Our European Long-Term Unconstrained strategy stock focused approach is driven by in-depth fundamental research. Each month we highlight key company newsflow, and where appropriate, insights from any engagement activity the team have undertaken with our investee companies. This is considered in the context of our long-term investment horizon.
- Earnings season update
- Atlas Copco – Semiconductor clients postponing orders
- Hexagon – ‘Manufacturing Intelligence’ leads accelerating organic growth
- ASML – Maintaining strong guidance – but uncertainty from export restrictions
Our long-term fundamental approach
Our research is focused on finding undervalued companies operating in industries with high barriers to entry, which also have dominant market positions, strong pricing power, low disruption risk, high structural growth prospects, generating high returns or with the potential to generate high returns over time, with solid balance sheets and compounding cash flows, and that have strong corporate culture and quality management, and sustainable business models well positioned in a transitioning world.
Our three mega-trends, (i) Demographic Changes, (ii) Future of Technology, and (iii) Resource Scarcity, provides us with opportunities to capture long term structural growth themes. Within these mega-trends, there are thematic opportunities with supportive structural growth prospects, such as the eight medium-term opportunities that we have identified.
Whilst still early to conclude, the results season is so far pointing to more downside revision risk in European equities.
Under (margin) pressure
Interim results season update
The Q4 2022 results season is underway, in contrast to their US counterparts, European companies are showing a significant negative earnings surprise – pointing towards more margin pressure coming through. Although only 12% of European companies have reported compared to 33% in the US, margin pressure is less pronounced in the US. This is likely a reflection of the impact of higher energy prices weighing on European companies. As shown in the chart below, there is the ongoing risk of corporate margin erosion this year, from high level compared to historic (EBIT) margins.
US Corporate EBIT margin trend
Source: JP Morgan as at 31 January 2022.
Elsewhere, the reporting season in Asia and Japan is showing more pronounced positive surprise so far on earnings despite mixed surprises on sales. Whilst still early to conclude, the results season is so far pointing to more downside revision risk in European equities. Whilst the US is at less risk perhaps owing to the more rapid action being taken by companies to reduce their cost base.
The -17% decline in European earnings, highlights the risks of an earnings recession, as flagged in our 2023 outlook. The -6.4% earning surprise also highlights the margin pressures coming through.
| Number of companies reported (%)|
|Year on year growth (%)||+15||-17|
|% of companies reporting positive surprises||+62||+45|
62% of companies reported a positive surprise on sales, whilst 45% of companies reported a positive surprise on earnings.
Atlas Copco, Sweden, Industrials
As shown above, Industrial companies have so far delivered positive sales growth, but a negative earnings surprise, and Atlas Copco was in line with this trend. While a number of acquisitions in Q4, drove sales to a +4% beat over consensus, adjusted EBIT was a 3% miss. Atlas Copco
reported an accelerated order decline in the semiconductor related Vacuum Technique (VT) segment, and as we expand on below, this may lead to some margin weakness, as customers delay orders.
Source: Martin Currie and Atlas Copco as 26 January 2023.
Order backlog can maintain sales and EBIT growth
The earnings update call provided some colour on this. Of the SEK1 billion cancellations in the VT segment, the lion's share was due to semiconductor memory customers postponing investments. These orders are expected to resume in 2024. While simultaneously cancelling some orders, these same customers insist on ‘copy exact’ for those orders that remain, meaning no change to components in short supply. This has led to Atlas Copco having to deploy costly extra shifts. Unlike its wider industrial customer base, with its semiconductor customers, Atlas Copco cannot always be compensated for such cost increases with commensurate price rises. The EBIT margin dilution was also impacted by a flurry of Q4 acquisitions.
In our view, sell-side estimates will come down c. mid-single digits. However, if Atlas Copco can maintain its order backlog, it can sustain mid/upper single digit sales and EBIT growth in 2023.
Hexagon, Sweden, Information Technology
‘Manufacturing Intelligence’ leads accelerating organic growth
Q4 net sales of +15% represented a 1% beat over consensus. This was supported by accelerating organic growth of +8% across geographies (up from +7% in Q3). Hexagon particularly called out its Manufacturing Intelligence segment, especially autos and aerospace, and China strength. EBIT growth of 12% also represented a 3% beat. Finally, management highlighted that component supply shortages issues were largely resolved.
Source: Martin Currie and Hexagon as 23 January 2023.
Some margin weakness
The market however took a more negative view of the firm’s weaker cashflow conversion and slightly weaker margins. Weaker margins came as a result of higher expensed investment from exceptionally low Covid levels in Manufacturing Intelligence, and the short reversal of dollar strength during Q4. Looking forward, management continues to guide to sustainable net positive expansion of the gross margin.
Hexagon also announced the acquisition of Projectmates, a ‘Software as a Service’ (SaaS), construction project management company. Hexagon management is prioritizing investment in construction, a conservative industry with a long runway for growth in the adoption of software at each stage of the construction process.
ASML, Netherlands, Information Technology
Maintaining strong guidance – but uncertainty from export restrictions
ASML published its Q4 2022 earnings release on 25th January, guiding for greater than 25% growth in 2023 (at a gross margin of 49-50%) versus 14% achieved in 2022 (50.5%). However, the gross margin trajectory has come under scrutiny, while the company reiterated its target of c.54-56% in 2025 (and c56-60% in 2030). There remains uncertainty about any further restrictions on ASML’s sales into China. Reportedly, steps have been made towards an agreement between the Netherlands, Japan, and the US. Meanwhile, ASML stated that any such measures were not expected to have a material impact on 2023’s operational performance.
Source: Martin Currie and ASML as 25 January 2023.
Geopolitics – Reduced chip availability and higher costs?
We covered the geopolitical background to the semiconductor market, in ‘Stock Insights – January 2023’ following ASML’s
Capital Markets Day. The post Q4 earnings press conference offered further insight. In response to further restrictions imposed
by the US, Netherlands, and Japan, ASML CEO Peter Wennink,was quoted
‘Chip availability could be reduced, could be as a result of export controls that go too far. It also means that we will have a less
efficient infrastructure and cost will very likely go up’.
We think further restrictions could pose a greater threat to semiconductor end markets than Covid – particularly German autos Mr Wennink has also highlighted a further risk of new entrants to the market, particularly in the trailing-edge equipment supply. If there are continued export restrictions to China, China could develop their own machines over time.
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