If you happen to know people who might also be interested in our strategy, we would be glad to talk to them as well. Gaining trust by speaking with investors directly is most important for us. We 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 www.sustainabledividends.com. Feel free to email (info@sustainabledividends.nl) or call (+31 20 244 36 54) with any questions you might have. The share price development can be found on the website or via Bloomberg (fund code SUSDVDV NA).


Best regards,

Simon van Veen – Founder & Fund Manager
Jasper Oeberius Kapteijn – Business Development & Sales Manager

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