Notes from EQMC

EQMC is a leading active investor in the pan-European listed small and mid-cap space. It has an active ownership strategy that takes significant minority positions in a concentrated portfolio of 12-16 companies. We partner with these companies and bring a tailored strategy to drive transformational change, accelerate value, and de-risk our investments.

Today, EQMC manages c.€1bn within a 12-person portfolio management team having repeatedly applied its successful process since its inception in January 2010, generating c.13% net returns.

In the inaugural edition of ‘Notes from EQMC’, we explore how 2022’s market turbulence, with high inflation and supply chain bottlenecks, impacted investor sentiment and valuation multiples across the portfolio, and how this may all turn in 2023.

Spotlight themes:

• EQMC’s companies made good operational progress in a very tough 2022 – a year clouded by market turbulence, with supply chain bottlenecks and rising inflation impacting businesses
• However, the operational progress was obscured by a compression in multiples. Pessimistic investor sentiment and positioning across EU small caps widened their discount (EU large-cap equities ended the year -10% vs small caps -23%)
• EQMC´s trading multiples (13x P/E pre-Covid, 9x on 2025 earnings) already seem to discount a very negative earnings scenario. In our view, they do not reflect the attractive growth of our companies given their pricing power and cost flexibility
• The small cap segment has historically performed well when inflation is falling, the yield curve is steepening, and tightening is past its peak – all of which we could see this year
• Market shocks delayed our active engagement programme which we expect to reassert itself in H2 2023

The second half of 2022 saw the European economy notably deteriorate as we faced war in Ukraine, an energy crisis, high levels of inflation, and expensive and difficult to access capital. However, household finances remain healthy, and inflation should start to gradually ease – due to higher interest rates and the normalization in supply chains and commodity prices. Moreover, mild weather should allow Europe to cope without rationing its energy supply this winter.

EQMC had operational progress across the portfolio in a very challenging year. Order intakes were particularly healthy, even if profitability remains subdued as supply chain challenges and inflation weighed on margins. We expect to end the year with c.20% earnings growth in 2022.

The reassuring operational progress was obscured by a compression in multiples. The discount of EU small caps widened this year, particularly in the UK (on political issues) and Germany (on gas supplies concerns), which jointly represent two thirds of our portfolio. We endured the full impact of this de-rating, despite our actual revenue exposure is broadly global – with UK and Germany representing only 11-12% each.

Our trading multiples (13x P/E pre-Covid, 9x on 2025 earnings) already seem to discount a very negative earnings scenario, and in our view, they do not reflect the attractive growth of our companies given their pricing power and cost flexibility. In this context, our valuation upside of 100%+ by year-end 2025 implies >25% IRR and stands at the top-end of our 13-year fund history, providing a very attractive risk-reward.

Sentiment and positioning are still very negative for EU small caps, as many large institutions await visibility before directing flows into small caps. However, we note our segment has historically performed well when inflation is falling, the yield curve is steepening, and tightening is past its peak – all of which we could see in the second half of this year.

We cannot predict what will happen in 2023 but we believe our selection of quality global niche businesses that generate a lot of cash should tilt the odds in our favor.