The following texts refer to the second quarter of 2018.

Performance
In the second quarter of 2018, KOP’s Net Asset Value (NAV) declined from €212.52 to €198.72 per participation. A dividend of €3.60 per participation (€3.00 last year) was paid in the second quarter. The return including dividend payments was therefore -4.9% over the second quarter and -6.3% over the first six months of 2018. The annual average return over the past three years was 23.9% and 13.6% (1992) since the fund’s inception.

Trading
As of 2 July 2018, the fund’s trading price was €195.74, based on the current NAV including a discount of 1.5% caused by net outflow from KOP. The number of issued KOP shares only declined by 0.2%, however, and this quarter we were again able to welcome new participants to a number of the existing holding companies. We continue to see interest from new and prospective clients. KOP decreased in size to €665 million as of the end of the second quarter. For the next trading date of 1 October 2018, an instruction deadline of 4pm on 31 August 2018 applies for orders in KOP (via Euronext) and a few days earlier for the holding companies (via the Kempen transfer agent).

Market review
The average performance of European small caps was nearly 5% over the second quarter of 2018 and unchanged for Dutch small caps. European momentum was chiefly driven by a positive market for UK small caps, whereby Dutch small caps are apparently more attuned to international economic trends (growth in global trade) than small-cap companies in the larger European countries.

The capricious nature of the second quarter can be attributed to a mix of both positive and more worrying trends. Businesses are profiting from the excellent economic trends and often sound operating results, yet we are also seeing economic indicators weakening in Europe and a number of cyclical companies have recently adjusted their forecasts downwards. A flattening of industrial orders and weaker consumer spending in Germany do not match the positive picture of that country’s economy. This may be due to the strong euro at the start of 2018 and the poorer sentiment surrounding international trade triggered by measures implemented by the US government. However, the euro again displayed weakness in the second quarter and is therefore having a less negative impact on the competitive position in Europe. Trump’s increasingly hardline statements on import tariffs could well harm global trade in the long term though. The ECB announced more detail on pursuing a less expansionary monetary policy, but interest rates look set to remain low for a long time. In the long term, we expect higher interest rates, following in the footsteps of the US, partly prompted by the start of cost-push inflation caused by e.g. higher commodity prices and rising wage costs, certainly in Germany. At the moment, a trade war would seem to be gaining momentum, although businesses continue to profit from economic growth, in which employees can selectively share via higher wages and investors via higher dividends. The market climate is selectively right for new flotations.

The markets responded in a highly volatile manner to all these factors, in part exacerbated by the political turbulence in Europe. If companies fail to live up to the occasionally high expectations, a severe price reaction could follow. Those companies enjoying stable earnings growth will often continue to be allocated high(er) valuations, but any worse than expected results will be punished harshly.

Within the KOP portfolio, we depend on the specific trends at the companies in which we participate. Many companies in the portfolio are displaying sound corporate growth, partly aided by a sound financial structure that creates substantial capacity for high-yielding investments and/or acquisitions. However, a few companies in our portfolio are susceptible to a potential trade war, a slowdown in global trade or an excessively strong euro. Economic trends in Asia are also becoming increasingly important for a number of companies.

The KOP managers again actively adjusted the portfolio in the second quarter. We have increased or decreased a few participations, based on the desired portfolio weights and convictions relating to companies (and their valuations). Having completed the accrual of two new participations in the first quarter, we now have several new interests under construction. We do not anticipate completing any new participations in the coming quarter. The portfolio adjustments are expected to contribute positively to a balanced portfolio composition and to the KOP portfolio’s price potential.

As expected, we did not complete the accrual of any new participations in the second quarter in the wake of adding the UK’s Avon Rubber and Germany’s Suess Microtec to the portfolio in the first quarter. The number of participations consequently remained stable at 18. With respect to our interests under construction, purchases are being made gradually and attractive valuations remain a very important aspect on purchase. We have sufficient resources at our disposal for accruing new participations from the existing cash position and as a result of sell transactions within the KOP portfolio. For instance, in the second quarter we reduced our positions in Besi and Washtec, partly in favour of existing participations El.En, Oeneo, Suess Microtec, SAF Holland, Coats and Avon Rubber.

In the second quarter, Coats, the global market leader in threads and yarns, held a Capital Markets Day in London which again confirmed our positive view of the company. At Coats we see some room for improvement in operations, but mainly solid growth for the long term. This growth is being driven by end markets picking up, earnings from market share and selective acquisitions. In the short term, higher commodity prices could have a negative effect on results, but this will have no impact on Coats’ competitive position. The positive trends for the long term are easy to predict.

As a result of the presentations, we now have an even better idea of the strong culture within the company. Coats has identified opportunities for further simplifying its business. For instance, Coats has developed ten geographical clusters rather than the 45-country structure and is selectively exiting a few small countries in order to reduce complexity and the number of management layers.

Coats has a very strong track record on cutting energy consumption, which has declined by 20% in five years, and water consumption, which has dropped by 26% over the same period. Next year it will continue to invest in its organisation and in technology in order to reduce energy and water consumption further. In doing so, Coats is ahead of its competitors, manufactures its products more efficiently and gains additional market share because customers such as Adidas also increasingly view sustainability as important. In this respect, it is telling that the Chinese government is closing the factories of several of its competitors because they cause excessive pollution.

Dynamics are high among Coats customers. Prompted by higher wage costs in China, customers are switching to cheaper manufacturing locations or even locations close to their sales markets. For Western customers, this drastically cuts the time-to-market, allowing manufacturers of footwear and clothing to respond more quickly to new and local trends. As a result, manufacture is shifting from China and Asia back to Eastern Europe, Turkey and the US. Coats’ unparalleled global production platform, serving more than 40,000 customers in over 50 countries, means that it is in a better position than its two main competitors to follow its customers and serve them properly in these countries as well.

In June, we visited the new El.En factory in Florence and discussed the most recent developments with its management. El.En is seeing an increase in revenue and earnings growth as a result of an impressive number of growth initiatives and innovations. Following the acquisition by Hologic and after a poor 2017, US distributor Cynosure has again put all its energy into selling El.En’s Mona Lisa Touch application. In addition, the recently launched Onda machine for removing body fat (using microwave technology) has been very well received in the market. In the industrial market, El.En continues to gain market share with its increasingly strong lasers (up to 20Kw), both in China and in Europe. For the long term, El.En is developing a new machine for treating tumours using minimal invasion (a laser inside a 0.7mm needle). In the wake of our visit, we remain enthusiastic about El.En’s innovative power and earnings outlook.

At a meeting with the CEO of SAF Holland, we discussed developments at the company in detail. The company manufactures chassis with braking and suspension systems, as well as a few other niche products for trucks and trailers, and occupies a global market position. The company’s strength lies in the fact that its earnings derive from both initial purchases (cyclical) and subsequent deliveries for maintenance and replacement (stable). SAF Holland occupies an excellent position in its niche market, but its operations could sometimes be tighter, especially in North America. It is doing very well In Europe, including Turkey. In the US, a reorganisation coincided with additional demand from the market, which resulted in additional expenses in order to serve customers properly. Via a reorganisation, SAF Holland is moving US production further to the south of the country, where the job market is less tight. From 2019, SAF Holland is aiming for an average profit margin of at least 8% in North America as well. The Chinese market is growing rapidly, partly due to changes in legislation. The company is investing in a large new location in China (twice the size of Germany), more than doubling its local production capacity. In our talks with the company, we asked for greater focus on the efficient management of its US operations in particular. We believe that it is currently more important to achieve its profit margin target than its revenue target via further acquisitions. Both the company and its equity price enjoy considerable (price) potential.

We always devote a great deal of time to the many shareholder meetings in the second quarter of the year. We exercised our voting rights at all our participations, discussed agenda points with a number of companies in advance of the meetings and attended a number in person.

When analysing points on the agendas of shareholder meetings, we always examine the specific circumstances of the company or its management. We then reach our own conclusions which may, in some cases, deviate from general opinion or the opinions of international consultancies for voting rights. For instance, we held a discussion with Interroll on the independence of its Supervisory Board as its members own shares in the company. Several international consultancies believe this compromises their independence, yet among others this case involves two families on the Supervisory Board who together have held a 20% interest for many years. We are satisfied with this alignment and believe it is appropriate for a company that is managed with a view to the very long term. At our insistence, a statement on remuneration was given during the Nedap general meeting of shareholders as this was missing from the annual report. The company has promised to rectify this next year. Following the outsourcing of production, Nedap is preparing for further growth and an increase in profitability. We talked to Kendrion about the calculation of the LTIP (Long Term Investment Plan) for its management. During discussions with the Supervisory Board chair, we discovered that the company will opt for a balanced explanation of the rules. Kendrion is well on the way to achieving its own targets for revenue growth and operational margins and will publish a new long-term update after the summer. Kendrion was also able to provide greater clarity on new products to compensate for the declining sales of products for use in diesel engines. At Lectra, we requested more information on the option programme that could cause excessive dilution over the next few years. At our meeting with the CEO and also major shareholder, we learned that the company is not taking full advantage of the available opportunities. Allocation of these options is being conducted in line with the company’s long-term objectives.

Some of our participations experienced sharp price gains in the second quarter. New participation Avon Rubber was up by 15%, boosted by positive sentiment on UK small-cap companies. Interroll increased by 16% in the run-up to a strong update, and smaller participation 2G Energy also rose by 8%. In talks prior to the shareholder meeting, the CEO and CFO of 2G Energy provided information on the company’s operations. The company manufactures highly-efficient energy units for the production of electricity and heat. Orders are evolving well, as is earnings growth. However, high costs for guarantee commitments and the substandard structure of international sales mean that the company is not taking advantage of its full potential.

A number of participations also suffered significant price losses in the second quarter. Firstly, a drop in equity price of 40% for Besi partly corrected the sharp price gain in 2017 (+124%) and the first quarter of 2018 (+24%). With a view to our portfolio as a whole, we partially reduced our position in Besi while prices were high; this creates capacity to buy back shares at lower prices where applicable. The company is performing excellently, has gained market share over the past year and is succeeding in growing sharply in the Chinese market via its Chinese organisation. In this cyclical market, however, Besi is concerned about saturation on the smartphone market, partly due to its relatively high market share there. Compensation could derive from e.g. more applications for the auto industry, 5G and the expansion of data centres. The semiconductor industry could be adversely affected by specific measures implemented by the US government to regulate the export of technology to China, and this also makes a production location in China extremely important to Besi.

In this quarter, we witnessed a clear drop in the equity price of SAF Holland (-19%), due to higher than expected costs for a US reorganisation, and -14% in Lectra. Lectra has been adversely affected by the stronger euro this year as it does not pass on its higher euro costs in its end prices. The company is focused on long-term growth of its market share and therefore accepts a temporarily lower profit margin. Its new products and new sales regions are displaying excellent growth. We will meet the management of Lectra (and Oeneo) in Bordeaux in July.

Valuations
Based on our earnings forecasts for the next twelve months, the KOP portfolio is trading at a price/earnings (P/E) ratio of about 19. As a large number of companies in our portfolio have a net cash position, something not properly reflected in a P/E ratio, we believe the EV/EBITA ratio to be more relevant. Based on our forecasts, this ratio is close to 13 for the next year. Average valuations also rose in the second quarter, which were partly compensated for via portfolio adjustments, sound growth at companies and new participations. The price potential based on our DCF valuation (cashflows) continues to be attractive and we see sound opportunities for return in the long term.