Sola's opinion on the Swiss stock market (Episode 28)

The Plutos Switzerland Fund gains 0.5% in September, Although the notorious month of September lived up to its reputation in the first week of trading: global markets came under pressure of around 5% due to renewed fears of recession. The hyped tech stocks literally collapsed and noticeably weighed on sentiment. In addition, the European PMIs remained in the weak range - no longer surprising for us, trust in German/European politics is at zero. The SPI Small/Mid Cap Index closes meanwhile marginal easier.

On September 18, 2024, we launched the First interest rate cut by the American Fed since March 16, 2020 - at that time it was 100 bps to counteract the Covid crisis. After that, interest rates remained almost at 0%. It was only two years later, on March 17, 2022, that the US Federal Reserve raised interest rates by 0.25%, only to then increase them extremely steeply and almost monthly, until July 26, 2023, to 5.25 - 5.5%. US interest rates were at this level until recently.

Now it is time to look at the following Paradigm shift to incorporate: While previously 'bad news' was 'good news' with regard to the economy, now 'good news' (i.e. falling jobless claims and unemployment figures, better retail sales and of course falling inflation) is really 'GOOD NEWS', because it strengthens the Fed's belief that it can lower interest rates without the risk of a recession.

The Swiss National Bank SNB has acted noticeably more proactively than the US Fed: a first interest rate hike in March, then in June and now another 25 bps - with wording that suggests further steps. Even though inflation has never been a really serious problem in Switzerland, the SNB has demonstrated its independence and acted calmly.

In the short term, this interest rate move is relevant for many, for us only a first step – a scenario of falling inflation, falling interest rates and an improving economy in the USA, Europe and China forms the macroeconomic framework of the Plutos Switzerland Fund. This investment environment creates fantasy for small/mid caps.

In this volatile environment, the Plutos-Switzerland Fund had a clear high flyer: ams OSRAMA very positive interview with CFO Rainer Irle, in which he focuses on the margin and rates the finances as 'very good', as well as the 'Buy' rating of the largest Swiss bank with a price target of CHF 1.60 has loosened the knot somewhat, even if the share is probably still 100% undervalued.

The R&S Group – the newcomer to the stock market has already gained 80% since the beginning of the year. We are pleased to have been one of the investors since the de-Spac in December 2023. The stock does not (yet) appear in most Swiss funds.

The cyclicals Bystronic, Lem Holding, Belimo, Zehnder anticipate further interest rate cuts and rose particularly after the US interest rate decision. Straumann also rose strongly - the stock, which some consider to be cyclical, climbs higher without any news and is said to have broken an important chart-technical mark. The interest rate cuts in China are also helping.

Despite strong Micron results and prospects, VAT and Comet suffered a small loss month-on-month – however, the upswing in the semi-cycle seems to be in full swing.

Accelleron is down slightly month-on-month, but we expect the contract manufacturing agreement with Hyundai Marine Engine, Accelleron's largest customer and major supplier of 2- and 4-stroke engines for the merchant marine industry, to provide a tailwind to the value in October.

A value whose development we do not understand at all at the moment is Aryzta: since mid-May and prices above CHF 1.80, perhaps the most successful turnaround in modern Switzerland has lost over 10%. This despite the fact that the 2025 targets will be achieved in 2024 and the segment is showing a certain defensiveness. Analysts agree that prices above CHF 2.20 would be fair, but buyers are not forthcoming. In addition to the inclusion of Aryzta in more relevant indices, M&A would certainly trigger a re-rating. The large bakery market is still very fragmented and although Aryzta is focusing on organic growth, Europastry is looking for a buyer after the canceled IPO. Around 30 other companies would also be possible targets. What is certain is that the stock is trading well below its value here - we have increased our weighting slightly.

Negative falls again Pierer Mobility where the restructuring has only just begun – but a China rebound would also be extremely positive for the KTM manufacturer, which is well positioned in China. Komax is testing new lows – this presents an enormous opportunity in the medium term.

No SMI stock has so far shown a worse annual performance in 2024 than Kuehne+NagelThe news that DSV is buying its competitor Schenker and thus becoming an industry giant did not help. It remains to be seen whether a competitor preoccupied with itself will cause problems for Kühne+Nagel.

In order to reduce the technology weighting in Plutos-Switzerland, we reduced the position in u-Blox completely sold.

Overall, it is noticeable that the SSwiss small/mid caps performed significantly better than Swiss large caps in September the beginning of a trend that we consider long overdue?

“It is always easiest to run with the stove; at times, it can take a deep reservoir of courage and conviction to stand apart from it. Yet distancing yourself from the crowd is an essential component of long-term investment success.”

Seth Klarman, US hedge fund manager, founder of the Baupost Group (1957)

Sunrise – welcome back!

With the telecom provider Sunrise, an already well-known company will be returning to the Swiss stock market via a spin-off in Q4 2024. At the beginning of September, I had the opportunity to find out more about this transaction, the status quo and future plans at the investor day and to talk to the management and the department heads.

Sunrise, the clear No. 2 in the Swiss telecom market behind Swisscom, was already listed on the Swiss stock exchange from 2015 to 2020 and was taken over by Liberty Global in 2020. Three years ago, in 2021, Sunrise took over its competitor UPC and has integrated it in recent years. Now Liberty Global is planning a 100% spin-off, and the IPO should take place in the course of Q424. I'm guessing November, as December does not seem ideal for IPOs.

Sunrise can be seen as an interesting Swisscom alternative (but without foreign exposure), a stable dividend story and a B2B challenger to Swisscom.

Sunrise is not a growth or margin expansion story: the guidance for 2024/25 envisages stable sales of around CHF 3 billion, a stable to low single-digit EBITDA margin increase (2023: 34%), the reduction of the CAPEX share from 16-18% to around 15% and thus an adj. FCF of over CHF 410 million (FCF CAGR 16%). In 2025, at least CHF 24 million will be paid out as dividends for FY240, which should correspond to a return of around 6% if my calculations are correct. The dividend policy envisages a payout rate of up to 70% of the adj. FCF - these dividends will be exempt from withholding tax for at least the next five years.

The presentations on the three areas 'Main Brand' (Sunrise), 'Flanker Brands' (Yallo, Lebara, Swype) and B2B were convincing, because in all three segments Sunrise is at least on a par with Swisscom in terms of technology or has the intention (B2B) to significantly increase its market share. The first two segments accounted for 2023% of sales in 74, and B2B 26%.

The main brand Sunrise has significantly increased brand recognition through strong partnerships with Swiss Ski and Roger Federer. 'Devices as a Service' (DaaS) represents an attractive customer offering: the collaboration with Apple allows a Sunrise customer to exchange a defective device free of charge in any Apple store worldwide, two different cyber security tools are available and Sunrise Moments is intended to reduce churn (NB: Churn fell by 223% Q224 vs. Q8).

The 'Flanker Brands' yallo and Swype, so-called Smart Shopper Solutions, are growing well thanks to an attractive price/performance offering. All products are already based on 5G.

The B2B team won Migros as a customer at the end of 2023 and integrated around 2500 stores and just as many locations. Anyone who can convince and handle such a large retailer seems to be viable for other large companies as well.

However, the SME segment in particular seems to be attractive in terms of growth and margins: many smaller companies have outsourced IT and Sunrise can focus on the consultants of these businesses.

As mentioned, the merger with UPC has been completed and the majority of investments have already been made: CtC (Cost to Capture), i.e. costs to create the synergies, were high at CHF 69m (2021), CHF 96m (2022) and CHF 41m (2023), but have now largely been eliminated. OPEX CHF 87.5 million and CAPEX 210.5 million had a heavy impact on the margin in 2022/23. The synergies were realized, a new organizational design and brand strategy were implemented, and customer migration was completed. A price increase was also implemented in July 2023. The UPC brand was 'retired'.

The media have already focused on two points of criticism:

The high level of debt: as of H124, the net debt/EBITDA ratio was a high 5.9x. A capital injection from Liberty Global will reduce this ratio to 24x by FY4.5 and Sunrise is targeting 3.5-4.5x in the medium term - in our opinion, this is still quite high, but should continue to decrease in the future after the dividend is paid out.

Liberty Global majority shareholders John Malone and Mike Fries: through the share structure with two categories (10% capital becomes 40% votes), they continue to hold the reins. Fries will also be Sunrise's Chairman and Sunrise will continue to work closely with Liberty after the spin-off. While this share structure can be described as outdated in Europe, there are several companies in the USA that have implemented a voting rights limit. This means that certain shareholders (often founders or institutions) have a higher voting right per share than other shareholders. Here are some examples of such companies - not all of them completely unknown: Alphabet (i.e. Google), NVIDIA, Alibaba, Dropbox, Meta (i.e. Facebook), Snap, LinkedIn (now part of Microsoft), Pinterest, Spotify Technology SA

This structure seems to be particularly common in the technology industry, as companies are often run by founders who want to retain control of the company even if they own a smaller share of the equity.

My personal opinion: Sunrise will certainly come to market with a certain price discount compared to Swisscom due to its debt and shareholder structure - both of these have been clearly communicated and are therefore not a problem for me. It is still too early to estimate the valuation, because although non-involved analysts may already be writing about the spin-off, no one has done so yet... However, I like the prospect of a stable high dividend and an alternative to Swisscom in the telecom sector is welcome. As was forced to do with Accelleron and intentionally with Sandoz, we will probably wait for the 'flow-back', i.e. the sales of existing Liberty Global shareholders, in the first few days or weeks before we decide to invest.

Swiss quality cyclicals – main beneficiaries of the interest rate turnaround?

On September 18, 2024, we saw the first interest rate cut by the American Fed since March 16, 2020 - at that time it was 100 bps to counteract the Covid crisis. After that, interest rates remained almost at 0%. It was not until two years later, on March 17, 2022, that the US Federal Reserve raised interest rates by 0.25%, before increasing them extremely steeply and almost monthly, until July 26, 2023, to 5.25 - 5.5%. US interest rates were at this level until recently.

Now it is important to accept the following paradigm shift: While previously 'bad news' was 'good news' with regard to the economy, now 'good news' (i.e. falling jobless claims and unemployment figures, better retail sales and, of course, falling inflation) is really 'GOOD NEWS', because it strengthens the Fed's belief that it can lower interest rates without the risk of a recession.

The Swiss National Bank (SNB) has acted noticeably more proactively than the US Fed: a first interest rate hike in March, then in June and now another 25 bps - with wording that suggests further steps are to come. Even though inflation has never been a really serious problem in Switzerland, the SNB has demonstrated its independence and acted calmly.

In the short term, this interest rate move is relevant for many, but for us it is only a first step - a scenario of falling inflation, falling interest rates and an improving economy in the USA, Europe and China forms the macroeconomic framework of the Plutos Switzerland Fund. This investment environment creates imagination for small/mid caps.

So the question arises as to which stocks could benefit most from this interest rate turnaround?

Since mid-2021, the share price of many cyclical Swiss companies has fallen significantly, despite the high quality of their products, balance sheets and management – ​​in inverse correlation with the rise in interest rates.

While the indices have made up a fair amount of their losses from 2022, and banks and insurance companies are even higher than in mid-2021, the valuations of high-quality cyclicals remain largely at multi-year lows.

The reason for this is clear to all of us: the problems in the supply chains did lead to great incoming orders after the pandemic, as many customers ordered excessive quantities to ensure they were in stock. These inventories were reduced only slowly and the steep rise in interest rates meant that new orders were not received and incoming orders collapsed. Added to this was the weak economic performance in Europe and China. The USA was the only exception in this regard. At the same time, fixed costs (factories, employees, raw materials) could not be adjusted quickly enough, and many companies had to cut costs and restructure.

Of course, there are also a few positive exceptions, such as Belimo: the Hinwil-based company was already in a serious crisis, but was able to improve service and innovation and gain market share. The share price is now also evidence of this, despite the high valuation - but just a few months ago the share price picture was anything but inspiring. That has changed in a very short time: +35% in just three months. I could also mention SFS, Accelleron or Holcim here.

In my opinion, the situation is much better today: supply chains have been running smoothly again for some time, customers' inventories are being emptied continuously, and interest rates are falling. The German traffic light government is still putting the economy on red, but a change of government seems imminent. In China, the government has triggered an economic rebound with lower interest rates. Companies have become leaner, more powerful, more innovative, and even more cost-conscious.

I am therefore convinced that it now makes a lot of sense to target the best companies with good products, strong balance sheets and good management, which were on all investors' wish lists just three years ago. My priority is Lem Holding, Forbo, Komax, Kühne + Nagel, SIG, Interroll, Bystronic, Schweiter, Zehnder, Bucher - some of which are already represented in the Plutos-Switzerland Fund. In addition, medmix, Adecco and the OC Oerlikon, which is undergoing a transformation, represent good potential for me. chart below compares some course images – but the selection is of course far from exhaustive.

With around five weeks to go before the US presidential election, small/mid caps are also likely to be boosted by a more likely election of Donald Trump. Smart minds have calculated that, based on market behavior after his election in 2016 and the attempted assassination of Trump in July 2024, a 5-10% outperformance of small/mid caps is possible within 1-3 months. After Trump's election victory in 2016, the S&P 600 Small Cap rose 15,7% by year-end, compared to a 500% rise in the S&P 5. Similarly, after the assassination attempt in July 600, the S&P 2024 rose 6,4% by month-end, while the S&P 500 fell 1,6%.

The Atlanta Fed's forecast for third-quarter GDP growth of 3,1% is also above consensus estimates. Small/mid caps have a history of significant gains when GDP beat expectations, so the October 30 GDP report could serve as a potential catalyst for the small/mid cap segment.

My personal opinion: Like Warren Buffett (“I make no attempt to forecast the market- my efforts are devoted to finding undervalued securities.”), we focus on finding undervalued companies. The above approach seems to me to be quite suitable for classifying the quality stocks and bringing future winners into the portfolio. In view of the above arguments and the expectation of a certain tailwind, it might be advisable to increase the exposure to small/mid caps.

Best regards,

Stephan