The following texts refer to the third quarter of 2019.

Performance
In the third quarter of 2019, KOP’s Net Asset Value (NAV) decreased from €186.46 to €180.81 per participation, translating into a return of -2.9%. This brings the return over the first nine months of the year to +10.4%. The return has averaged +9.9% per year over the past three years.

Trading
As of 1 October 2019, the trading price was €181.72, based on the NAV as of that date and including a premium of 0.5% as a result of net inflow into KOP. The number of issued shares in KOP increased by 1.8%, bringing the size of the fund to about €650 million. For the next trading date of 2 January 2020, an instruction deadline of 4pm on 29 November 2019 applies for orders in KOP (via Euronext) and a few days before that for the holding companies (via the Kempen transfer agent).

Market review
The MSCI Europe small cap index rose by 1.6% in the third quarter. Equity markets are being batted back and forth between the negative impact of the global economic slowdown (China, Europe and to a lesser extent the US) and the positive impact of further interest rate cuts by almost all the central banks. The economic weakening in Europe was corroborated by a very poor German PMI of 41.7 in September and a number of profit warnings this summer from German industrial companies, such as Jungheinrich (forklift trucks), Dürr (paint shops for vehicle production facilities, machinery for the woodworking industry) and Krones (filling lines for beverage manufacturers), all of which saw a sizeable drop in orders. On the equity markets this is triggering clear sector rotation from cyclical and financial equities to more defensive sectors and infrastructure. Nestlé’s equity price, for instance, reached an all-time high this quarter with a price/earnings (P/E) ratio of 25, while the prices of ING and Daimler fell to all-time lows and P/E ratios of just 7 and 9 respectively. The economic and political uncertainty has led investors around the world to ignore Europe for some time now, as is illustrated by the underperformance of European equities versus their US counterparts of 20% (in US dollars) since May 2018. Within Europe, small caps are lagging 3% behind large caps this year. Moreover, the return on micro caps (market capitalisation of less than €1 billion) is substantially lower than that on small caps this year (+10% versus +20%).

In relation to the portfolio, no new participations were reported in the third quarter, although we do have a number under construction. As noted in previous reports, liquidity continues to be a challenge and we hope to be able to announce a new participation in the next few months.

As to our current participations, BESI, El.En and Avon Rubber are the companies exceeding growth expectations this year.

BESI is by far our largest and most important participation at a weight of 18% in the KOP portfolio. Since the second quarter of 2018, it has found itself in a (normal) downward semiconductor cycle that is expected to recover in 2020. Yet BESI has achieved impressive earnings growth during the current weak cycle and this confirms our belief that BESI is one of the best managed companies in its sector. This is underlined by a gross margin of 56% and operating margin of 27% in the second quarter of 2019, in which revenue was down 42% on a year earlier. Investors have a marked preference for technology and as a result the expected recovery in the semiconductor cycle in 2020 is already partly reflected in the upturn in BESI’s equity price (+66%).

As expected, the medical laser division of El.En is profiting from the innovations the company launches each year. However, we are chiefly impressed by the growth of its industrial laser division, which at a time of general economic uncertainty noted excellent revenue growth of 12.8% in the first half of 2019. El.En is also focusing more and more on single-use consumables in its medical activities, increasing the portion of recurring revenue and predictability of these. Following weak price growth in the second half of 2018, when political and economic risks in Italy adversely affected its equity price, El.En has seen a price hike of 93% this year.

Avon Rubber used its strong balance sheet to acquire an attractive North American personal protection business (bulletproof vests and helmets) that is a good fit with its gas mask products. Avon Rubber’s equity price is up by 36% this year.

The profitability of our participations Acomo, Oeneo, LaDoria, Coats, Interroll and Suess has generally developed in line with our expectations. Acomo, LaDoria and Coats have noted steady earnings this year, Interroll continues to grow fast and as expected Oeneo’s earnings are up in the wake of a temporary weakness last year caused by a sudden hike in cork prices. With the exception of Coats (Brexit-related fears at UK small caps), these companies are seeing equity price gains that are a reasonable reflection of their earnings growth. The 7% drop in the Coats equity price this year is remarkable because the company has no exposure to the UK and even reports its results in US dollars.

There are also a number of companies in the portfolio performing below expectations this year, whereby we distinguish between weak end markets and company-specific challenges. The participations facing weak demand in their end markets are Washtec, Kendrion and Lectra. These are well-organised, innovative and excellently-positioned companies. However, the global automotive industry (Kendrion, Lectra) is seeing a decrease in volumes, Washtec is experiencing weak demand from a number of large accounts this year and the clothing industry (Lectra) is exhibiting restraint in its investment decisions at the moment due to the trade war. In spite of this slowdown, Lectra continues to be highly profitable as a significant portion of its revenue is software-related.

The economic uncertainty is also causing transport companies to adopt cautious investment policies on new trailers and this means SAF Holland needs to significantly enhance its flexibility and automation in order to structurally improve profitability in future. The abrupt drop in demand in Europe has led SAF to adjust its forecasts sharply downwards for the whole of 2019. During a meeting at SAF’s head office, we discussed in detail the ongoing reorganisations in both North America and China. We believe that the new SAF management has made a good start but there is still a great deal to do. This was also confirmed in a call with the chair of the SAF Supervisory Board. In addition to discussing current developments, we also set out our wishes relating to the strategy for 2025, in which we expect much better capital discipline from the Executive and Supervisory Boards. The sentiment surrounding German industrial companies is negative and they are being expressly avoided on the markets. German industrial production has slumped throughout the year, not least as a result of the problems in the German car industry, which is dealing with the combined effects of the US-China trade war and the shift towards electrification. This is placing additional pressure on the equity prices of SAF Holland (-40%), Washtec (-19%) and Kendrion (-8%) this year.

In the case of ForFarmers, our concerns are of a more fundamental nature. The original investment case is based on a robust company with low growth but high cashflows, some of which are paid out to shareholders and some used to achieve logical consolidation of the livestock feed industry in North West Europe. Over the past few years, ForFarmers has earned high cashflows but struggled to find attractive acquisition candidates abroad, and for this reason 75% of its earnings still depend on the Netherlands.

The company initially suffered from unfavourable stock positions caused by erroneous estimates of future commodity prices. On top of this, this year’s debate in the Netherlands on nitrogen emissions caught us (and ForFarmers) off-guard, and in particular the extreme nature of the measures being considered by the Dutch government and their potential structural consequences on the country’s livestock. For some time now there has been a voluntary restructuring programme in which the Dutch government buys up ‘pig rights’, which will reduce the pig population by a maximum of 15% in the next two to three years and has already led ForFarmers to close a number of factories. It currently looks as if the agricultural sector will be part of a package of measures aimed at reducing nitrogen emissions. The debate points to possible region-specific (close to nature areas) and farmer-specific (out-of-date infrastructure) measures that will not affect the entire sector. In the meantime, ForFarmers is drawing up plans to make its cost structure more flexible and optimise its network of factories, whereby the research budget will be used to develop emission-reducing feed. All the uncertainty has pushed the ForFarmers equity price down by 25% this year.

Valuations
On balance, the valuation of the KOP portfolio remained unchanged in the third quarter. The portfolio’s cash-adjusted price/earnings ratio (EV/EBIT 2020E) stands at 11. We believe that the portfolio continues to enjoy interesting long-term price potential.