Tepid market creates opportunities for stock-picking

Performance

Adrigo Small & Midcap L/S Class A and Class C fell 5.81% in August, net of fees. The Carnegie Small Cap Return Index Nordic fell by 2.99 % in August.

The fund’s larger holdings in Frontline (shipping) provided a good contribution whilst Bonesupport (medtech) affected performance negatively after a strong contribution in July. Among the fund’s more dynamic midsized holdings, we note solid contributions from Alleima (special steel) and our recently initiated position Billerud (packaging). Initiator Pharma provided a good contribution, and shares have been trading relatively strong since the Phase 2 results in June. Our short positions had a positive contribution in aggregate, driven by good individual shorts and our index hedge. Our overall performance was negatively affected by two unlisted holdings that were impaired down in August. 

Adrigo Small & Midcap L/S Class A has returned 65.4% since inception, net of fees. The compounded return has been 9.0% per year since inception. In the same period, the benchmark STIBOR 1M rate has returned 2.3% and the Carnegie Small Cap Return Index Nordic gained 64.6%.

Market comment & the companies

Overall, global stock markets fell in August. MSCI World fell 1.9% while EURO STOXX 50 declined 3.9%. The Swedish large cap index (OMXS30GI) was down 2.9%, while Swedish small caps underperformed and fell 4.4%. Sweden clearly underperformed its Nordic peers during the month. Oil prices rose 1.5% while the commodity index, CRB was flat after a strong rally in July. 

After a strong return in July, our performance was clearly weaker in August. Among our negative contributors, we noted several holdings that had performed well in July, e.g., BHG (consumer discretionary) and Bonesupport. We do not note any significant news-flow and regard the share price movements as short-term profit-taking. 

Online Brands’ (e-commerce) Q2 report was a disappointment. Its largest subsidiary, Trendcarpet, suffered from logistics problems during the quarter, which clearly hampered sales. To our understanding, these problems are short-term, and we note several e-commerce peers having improved their sales momentum, albeit from relatively modest levels. Other companies within the Group, e.g., Nordic Kidswear (with retail award-winning Isbjörn of Sweden) and Bread & Boxers continue to drive volume through e-commerce platforms, compensating for weaker demand from its resellers. Undeniably the business environment for both brick and mortar and e-commerce is tough short-term. However, we continue to see structural growth, clear margin potential, and strong cash flows from Online Brands. We believe the BoD and management can redeploy excess cash in additional value-add M&A or pay solid dividends once the market normalizes. 

Pierce’s (e-commerce) Q2 report indicated that the company is heading in the right direction. As described above, the climate is tough, and the turnover fell 7% (excl. currency). However, price adjustments and lower container shipping costs contributed to a gross margin increase of 260 bps year-over-year. Pierce indicates that the cost pressure is decreasing and that its main focus going forward is to drive sales within its own brand portfolios. These brands, whose sales were unchanged during the quarter, account for over 40% of net sales. Growing sales of proprietary brands and reducing OPEX are two important drivers for Pierce to reach the Group target of an 8% operating margin.
 
The market has low confidence in the BoD and management's ability to generate shareholder value. Pierce's current assets exceed the corresponding liabilities to the equivalent of SEK 5 per share compared with August's closing share price of SEK 6.8. We believe that this debt-free e-commerce retailer with a loyal customer base, will receive more attention as margins strengthened and inventory is converted to cash. Thanks to a strong balance sheet, investors have time to wait.

Among our new holdings, we would like to mention Billerud. After its significant board machine investment of SEK 8 bn in its Gruvön facilities, the market expected Billerud to generate great cash flows. Instead, the company acquired the US-based company Verso in a USD 825m transaction and invested SEK 2.6 bn in a new recovery boiler in its Frövi facility. Overall, shareholders were disappointed by Billerud’s capital allocation decisions. The Verso acquisition was partly financed through a SEK 3.5 bn equity issue. By July, the stock had lost 40% since the Verso announcement. The CEO got fired in late July, and we hope that the company chooses to retreat and abandon its plans to convert one of the Verso mills to board production.  With an enterprise value of SEK 28 bn, the share trades at a significant discount to the sector despite having well-invested and competitive production units.

Finally, we would like to thank you, our co-investors, for your continued trust!