The following texts refer to the third quarter of 2020.

Performance
In the third quarter of 2020, KOP’s Net Asset Value (NAV) increased from €199.02 to €212.76 per participation, bringing the total return over the third quarter to 6.9%. At a return of 3.7% over the first nine months of the year versus a return on the MSCI Europe Small-cap Index of -10%, we are pleased with how the portfolio has performed so far in 2020. KOP has averaged a return of 2.8% per year over the past three years and of 17.8% per year over the past five years, resulting in a performance above our target of an average of 10% per year.

Trading
As of 1 October 2020, the trading price was €209.56, based on the NAV of that date minus a discount of 1.5% caused by net outflow from the fund. The size of the fund was €770 million as of the start of the fourth quarter. For the next trading date of 4 January 2021, an instruction deadline of 4pm on 30 November 2020 applies for orders in KOP (via Euronext) and a few days before that for the holding companies (via the Van Lanschot Kempen transfer agent).

Market review
After the roller coaster first half of 2020, the markets displayed a calmer and generally positive picture in the third quarter (the MSCI Europe Small-cap Index was up by 6.3%). Aided by the easing of lockdown restrictions in May and June, European economies tentatively started to pick up again in the third quarter. Combined with ongoing support from governments and central banks, as well as better-than-expected second-quarter earnings, this created a positive mood among investors over the summer. However, the positive months of July and August were followed by a downturn in the MSCI Europe Small-cap Index of 0.6% in September. In the wake of earlier optimism, a recent increase in the number of new COVID-19 cases and the tightening of government restrictions have made investors more cautious. We expect volatility to remain high while investors are preparing for the coming US presidential election and partly due to the reduction in government support to businesses, which could depress earnings further. Daily news reports of mass redundancies (Disney, KLM, Royal Dutch Shell, Tata Steel) do not bode well.

Portfolio
We came through the second-quarter earnings season (the ‘COVID quarter’) relatively well, with few major surprises. We are fortunate in holding a portfolio of companies with robust business models, solid balance sheets and strong management teams that is the result of a clear and robust investment process. On balance, cyclical companies such as SAF Holland and Kendrion have performed well in the face of low expectations and been well rewarded for it with price gains of 31% and 27% respectively.

If we examine share price performance, the gain in Avon Rubber shares stands out (+33% in the third quarter). The company announced the sale of its Dairy operations (rubber parts for milking machines) to DeLaval and subsequently bought a US helmet manufacturer (Team Wendy) for a similar price. This means that in future Avon Rubber will concentrate entirely on personal protection, such as gas masks, helmets and protective vests. On the back of its strong position it enjoys at its largest customer, the US Department of Defense, Avon Rubber aims to increase its business with other customers, such as European armies and police forces. The Dutch police are already a customer and Avon Rubber is now bidding for a contract for which the Dutch army is inviting tenders in conjunction with a number of NATO partners.

Other strong share price performers were XP Power (+25%), which is profiting from a recovery in the semiconductor market and from the high demand for medical equipment, and Lectra (+25%), which in spite of difficult end markets (clothing, car seats, furniture) is profiting from its defensive business model based on software licences. XP Power in particular is profiting from the sudden demand for ventilators and other medical systems triggered by the COVID-19 pandemic. The company has expanded its production capacity in Vietnam substantially in order to meet demand and to be able to continue supplying the US market without being affected by the high import tariffs imposed on goods from China.

La Doria was one of the companies that profited from COVID-19. Its products include private label tinned tomatoes and beans. La Doria initially profited from consumers hoarding long-life products. Yet even after this one-off effect had dissipated, demand for its products remains high as consumers are eating at home much more than they are eating out. This led to La Doria reporting revenue growth of 23% in the first half of 2020 and its EBITDA rising by nearly 50%. Renewed government restrictions in a number of countries aimed at suppressing the second wave of COVID-19 will also boost La Doria’s revenue growth in the second half of the year.

Those equities that lagged behind in the third quarter included a couple of sizeable names in the context of the portfolio: BESI (-8%), ForFarmers (-4%) and El.En (-4%). BESI’s equity price came under pressure in line with the global chip sector. Sentiment deteriorated in the wake of further measures by the US government to prevent the Chinese government from importing (US) semiconductor technology. BESI is a big player in China, where it supplies local customers. At its recent Capital Market Day, ForFarmers announced its intention to seek growth by means of acquisitions. It is even considering acquisitions outside Europe, even though it currently has few business contacts and little M&A experience for such a move. Investors gave this risky strategy a lukewarm reception, preferring to believe it when they see it, partly because of ForFarmers relatively weak acquisition track record.

Coats is one of the companies in the portfolio that has been hit hard by COVID-19. It has factories in over 50 countries, a number of which were shut down completely in the second quarter. Coats’ threads and yarns are used mainly in discretionary end products such as clothing and shoes. As many clothes shops were also closed in the second quarter, there was little demand for threads and yarns. Prompted by the uncertainty, many customers cancelled orders they had already placed. This led to an organic drop in revenue of 45% in the second quarter, with June ‘only’ down by 25%. The month-on-month recovery continued in the summer, but September, October and November are much more important. In spite of the sharp drop in revenue, Coats earned a positive operating result in the first half of the year. This was partly because 4,000 employees, including members of the Executive and Supervisory Boards, agreed to a temporary cut in salary. Coats did this not just to safeguard its earnings, but above all to spare the more vulnerable groups in the organisation and continue paying their salaries, even though factories were completely closed in some cases. Coats’ global network of locations also gave it an advantage over local competitors that only operate a single factory in a single country. Some of its competitors were unable to manufacture any products at all, while Coats could deliver from other countries. Delivery reliability to customers was high even in these difficult times and we believe that this, together with its strong ESG policy, will allow the company to increase its market share further in the years to come.

After adding to existing participations at lower share prices and announcing a new participation (DiscoverIE) in the second quarter, the third quarter was much quieter.

In a world in which cash yields a negative return in real terms, investors are forced to search for positive returns in order to safeguard their capital. Equities can generate those high returns, but also bring a higher level of risk. Given the low global economic growth and risks that can arise in unexpected places (pandemics, (geo)politics), equity investors are restricting their risk exposure by opting for companies with structural growth profiles (technology) and defensive qualities (food, pharma), and preferably a combination of the two (software, medical equipment). Since the COVID-19 virus outbreak, the difference in valuation between growth/defensive on the one hand and cyclical sectors on the other has widened further. As an illustration of the willingness of investors to pay for defensive growth: the loss-making dialysis equipment manufacturer Outset Medical reports annual revenue of less than US$15 million and yet following its recent stock market flotation now has a market capitalisation of no less than US$2 billion. Investors are paying more than ever for (structural) growth and predictability. Some commentators are even talking of a bubble in these equities and are making comparisons to the internet bubble at the end of the 1990s.

We also seek growth and predictability in our role as managers of KOP, but we are equally alert to equity valuations. In spite of the higher valuations, we are still able to identify companies that score well on both fronts. We continued our accrual of new participations in the third quarter and in September announced a new participation in the UK’s Alliance Pharma. This company focuses on the marketing and sale of pharmaceutical products. It sells over 90 products in more than 100 countries.

Alliance Pharma’s expertise lies in taking over what are often relatively small-scale products from larger pharmaceutical companies that are a low priority when it comes to product development, marketing and regulation. Alliance Pharma buys the rights to these products and subsequently promotes them to create long-term growth.

The product portfolio contains a number of larger international brands, such as creams for scar reduction, medicated anti-dandruff shampoo, eye supplements and head lice treatments. A large number of smaller local brands are used in, for example, treating burns, nappy rash and mouth ulcers. The markets for these products are usually too small to justify product launches by the major pharmaceutical companies, meaning there is a low risk of new entrants to the market.

Alliance Pharma makes use of production partners and sales distributors. This asset light model enables it to generate high free cashflows, which are in turn used to expand the product portfolio via fresh acquisitions.

The participation in Alliance Pharma represents about 3% of the KOP portfolio and is a defensive, high-quality addition to the portfolio.

Valuations
The value of the KOP portfolio increased across the quarter. Given the 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 13. 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.