Once again, the Spanish stock market regains its allure for investors. In 2023, it obtained higher returns than the main European indices, with better relative results for the second year in a row. The rise in share prices has been inconsistent, but some sectors, like banking, have experienced notable appreciations. On the upside, the market has considerable potential left to continue excelling, underpinned by the good fundamentals of Spanish companies in various sectors. In this respect, it is worth parenthetically describing the composition of our domestic market.
The Spanish stock market’s benchmark index, the Ibex 35, consists of the 35 largest listed companies. The contribution of each company depends primarily on size. The top three are Inditex, Iberdrola, and Santander, with a combined weight of 40%. If we include the energy and banking sectors, the weight exceeds 62% of the Ibex 35. Thus, the index is heavily concentrated in a few securities and sectors, which, in our view, do not accurately reflect the listed companies in Spain. This means, therefore, that its results are highly contingent upon the evolution of very few companies in a small number of sectors.
EDM Inversión, our Spanish equity fund, displays better the diversity of the Spanish stock market, with investments more effectively balanced between sectors and companies that hold less weight on the index. We base our selection on fundamental analysis and a set of criteria that define our DNA: sustainable profit growth with returns, a strong balance sheet, minimal leverage and competitive advantages, elevated cash generation, management team quality, and reasonable valuations. The Fund is actively managed, as demonstrated by its active share ratio of 82%. (An active share of 0% indicates that the portfolio has the same components and weight as the benchmark index, meaning, it is fully indexed. At 100%, a portfolio contains no components with which to compare to the index.)
Using these criteria, we invest in multinational Spanish companies that maintain global or European leadership positions within their respective business niches. These include Fluidra, Viscofan, Vidrala, CAF, Befesa, Tubacex, Coca-Cola Europacific Partners, and GCO. Fluidra, which operates in over 54 countries, is a global leader in the swimming pool sector, with 13% market share. Viscofan is the world’s top producer of artificial casings for meat products. It holds a dominant position that grows every year due to its competitive advantages in innovation, customer service, and healthy balance sheet. Vidrala is a European leader in glass container manufacturing. In 2023, it purchased the Brazilian company, Vidroporto, at an attractive price, giving it entry into a new, highly profitable market with tremendous potential. CAF is a major player in the energy transition, given its exposure to the population mobility and urbanisation megatrends through Solaris, its electric/hybrid bus division, and its traditional metro/tram/train business. Befesa is a paradigm of the circular economy as a world leader in the recovery of zinc through the recycling of steel dust waste at steel mills. It operates in Europe, China, and the United States. Tubacex specialises in seamless, stainless steel pipes and umbilical tubing, highly demanded among energy industries like gas, oil, nuclear, and hydropower. The company will play an active role as a global supplier in the energy transition. Lastly, GCO, formerly Catalana Occidente, not only runs a successful traditional insurance business in Spain, but is also one of the world’s top three credit insurers. The Fund also invests in Ibex companies, including Inditex, Repsol, and Cellnex. The latter two are considerably undervalued relative to their fundamental valuation.
In terms of sales by region, the EDM Inversión portfolio is broken down into thirds and divided among Spain, Europe, and the rest of the world; in other words, multinational companies that combine a clear international vision with one-third of all sales exposed to the domestic market, which in 2024 will see higher growth than the main developed economies. Spain’s GDP grew 2.5% in 2023 and is expected to grow 1.4% in 2024, similar to that of the United States, and far outpacing slower growth in the Eurozone of 0.5% and 0.6%, respectively.
Despite the appreciation of portfolio shares in 2023 (+18%), the Fund’s valuation remains low. This is due to appreciations derived from profit growth and not the result of expanding multiples. This fact allows us to maintain a high margin of safety and feel comfortable with EDM Inversión’s current portfolio, given the quality of the assets (average ROE of 16%), healthy balance sheet, minimal debt (net debt/EBITDA of 1.1x), annual profit growth of 11% over the next five years, and 2024 P/E ratio of 9.4x (vs. a historical average of 14x).
One final reflection that supports our view of the Spanish market as a great opportunity is the unprecedented fact that in the last 12-18 months, business insiders (management teams, main shareholders) and the companies themselves have been buying shares in these same portfolio companies. We had never seen this before. And, in addition, offers made by other private investors (VC or infrastructure funds) to Spanish companies have been revived. Such is the case with OPDEnergy and Applus, which we had in the portfolio. We are confident that this process will continue in 2024, while share prices remain inexpensive.
Albert Fayos,
Analyst & Fund Manager EDM Inversion
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