Quality Among Swiss Small & Mid Cap Stocks

INVESTMENT STRATEGY & RESEARCH Research Research Alert

Private Banking & Wealth Management, Investment horizon: 3-6 months, 02/07/2015

Switzerland Quality among Swiss small & mid cap stocks

Owing to a turnaround in earnings revisions, our strategists recently changed their country view on Switzer- land’s equity market, and now expect it to outperform. The pressure on Swiss firms to live up to increased earnings expectations is compounded by two factors: Swiss equities are at peak levels, and the SNB’s removal of the EUR/CHF floor. Populating Switzerland-focused portfolios with high quality stocks can offer an attractive value proposition. Compared with non-quality stocks, quality stocks tend to show higher returns and a lower beta. This Research Alert identifies quality stocks among Swiss small and mid caps with a market cap of up to CHF 15 bn.

Javier José Lodeiro Table 1: Return differential quality vs. Non-quality stocks Senior Equity and Credit Research Analyst - US Banks & Global Insurers [email protected], +41 44 334 56 44 Annual performance Annual performance over 10 years over 5 years Non-quality stocks 6.02% 4.47% Quality stocks 11.72% 16.90% BUY Return differential 5.70% 12.43% AMS, Baloise, Barry Callebaut, Flughafen Zürich, GAM Source: Bloomberg, Credit Suisse Holding*, Geberit, Givaudan, Helvetia, Lindt & Sprüngli, Logitech and Partners Group*. Paying attention to stock-picking should pay off in terms of Based on five quality criteria, we identify 12 stocks with a mar- overall portfolio performance, as the pressure on Swiss com- ket cap of up to CHF 15 bn which we believe will outperform panies to live up to rising earnings forecasts has been com- over the long run. pounded by a strong stock market performance of Swiss equities (Swiss stocks are trading at peak levels) and by the remov- Appealing quality stocks al of the EUR/CHF floor by the Swiss National Bank (SNB). In a recent report (“Swiss quality: Invest in companies with a The 10-year return differential between quality and non- proven track record”), we argued that portfolios benefit from quality stocks is close to 5% p.a. While we expect quality quality stocks in two ways: better performance and lower risk. stocks to suffer in line with non-quality stocks during periods The return differential (vs. non-quality stocks) has been close of market turmoil, quality stocks should recover more swiftly as to 5% p.a. over the past decade. Additionally, a higher quality they tend to cope better with a more challenging environment. ranking is typically associated with a lower beta. Quality stocks have tended to earn the aforementioned return differential precisely during such periods. The return differential over the five-year period is significantly higher than in the

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10-year period. In our view, this highlights the strengths of quality investing: the five-year period falls within the recovery A higher quality ranking can be associated with a lower phase following the last financial crisis. beta The second return analysis is based on the Bank of Amer- ica Merrill Lynch’s (BAML) definition of Swiss quality. Quality stocks are ranked from highest quality to lowest quality and then divided into quartiles. First quartile quality stocks have out- performed fourth quartile quality stocks by 4% p.a. over five years and by 4.7% p.a. over 10 years. Second quartile quality stocks have a similarly positive return differential.

Table 2: Return differential does not change with differences in definition of quality

Quality ranking Median perform- Median performance Beta ance over 5 yrs over 10 yrs 1st quartile 16.5 13.86 1.02 2nd quartile 16.03 12.21 0.97 Source: Bloomberg, BAML, Credit Suisse 3rd quartile 13.29 10.4 0.93 4th quartile 12.51 9.2 1.11 Delta to 4th quart- Delta to 4th quartile Delta to 4th The five criteria defining Swiss quality stocks ile quartile We identify quality stocks with the following five criteria: 1st quartile 3.99 4.66 -0.09 2nd quartile 3.51 3.01 -0.13 3rd quartile 0.77 1.19 -0.18  The key criterion is a strong end-market position. We fo- Source: Bloomberg, BAML, Credit Suisse cus on the following factors, which should ultimately im- prove the end-market competitiveness of a firm: product The higher the quality ranking, the better the return and innovation, cost efficiency/production technology, and the lower the stock beta last but not least, product distribution strategies. As this The preceding table is a simple data-point analysis. Here we is a qualitative statement, the view of the bottom-up ana- show how a better quality ranking influences return and risk. lyst is very important. The higher the quality score, the better the performance, espe-  The second criterion is a convincing financial track re- cially over longer periods of time. The explanatory power of the cord. The bottom-up sector analyst decides which finan- regression is low, and we attribute this to the financial crisis. cial metric is most important for his or her sector, and then selects quality stocks accordingly. The aim is to select stocks whose financial performance is clearly among Positive impact of quality ranking on total return over the best. 10-year horizon  We identify firms with above-average capital efficiency (high or improving return on equity/return on assets) which ensures that the firm earns its cost of capital and can return capital to shareholders.

 We include firms whose indebtedness is low or at least improving. An exception to this criterion could be the fin- ancing of an M&A transaction with debt, but generally we select firms with a solidly financed balance sheet.

 Last but not least, we choose stocks whose management we consider to be both strong and shareholder- friendly (and not only in terms of capital return strategy). With this criterion, the ability to cope with challenging situations is pivotal. Source: Bloomberg, BAML, Credit Suisse

We apply these criteria to Swiss small and mid cap stocks with Similarly, beta can be displayed as a function of the quality a market cap of up to CHF 15 bn and identify a list of stocks ranking. As expected, beta tends to be lower when quality is (please see stock table). The FY 2016E P/E of 21.4x of qual- higher. This relationship is not very strong statistically, but, in ity stocks represents a P/E valuation premium compared with our view, is nevertheless a good indicator of risk. the Swiss stock market of close to 20%. In our view, this premium is justified. *Please find disclosure information on Credit Suisse Invest- ment Banking rated companies mentioned in this report at: https://rave.credit-suisse.com/disclosures. (02/07/2015) Research Alert, 02/07/2015 Quality among Swiss small & mid cap stocks 3

Quality stocks among Swiss small & mid caps with a market cap of up to CHF 15 bn

Company Bloomberg Sector CS rating Crcy Close Market Cap P/E FY1 DY FY 1 (%) (1/7/15) (bn) AMS AMS SW Semiconductors BUY CHF 56.1 4.11 23.8 0.7 BALOISE HOLDING AG BALN VX Insurance HOLD CHF 114.9 5.37 10.75 4.61 BARRY CALLEBAUT BARN SW Food Beverage HOLD CHF 1062 5.83 22.47 1.51 FLUGHAFEN ZUERICH FHZN SW Transportation BUY CHF 727 4.43 19.62 2.21 GAM HOLDING AG * GAM SW Div. financials NEUTRAL CHF 19.7 3.09 16.51 3.56 GEBERIT AG GEBN VX Capital goods BUY CHF 313.7 11.29 23.7 2.67 GIVAUDAN GIVN VX Materials HOLD CHF 1626 14.96 24.38 3.28 Helvetia Holding HELN SW Insurance HOLD CHF 543 5.45 14.6 3.4 LINDT & SPRUENGLI PC LISP SW Food BUY CHF 4997 11.44 30.52 1.62 LOGITECH LOGN SW Technology BUY CHF 13.8 2.39 18.17 3.55 PARTNERS GROUP HOLDING * PGHN SW Div. financials OUTPERFORM CHF 280.75 7.5 21.41 3.22 Median quality stocks in Swiss small and midcaps 21.4 2.7 Median Swiss non-quality stocks 18.7 2.7 * Please find disclosure information on Credit Suisse Investment Banking rated companies mentioned in this report at https://rave.credit-suisse.com/disclosures. Source: Credit Suisse Research Alert, 02/07/2015 4

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reach different conclusions from, the information presented in this report. Company Rating Date Those reports reflect the different assumptions, views and analytical methods of the analysts who prepared them and CS is under no obligation to HOLD 06/02/2015 ensure that such other reports are brought to the attention of any recipient TERMINATED 13/01/2015 of this report. HOLD 10/10/2014 Analyst certification HOLD 19/09/2014 The analysts identified in this report hereby certify that views about the HOLD 24/02/2014 companies and their securities discussed in this report accurately reflect HELVETIA HOLDING AG HOLD 09/02/2015 their personal views about all of the subject companies and securities. The (HELN SW) analysts also certify that no part of their compensation was, is, or will be TERMINATED 20/01/2015 directly or indirectly related to the specific recommendation(s) or view(s) in RESTRICTED 07/07/2014 this report. HOLD 03/09/2013 Knowledge Process Outsourcing (KPO) Analysts mentioned in this report LINDT & SPRUENGLI AG BUY 11/03/2015 are employed by Credit Suisse Business Analytics (India) Private Limited. (LISP SW) Important disclosures BUY 03/02/2015 CS policy is to publish research reports, as it deems appropriate, based on TERMINATED 12/01/2015 developments with the subject company, the sector or the market that BUY 16/09/2014 may have a material impact on the research views or opinions stated RESTRICTED 14/07/2014 herein. CS policy is only to publish investment research that is impartial, independent, clear, fair and not misleading. BUY 13/03/2014 LOGITECH INTERNATION- BUY 23/04/2015 AL SA (LOGN SW) The Credit Suisse Code of Conduct to which all employees are obliged to BUY 20/03/2015 adhere, is accessible via the website at: BUY 11/02/2015 http://www.credit-suisse.com/governance/en/code_of_conduct.html TERMINATED 20/01/2015 BUY 24/10/2014 For more detail, please refer to the information on independence of finan- BUY 25/07/2014 cial research, which can be found at: BUY 29/04/2014 https://www.credit-suisse.com/legal/pb_research/independence_en.pdf The analyst(s) responsible for preparing this research report received compensation that is based upon various factors including Credit Suisse's total Fundamental and/or long-term research reports are not regularly produced revenues, a portion of which is generated by Credit Suisse Investment for (BALOISE HOLDING AG, GEBERIT AG, GIVAUDAN SA, HELVETIA Banking business. HOLDING AG, LINDT & SPRUENGLI AG, LOGITECH INTERNATIONAL SA). The Global Research department reserves the right to terminate coverage at short notice. Please contact your Relationship Manager for the Equity rating history as of (02/07/2015) specific risks of investing in securities of these companies. Extracts of this research have not been sent to (AMS, BALOISE HOLDING AG, Company Rating Date BARRY CALLEBAUT, FLUGHAFEN ZUERICH, GEBERIT AG, AMS (AMS SW) BUY 11/06/2015 GIVAUDAN SA, HELVETIA HOLDING AG, LINDT & SPRUENGLI AG, BUY 06/05/2015 LOGITECH INTERNATIONAL SA) prior to publication for the purpose of BUY 04/03/2015 verifying factual accuracy. The subject issuer (BARRY CALLE- BUY 09/02/2015 BAUT, FLUGHAFEN ZUERICH, HELVETIA HOLDING AG, LINDT & SPRUENGLI AG, LOGITECH INTERNATIONAL SA) currently is, or was BUY 21/01/2015 during the 12-month period preceding the date of distribution of this re- BUY 23/10/2014 port, a client of Credit Suisse. Credit Suisse provided investment bank- BUY 31/07/2014 ing services to the subject company (BARRY CALLEBAUT, FLUGHAFEN BUY 05/05/2014 ZUERICH, HELVETIA HOLDING AG, LINDT & SPRUENGLI AG) within BALOISE HOLDING AG HOLD 27/03/2015 the past 12 months. Credit Suisse provided non-investment banking (BALN VX) services, which may include Sales and Trading services, to the subject is- HOLD 04/02/2015 suer (BARRY CALLEBAUT, LOGITECH INTERNATIONAL SA) within the TERMINATED 20/01/2015 past 12 months. Credit Suisse has managed or co-managed a public HOLD 28/08/2014 offering of securities for the subject issuer (BARRY CALLEBAUT, HOLD 06/08/2014 FLUGHAFEN ZUERICH, HELVETIA HOLDING AG, LINDT & HOLD 29/08/2013 SPRUENGLI AG) within the past three years. Credit Suisse has man- BARRY CALLEBAUT HOLD 10/04/2015 aged or co-managed a public offering of securities for the subject issuer (BARN SW) (HELVETIA HOLDING AG, LINDT & SPRUENGLI AG) within the past 12 HOLD 21/01/2015 months. Credit Suisse has received investment banking related com- HOLD 10/11/2014 pensation from the subject issuer (BARRY CALLEBAUT, HELVETIA HOLD 03/07/2014 HOLDING AG, LINDT & SPRUENGLI AG) within the past 12 months. Credit Suisse has received compensation for products and services other HOLD 07/04/2014 than investment banking services from the subject issuer (BARRY CALLE- FLUGHAFEN ZUERICH BUY 20/03/2015 BAUT) within the past 12 months. Credit Suisse expects to receive or (FHZN SW) intends to seek investment banking related compensation from the subject HOLD 09/12/2014 issuer (BARRY CALLEBAUT, FLUGHAFEN ZUERICH, HELVETIA HOLD 08/09/2014 HOLDING AG, LINDT & SPRUENGLI AG) within the next three months. HOLD 24/03/2014 Credit Suisse holds a trading position in the subject issuer (AMS, GEBERIT AG (GEBN VX) BUY 29/04/2015 BALOISE HOLDING AG, BARRY CALLEBAUT, FLUGHAFEN BUY 12/03/2015 ZUERICH, GEBERIT AG, GIVAUDAN SA, HELVETIA HOLDING AG, TERMINATED 12/01/2015 LINDT & SPRUENGLI AG, LOGITECH INTERNATIONAL SA). As at HOLD 10/11/2014 the end of the preceding month, Credit Suisse beneficially owned 1% or HOLD 20/10/2014 more of a class of common equity securities of (BALOISE HOLDING AG, HOLD 19/08/2014 BARRY CALLEBAUT, FLUGHAFEN ZUERICH, GEBERIT AG, HELVE- HOLD 05/05/2014 TIA HOLDING AG, LINDT & SPRUENGLI AG, LOGITECH INTERNA- TIONAL SA). GIVAUDAN SA (GIVN VX) HOLD 10/04/2015 Research Alert, 02/07/2015 6

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apply to investments or services provided by a person outside the UK, nor Imprint will the Financial Services Compensation Scheme be available if the issuer of the investment fails to meet its obligations. UNITED STATES: NEITHER THIS REPORT NOR ANY COPY THERE- Investment horizon: 3-6 months OF MAY BE SENT, TAKEN INTO OR DISTRIBUTED IN THE UNITED STATES OR TO ANY US PERSON (WITHIN THE MEANING OF REGU- Publisher LATION S UNDER THE US SECURITIES ACT OF 1933, AS AMENDED). Loris Centola This report may not be reproduced either in whole or in part, without the Head of Research written permission of Credit Suisse. Copyright © 2015 Credit Suisse +41 44 333 57 89 Group AG and/or its affiliates. All rights reserved. [email protected] 15C028A_R

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Authors

Javier José Lodeiro Senior Equity and Credit Research Analyst - US Banks & Global Insurers +41 44 334 56 44 [email protected]