The following texts refer to the second quarter of 2020.

In the second quarter of 2020, the Net Asset Value (NAV) of Kempen Oranje Participaties (KOP) increased from €163.08 to €199.02 per participation. KOP went ex dividend on 5 June 2020 (€3.80 per participation), bringing the total return over the second quarter to +24.3%. Looking back, the portfolio held up relatively well in the first half of 2020 with a return of -3.0% versus a return on the MSCI Europe Small-cap Index of -15.5%. KOP has averaged a return of +2.8% per annum over the past three years and +14.7% per annum over the past five years, resulting in a performance above our target of an average of 10% per year.

Trading
On the trading date 1 July 2020 the trading price was €200.02, based on the NAV of that date plus a premium of 0.5% caused by net inflow into KOP. The number of issued shares in KOP increased marginally, bringing the size of the fund to €740 million as of the end of the quarter. For the next trading date of 1 October 2020, an instruction deadline of 4pm on 31 August 2020 applies for orders in KOP (via Euronext) and a few days before that for the feeders (via the Van Lanschot Kempen transfer agent).

Market review
After the shockwaves that sent the European small cap index plummeting by a dramatic 42% between 19 February 2020 and 23 March 2020, it underwent a sharp recovery in the second quarter and climbed by 19%, mainly driven by the enormous stimuli introduced by governments and central banks. Looking back at the first half of 2020, broadly speaking, the equity market experienced a period of relative calm in January and February, followed by panic in March, optimism in April and May and finally reflection in June. Large cap indices are now almost back at levels seen at the start of the year, driven by technology stocks, while the MSCI Europe Small-cap Index is still 15% below the start of the year. Investors are still taking refuge in relatively liquid equities with the prospect of revenue growth and are wary of taking positions in less liquid small caps, given that the visibility of earnings growth remains very low in their short-term investment horizons.

Once the number of new COVID-19 cases started to decline in April, many European countries eased their lockdown restrictions in a bid to tentatively kick-start their economies. Initial optimism has turned to continued caution in some parts of the US and Europe as a result of fresh outbreaks. While equity investors are preparing for the coming earnings season of very weak Q2 2020 results and (geo-) political tensions are high, we expect volatility to remain high. Following on from a probable trough in corporate earnings in the second quarter, it remains to be seen which countries, sectors and companies will display the fastest and most robust (earnings) recovery over the next few quarters.

Portfolio
It’s said that in order to be a good investor it’s more important to possess the right emotional temperament than the right analytical abilities. Those investors have been able to control their emotions during the rollercoaster ride of the first half of 2020 have likely been the most successful. In terms of performance it makes little difference what investors did, as long as they didn’t sell in panic at the end of March. On the other hand, there will have been few investors who sold at the peak in February, bought again at the end of March and sat tight in the months that followed. Investors often allow their emotions to determine their decisions, fuelled by sharp price fluctuations, losses on paper and the noise coming from market commentators. We have remarked before that we are occasionally jealous of private equity investors as they are unaffected by daily price fluctuations and can focus fully on trends at their portfolio companies. On the other hand, equity prices yield us opportunities that private equity investors don’t enjoy. A cool head is therefore important, while a strong management team and robust and solid, structured investment process are also essential.

We are pleased to see that the significant stock price fluctuations have not prompted outflow from the fund, but that we have in fact experienced inflow over the past two quarters. This has allowed us as managers to focus on long-term trends at companies and grasp opportunities presented by the equity market. Nevertheless, KOP’s size, investment universe and fiscal structure means that we have not always been able to make the most of the high volatility in equity prices over a short period (the market nosedived by over 35% in just 20 trading days and subsequently climbed by 25% in the 16 trading days that followed). Trading volumes in small caps were simply too low.

This does not alter the fact that we sold equities at high prices at the start of the year (BESI, offers for Oeneo and Hunsworth) and bought shares at low prices in March and April, both in existing participations (such as BESI, Coats, XP Power, Lectra, Kendrion, Acomo, Nedap) and in participations under construction. Unfortunately, there was not always enough liquidity available for us to be able to acquire participations immediately, but this has not stopped us profiting from the upturn on the equity market. Timing is tricky and we have seen firsthand how rapid the recovery can be; one of our participations under construction has risen over 100% in price since its low in March.

In April we announced a new participation in the UK’s DiscoverIE Plc. The company is a global player in the development, manufacture and sale of high-end electronic systems used in structural growth markets, such as renewable energy, transport, care and industrial telecommunications. It designs a wide range of critical products for its 25,000+ customers, such as measuring systems for wind turbines, charging systems for electric vehicles, cable systems for medical equipment and telematics for factories. The company has doubled its revenue and earnings over the past five years and aims to repeat this over the next five. It does so by using its high cashflows to buy up small, specialist companies in the fragmented international markets in which it operates. A combination of autonomous growth and acquisitions should serve to push up profit margins from the current level of 8.5% to 12.5%. As of the end of the second quarter, our participation in DiscoverIE represented about 4% of the KOP portfolio.

The two best-performing stocks in KOP in the second quarter were technology companies SUSS Microtec and BESI, with price gains of 122% and 47% respectively. Technology equities have proved to be a safe haven for investors around the world and their prices have rallied considerably over the past few months. Both SUSS and BESI are excellently positioned to profit from the growing digitisation in our society, a trend that is being accelerated by COVID-19. Moreover, SUSS investors are increasingly enthusiastic about the changes to the company’s management that should lead to a structural improvement in profitability and cashflows in the long term. As a long-term shareholder, we conducted meetings with the prospective supervisory board members prior to their appointment and shared our expectations with them.

The poorest price performances in the second quarter were at DiscoverIE (-7%), Lectra (0%) and ForFarmers (+1%). DiscoverIE published solid results but as its equity price had risen relatively strongly in the first quarter it subsequently failed to participate in the general market recovery. Investors continue to adopt a wait-and-see policy towards Lectra, a company that is being adversely affected by the weak investment cycle in the global automotive, clothing and furniture industries. Thanks to its defensive nature, the ForFarmers equity price also lagged behind the general upturn on the market of the second quarter, although it did earn a positive total return over the first half of the year.

If we examine the first half of 2020, the best performers were Avon Rubber (+54%), La Doria (+20%) and SUSS Microtec (+18%) and the sharpest losses were seen at (industrial) suppliers Kendrion (-45%), El.En (-32%) and Washtec (-32%). A combination of exposure to weak demand for cars and above-average debt levels due to its acquisition of Intorq at the end of 2019 has led to caution among investors with respect to Kendrion. As a North Italian company with operations in both Italy and China, El.En found itself at the eye of the COVID-19 storm. The company had said it was heading for its best-ever year before it was hit head-on by COVID-19 in February. Its Chinese and Italian factories have now restarted production, but demand for its machines remains weak. El.En’s balance sheet holds a net cash position, while the company continues to innovate and will in our opinion come out of this crisis stronger than ever. During the lockdown, car wash operators postponed investment and Washtec maintenance workers struggled to reach customers. With more people now back on the road, demand for car washes is growing again and the investment cycle will follow suit.

There were few surprises among the first-quarter earnings of our companies. The COVID-19 crisis barely affected earnings up to the end of March and in many cases it remains unclear what impact the lockdown has had on revenue, costs and cashflows since March. We are preparing for the publication of results over the second quarter, which for most companies will represent a low. We may then be able to draw some tentative conclusions on the expected annual results and – just as importantly – the quality of the balance sheets at the end of the year. We are fortunate enough to hold a portfolio containing companies with robust business models, solid balance sheets and strong management teams. Companies such as Coats and DiscoverIE believe that the current crisis could in fact present them with opportunities to consolidate their market positions via attractive acquisitions.

Valuations
The value of the KOP portfolio increased across the quarter. Given the enormous uncertainty surrounding the short-term profitability of our companies, we have confined ourselves here to examining the reported earnings over 2019. The portfolio’s cash-adjusted price/earnings ratio (EV/EBIT 2019) stands at 12. Based on the assumption that our companies will revert to normal (2019) earnings levels in the medium term, we continue to believe that the portfolio enjoys long-term price potential.