Monthly Update - October

Good returns despite market headwinds

• Strong stock selection lifted funds despite market challenge
• A multi-year opportunity in undervalued small-cap stocks
• Short book – focus on accounting

Origo Seleqt
Origo Seleqt rose by 0.4% during the month. Meanwhile, the Nordic small-cap market fell by 2.6%, and the Swedish small-cap index CSRX declined by 5.4%. Year-to-date, the fund's return stands at 18.9%, which is about 5 percentage points above its benchmark.
Protector, Hanza, and Thule experienced significant revaluation and made strong contributions to the total return. Conversely, real estate company Catena, along with the broader real estate sector, underperformed and had a negative impact.
During the month, we continued increasing our holdings in the healthcare sector, which has been a recurring theme for Origo throughout 2024. BioGaia is a new investment where we see an interesting combination of accelerating growth in a forward-looking industry and a valuation at a 10-year low. The fund’s top five holdings are currently Elekta, Freetrailer, Vaisala, SPNO, and SOBI.
It is worth noting that the fund's strong relative performance compared to the market and similar funds has not been achieved through unusually high risk-taking. Both beta and volatility have been significantly lower than the index and fund category since its inception in 2022, ensuring that the excess returns are of high quality.

Origo Quest
Our hedge fund, Origo Quest, gained 4.4% during the month, while the Nordic stock market fell by over 5%. The fund’s volatility was half that of Carnegie’s small-cap index CSRX, and its correlation (beta) was 0.3. Risk-adjusted, October was one of the strongest months for the fund since its inception in 2013. Since inception 12 years ago, the total return has reached 166%, compared to the Nordic hedge fund index (NHXE), which has delivered 111%.

The fund’s long investments defied market trends and posted absolute gains. Protector, Hanza, and Thule made positive contributions, while Elekta, one of the top holdings, negatively impacted returns. The long book remains relatively concentrated, featuring high-quality Nordic small- and mid-cap companies where we see significant discrepancies between operational improvements, fundamental value, and broader market perceptions.

Meanwhile, several companies in the short book reported weak quarterly results, leading to significant price declines. Better Collective was the standout performer in the short book, with its stock dropping 40%. Nonetheless, the short book's success was broad-based and not reliant on any single position. Our short book focuses on identifying companies with significant risks in accounting, balance sheets, or cash generation. More details about this strategy will be provided later in the report.

Market Overview
Globally, the market has been influenced by increased concerns about inflation and interest rates. The U.S. 10-year Treasury yield rose nearly 0.5% during the month to 4.25%. The MSCI World Index closed the month down by 1%.

Nordic markets showed mixed performance. The Oslo Stock Exchange rose slightly despite declining oil prices, driven by strong banking sector reports and a continued rally in salmon stocks following a proposal for substantial tax cuts on salmon farming. Other Nordic markets fell by around 4%. In Sweden, the interest rate-sensitive real estate sector dropped 11%, putting significant pressure on Carnegie’s small-cap index (-5.4%).

Investments in focus
We are currently in the reporting season for the third quarter, and so far, there has been a marginal overweight of reports exceeding expectations in the Nordic region. For Origo, the majority of companies have delivered strong results so far.

Nolato delivered a strong quarter, with organic growth of 5%, which was double the expected figure. We appreciate the company’s increasing focus on the non-cyclical Medical Solutions segment and the continued positive trend in margins.

The Norwegian insurance company Protector impressed with its Q3 results. Historically, the company has often delivered surprisingly strong financial management results, but this time it was the insurance operations that stood out, with results 41% better than consensus estimates. We also note that the international expansion in markets like the UK and France is progressing better than planned.

SOBI came out with yet another strong report, well above expectations. We have repeatedly emphasized that SOBI is undervalued given its broad, promising, and fast-growing product portfolio. As such, SOBI has been an Origo favorite since the failed acquisition attempt in 2021. Revenue of SEK 6.9 billion was 39% higher than the same quarter last year and 15% above expectations, prompting the company to raise its full-year forecast. The stock has risen by over 75% in the past two years, but this revaluation has been entirely driven by rising profits. We still find the valuation multiple highly attractive given the growth we foresee for 2024–2026.

Our Danish distributor A&O Johansen delivered a report roughly in line with expectations. The market for HVAC and other construction products is very weak, with declining volumes directly impacting AOJ. This is most evident in the large enterprise segment, where the gross margin was squeezed by nearly two percentage points. Nevertheless, organic growth reached 1.9% for the quarter, demonstrating continued market share gains. The strategic expansion plan is fully underway and progressing as planned. The company recently completed three acquisitions with successful integration and plans to open two new facilities in Stockholm within the next six months. The stock has stagnated over the past two years, and we underestimated its sensitivity to economic conditions. However, leverage works both ways and we expect significant improvement when the macroeconomic picture stabilizes and rate cuts begin to impact the economy.

The star of the reporting season so far must be the contract manufacturer Hanza, at least in terms of expectations. Sales declined by 4%, but this was far better than the -10% to -20% seen among similar contract manufacturers like Note and Kitron. The margin increased to 6.7% (from 5.7%), and most notably, the company reiterated its message of solid profitability growth from the Orbit One acquisition completed earlier this year, maintaining its margin target of at least 8% by 2025. We recently met with both the main owner and the company’s management and see no reason to change our positive assumptions from when we invested during the 2022 share issue. Since then, Origo, along with the main owner Gerald Engström, has increased its holding in Hanza, and we anticipate continued strong execution while the reshoring trend provides structural tailwinds.

Multi-year opportunity in undervalued small-caps
In several monthly letters, we have highlighted an interesting and long-term opportunity in the small-cap segment, following a historically weak performance compared to large-cap companies in recent years in Europe, the Nordic region, and even more so in the U.S. Valuations are at very low levels relative to large-cap companies, as the largest firms in the U.S. (the "Magnificent 7"), Europe (LVMH, SAP, Novo), and the Nordics (Novo, Atlas Copco, Astra, etc.) have performed much better. When interest rates fall, it is typically the starting signal for small-cap companies.

Origo's investment thesis for the Nordic region in the coming years is that the greatest returns will be found in smaller and lower-valued small-cap companies when the small-cap cycle begins a more long-term phase of outperformance.

In the initial phase, the market often buys what worked best in the previous cycle. Looking at returns over the past 12 months, since small-cap companies started showing signs of revival, the strongest performance has been seen in larger small-cap and especially mid-cap companies. However, our thesis is that for small-cap companies to outperform over the long term, valuation must also play a role, not just potential earnings growth.

At Origo, we focus on value, quality, and transformation, which we believe will drive both earnings growth and valuation change, as opposed to relying solely on earnings growth. Comparing the largest companies in the small- and mid-cap segment today with those in 2017, we can see that the largest companies are now valued higher than historically, both in absolute terms and at a greater premium than seven years ago. In 2017, the 20 largest companies traded at a roughly 15% premium to the small-cap market, while today, the premium is about 30%. Looking beyond the top 20, the valuation is at 15 times earnings, which is roughly the same as in 2017.

ABG Sundal Collier conducted an analysis on the theme "the most overweight small-cap companies in Sweden," and unsurprisingly, several of the highest-valued and mid-cap companies appear on the list. ABG also notes that over the past three years, the concentration of top positions (top 10) in small-cap funds has increased from 37% to 42%, the highest level in many years. At the same time, these top 10 positions are valued at an aggressive 29 times earnings, the highest valuation in many years, and a 50% premium to the index.

The short book – Focus on aggressive accounting
As mentioned earlier in this report, we have had a great spread between the long book and the short book this month. The long book remained stable as the market declined, while the short book fell even more than the market. Some of the biggest contributors in Quest came from the short side of the fund, which is unusual given that position sizes on the short side are typically smaller than in the long book. Our short strategy generally relies on having a high "batting average" — meaning the majority of positions should perform well rather than relying on a few standout cases.

We hold several short positions in the online gambling segment due to structural issues we see in the industry. The most significant positive contributor to returns in October was Better Collective. The stock dropped over 40% after issuing one of the largest profit warnings in Europe this earnings season. The company revised its EBITDA forecast down by 30%, impacting net profit even more due to interest expenses eating into earnings. The stock was a top position in Quest's short book. While the position has organically reduced, we will monitor whether the industry's challenges persist in 2025 and whether Better Collective can significantly cut costs without affecting revenues.

It’s worth mentioning that Origo’s short book strategy is substantially different from the approach taken in managing the long book in Quest or the Seleqt fund. The primary focus of the short book is on accounting practices and balance sheets. We look for companies with questionable accounting and/or balance sheet issues, which can serve as early indicators that a company is performing worse than its income statement suggests. We grade the "aggressiveness" of the accounting and balance sheet concerns on a scale of 1–5. After this evaluation, we assess the timing and attempt to determine how we expect the position to play out within 12 months. Beyond this, we prefer to see additional signals, whether fundamental or more subtle, that support a short thesis.

Using Better Collective as an example, we rated the aggressiveness of its accounting a 4 out of 5. From an accounting perspective, it has been difficult to understand how the company reports its organic growth and how acquisitions have impacted results. This lack of transparency has persisted for some time, raising a red flag that the company’s underlying health may be weaker than portrayed.

When Better Collective made a large acquisition this spring and raised its financial targets, we interpreted it as a sign that the company had become more negative about profits from its legacy business. Additionally, we had concerns about potential accrued-like revenues, which might have obscured price pressures in the market.

As for timing, we rated it a 5 out of 5. We noted that competitor Catena Media was already experiencing significant issues and mentioned that its clients were reducing marketing spend. In the Q2 report from major U.S. operator Rush Street, we found the following statement:
“There were some recent articles about us that recently came out where we decided to pull back some affiliate spend in some markets. The reason why we did that is ultimately we want to have the flexibility to spend more with affiliates in other markets, make sure we focus on the markets where we get the best ROI. And secondly, there are other channels in the markets where we may have pulled back that we see opportunities to do other types of channels to acquire customers.

So we’re constantly looking at the data and evaluating the right opportunities to deliver the best ROI for us in those markets.”
Rush Street clearly indicated their view on affiliate marketing investments, leading us to assume that other U.S. operators might adopt a similar stance. Additionally, there were discussions about Better Collective's partners being increasingly impacted by Google’s algorithm changes. Coupled with insiders preferring cash over shares in their warrants, we believed the likelihood of a negative scenario unfolding was high. We rarely assign a 5/5 to timing, but in this case, we did.
While the exact details remain unclear since the company has not yet released its official report following the profit warning, it’s likely a combination of all these factors contributed to the collapse of the income statement. We expect EPS for 2025 may need to be revised down by as much as 50%
 
Best regards,
Team Origo
 
Risk Information
Past performance is not a guarantee of future returns. If you invest in securities or funds, your investment can both increase or decrease in value, and it is not certain that you will get back the entire invested capital. An investment in our funds should be viewed as a long-term investment.