Despite his management roles, Leon Kirch, managing partner and conducting officer in charge of portfolio management at European Capital Partners, keeps a hands-on approach on investment of the firm. Being in the business of investment, he thinks that it is crucial to stay on top of market developments. “It is a very competitive market and we must be able to justify why we charge management fees.” Moreover, he commented that an active involvement in investment enables him to better understand the need of third-party investors when it comes to asset servicing.

Investment philosophy and how it has evolved over time

“Our philosophy is based on ‘entrepreneurial value investing’…  these three words summarise my entire career,” said Kirch. He explained that entrepreneur means that the investment risk of an investment is linked to the fundamentals of a company.  Provided that you paid an “acceptable” price, he thinks that one should see valuation increase when the fundamentals are also improving.

Kirch admitted being inspired by Benjamin Graham, the father of value investing in the 1930s. More specifically, he focusses on the earning power of a company that he defined as the discounted discretionary cash flows while assigning very little weight to their growth to obtain a fair value. It is then compared against the market valuation. A safety margin of around 40% between both levels may reflect an attractive proposition.

The third part of its philosophy, investing, is about buying a security and staying patient until “Mr Market” discovers the intrinsic value, resulting in the margin of safety closing off, i.e., falling to zero. Normally Kirch sells once the stock has reached a fair valuation.

Such strategy enables him to be patient as the company generates cash flows or reduces its debt load, pays dividends and buys back shares. Kirch stressed that he has a greater focus on a company’s ability to generate profits than the dividend level as a high dividend distribution may hide other problems and even weaken a company’s financial profile.

European equities: valuation discount to decline with US equities?

Kirch talked of an oversized attention by the market to the US and the Magnificent 7 tech giants as the market cap of the former accounts for 68% of the MSCI and 33% of the S&P 500 for the latter. He sighs at the little attention paid by Anglo-Saxon investors to the European market, but acknowledged that the US is the “real economic engine of the world,” while Europe is still “full of problems.

”The punchline “America innovates, China replicates and Europe regulates” partly explained the underperformance of European stocks, according to Kirch. He is concerned that the extensive regulation of AI may stifle innovation for an emerging industry. “You may need to hire 50 legal advisors for one computer scientist when launching a company based on” large-language models in Europe “while you need, in fact, the opposite setup.”

There is no doubt that most of the world has performed badly when compared to the US in terms of stock performance in recent years. It is therefore not solely a European phenomenon. However, Kirch noted that European stock performance compares well to its own past. He pointed out that the MSCI Europe forward P/E ratio is close to the average (14.3%) of the last 35 years. The same is true for the cyclically adjusted P/E ratio (19.2X) and the price-to-book at 2.1X. Without providing aggregated market levels, he commented that his favourite valuation metric is the enterprise value-to-cash flow ratio when looking at individual stocks.

Reviewing the marketing material from ECP that included a chart from JP Morgan, it was remarkable to note that all industries in Europe are cheaper compared to the US, with banks and utilities being the cheapest.

It will therefore not come as a surprise that he observed the beginning of rotation from the US, to European stocks. Kirch thinks that it is a combination of US investors refocussing across the pond and European investors taking profits on their US tech positions and repatriating financial assets back home.

Kirch is agnostic on the sector, country or company. He is not a large or a small cap investor but a self-labelled “flexcap.” He applies a stock screening from which he finds his investment ideas. He ensures that the portfolio is diversified enough in terms of sectors and would not favour one country over another.

Individual stock valuation prevails over other preferences

Few companies were discussed during the interview. One of them was Novo Nordisk. Despite the concerns of sanctions by the US on Denmark and/or its firms on the back of tensions over Greenland, Kirch commented that he started to invest again in the stock in January after it was hit hard enough in December. The stock repricing justified a review of the investment case given an ongoing “substantial” growth potential and a potential return on invested capital above 40%.

Kirch thinks that the company badly communicated the outcome of their latest clinical tests about the reduced efficiency of the weight-loss product due to a dose reduction by patients. Besides, he sees the capacity to produce its treatment for obesity and diabetes on a large scale as a competitive advantage.

Kirch thinks that reason will take precedence over possible US sanctions given the pressing need for Americans to reduce obesity and the imbalances between offer and demand on GLP-1 products.

On the other hand, he is very reluctant to invest in “price taker” industries such as steel where a competitive advantage is hard to build. He would therefore avoid a company such as ArcelorMittal. Partly given the lack of internal expertise, he also shuns utilities as adverse regulatory actions may cut down the return on investment.

AI: synonymous with productivity gains

Measuring his words, Kirch thinks that AI is a “real revolution in all sectors.” He commented that “at my age, I do not want to miss that train given its potential.” He reads extensively on the subject, including a recent keynote from Nvidia’s CEO Jensen Huang which revealed insights on AI’s practical use in robotics amongst other sectors.

However, he struggles to think of any--listed--European firms at the technological AI forefront. Kirch noted that Nvidia processors could not be built without Dutch equipment-maker ASML, but believes that Europe lost the war against China and the US and that the recent small investment announcement dedicated to AI by the EU will not change the picture.

Yet it is not all gloom and doom as some old European industries have decide to go AI. Kirch spoke enthusiastically about Kion, originally known for its forklifts which nowadays uses AI in a collaboration with Accenture and Nvidia to automate and improve productivity of manufacturing plants and logistic centres for its clients.

Elsewhere, he thinks that the pharmaceutical industry--with companies such as Roche, Sanofi and Novo Nordisk--have embraced the technology on pre-clinical trials amongst other use cases.

Kirch also reported the comment of Goldman Sachs CEO David Salomon, saying that more than 90% of an IPO prospectus is written in less than 10 minutes. He thinks that the same could apply for fund prospectuses.

Yet Kirch does not think that AI has reached the point of “reading between the lines”, making the role of humans still essential.

Learning from previous mistakes

Kirch also talked humbly to Paperjam about past mistakes, probably as a signal that he learned the hard way. In the case of Agfa, a firm better known for its photo films before the advent of digital cameras, he strongly believed that its “cash cow” businesses in healthcare, imaging and offset printing would have helped its digital transition. However, the firm was hit by a succession of profit warnings on the back of a transition that took too long to materialise.

Kirch commented that in 2018, ECP took a “contrarian bet” on Europcar after its share price tumbled amid investors’ fears over high debt and disappointing earnings. Despite the prevalent pessimism, ECP believed the market misunderstood Europcar’s leverage story given that the rental industry often benefits from repurchase programmes from car manufacturers that help manage fleet costs. The asset manager exited its position just before the onset of the covid crisis, when the company suffered from “plummeting revenues” that hit its profitability hard. These events ultimately forced Europcar into a deep restructuring and paved the way for its acquisition by a consortium that later delisted the company.

ECP is not all about stock picking

Kirch considers his shop as an active manager. Yet ECP’s wealth managers may recommend ECP funds but also exchange-traded funds (ETFs) for its high-net-worth clients. As the focus of ECP is on Europe and the US, it may recommend, for instance, ETFs focussed on India and Japan, as appropriate. “It is always long only, no reverse ETFs.” ECP would also take exposure on thematic ETFs on the back of a strong view but also when it has no internal competencies on the underlying individual companies.

This article was written for the  to the  magazine, published on 26 February. The content of the magazine is produced exclusively for the magazine. It is published on the website as a contribution to the complete Paperjam archive. .

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