Sustainable Equities Boutique

Swiss Equities Outlook: Small will be big

Outlook
Sustainable Investing
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Marc Hänni

Head of Swiss Equities, Senior Portfolio Manager

In 2021, Swiss equity investors should focus on companies with global industry leadership, innovative strength and healthy balance sheets. Among them, well-managed Swiss small and mid caps could be one of the most promising return sources next year.

Thanks to the prospect of a global rollout of COVID-19 vaccines, the pandemic could soon lose its threat. Nevertheless, there is no doubt that 2021 will again be a year of great uncertainty and change. To navigate such an environment, it is worth taking a look at Swiss small and mid caps. They may have been hit particularly hard by the pandemic, but they have been able to recover much faster than the overall market.

Small and mid caps and are underestimated

Thanks to their resilience, Swiss small and mid caps could harbor significant return potential next year. They often, yet unfairly, play a wallflower role since the spotlight tends to be on big, international players such as Nestlé, Roche und Richemont. However, there is no need for their long-term performance to hide behind the index heavy weights. Over the past 25 years, the Swiss small and mid cap segment has posted a return of over 1000% - more than twice as much as the performance of the Swiss market as a whole.

This success is remarkable and arises from the fact that many Swiss small and mid caps are well managed, have strong brands and pursue a clear long-term corporate strategy. They are also highly innovative and often have strong balance sheets with low debt levels. This combination results in high-quality products and services that are well received around the world.

Over the past 20 years, companies from a wide range of industries have succeeded in becoming global market leaders. Examples of this are Ems Chemie, Sonova and Schindler. Originally, companies with Swiss roots were mostly active only on their home turf or, at best, in neighboring Europe. Over time, they ventured into other countries thanks to successful business activities. In addition to establishing a sales presence, there has been a trend for several years now to relocate production facilities closer to the customer. Especially in early 2020 with the outbreak of the Corona crisis, a local presence has turned out to be a key to success as supply chains were disrupted around the globe. The trend towards local sourcing is likely to continue in the post-pandemic period.

Cyclical but resilient

The Swiss small and mid cap segment is heavily dependent on the export economy and is much more cyclical than the general Swiss market, which has a strong defensive character due to the index heavyweights. This is a double-edged sword. Although many Swiss companies have been very successful in emerging markets over the last ten years, Europe is still the most important trading partner, alongside the US as well as China. For example, exports to the neighboring state of Baden-Württemberg alone amounted to the same volume as exports to China in 2019. Therefore, the prospects of Swiss small and mid caps are directly related to the economic health of their trading partners.

Moreover, their cyclical nature has one distinct disadvantage: Swiss small and mid caps suffer more in any slowdown in global economic growth than Swiss blue chips. For example, Swiss small and mid caps underperformed the overall Swiss market by 12% in the period between September to December 2018, when market activity was negatively impacted by uncertainties surrounding the trade war between the US and China. Similarly, they lost over 25% of their value in the first 10 weeks of 2020 underperforming the Swiss Performance Index (SPI) by almost 8%. However, the cyclical tilt also favors a swift recovery. Between the end of March and the beginning of December 2020, Swiss mid and small caps gained more than 40%, strongly outperforming the overall market.

Even though earnings for the entire Swiss small and mid cap segment are expected to shrink by an estimated 24% in 2020, double-digit growth is well within the range of possibilities again across all sectors in the next two years. Earnings growth of slightly above 25% is expected for 2021, which should be followed by 15-20% in 2022.

Good prospects in various sectors

In the biotechnology sector, for example, Idorsia should be able to look ahead to significant milestones in 2021, as the company is preparing to take important steps towards the commercialization of its first products. FDA approval of the multiple sclerosis drug Ponesimod, which is being launched by Johnson & Johnson, is expected in Q1. Furthermore, the approval of the sleeping aid Daridorexant in the US could also come through towards the end of 2021. Once revenues start to come in, the company's business model could be considered less risky.

Zurich Airport has had a very difficult few months. After a new record of 31.5 million passengers was achieved in 2019, these figures have collapsed since the outbreak of the pandemic. A normalization of passenger numbers back to 2019 levels is unlikely to happen before 2024. Nevertheless, the company is well positioned to recover quickly from the crisis due to its strong balance sheet, transparent fee disclosures for the next five years, and the diversification of revenues, which makes sure that 25% of future earnings are independent of passenger numbers.

Lindt & Sprüngli, the global market leader for premium chocolate, should be able to report improved business development figures for the second half of 2020, as retailers worldwide have placed orders in time for the Christmas period and with volumes similar to the previous year. Furthermore, the monthly sales indicators of the market research institute Nielsen point to solid growth compared to the previous year. In addition, Lindt & Sprüngli's strong balance sheet and stable cash flow generation have enabled the company to take advantage of the crisis by securing new market share thanks to the rollout of a successful marketing strategy.



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