Small cap market remains sullen, active stock-picking pays off

Performance

Adrigo Small & Midcap L/S Class A and Class C rose 2.8% in October, net of fees. The Carnegie Small Cap Return Index Nordic fell by 3.4% in October.

Among the fund’s larger holdings, Initiator Pharma (Biotech) and Bonesupport (Medtech) again provided good contributions. Among the fund's middle-sized positions, Wärtsilä (Capital Goods), Camurus (Healthcare) and Nolato (Industrial components) provided good contributions. Our short positions had a positive contribution in aggregate, driven by good individual shorts and our index hedge. 

Adrigo Small & Midcap L/S Class A has returned 71.6 % since inception, net of fees. The compounded return has been 9.4% per year since inception. In the same period, the benchmark STIBOR 1M rate returned 3.0% and the Carnegie Small Cap Return Index Nordic gained 52.6%.

Market comment & the companies

Global stock markets continued to develop quite poorly during October. MSCI World as well as STOXX 50 fell by 2.6%. Swedish large caps (OMXS30) were down by 3.5% while Swedish small caps (CSX) declined by 3.2%. The Norwegian and the Finnish markets fell while Denmark was unchanged.  Base metals declined with the commodity index (CRB) being down by 0.7%. Again, we noticed a big move in the oil price which, after a very strong September, contracted by 7-8% over the month.  

One of the fund's first investments, Bonesupport (we made our first investment in November 2017), again made us cheer. Sales of its main product, Cerament G, a synthetic bonegraft, accelerated further during the third quarter. Total sales rose by 76% while sales in the US jumped by 102%. The gross margin strengthened even further to 92.1%. Another milestone was passed as the company reached positive cash flow for the first time. The product made inroads to more hospital systems and today the company has access to more than 1000 hospitals in the US. The product has only been available in the US since late Q4 2022 and there are big differences in usage between various surgeons and hospitals. Hence, the growth potential is huge.

In Q4 the company is planning to send in an application for a label extension, to include open trauma fraction. The FDA has indicated a three-month lead time target. Even if today Cerament G is used "off label" we believe an approval would further boost sales and penetration. Moreover, Bonesupport continues to work with various clinical programs with the aim of broadening clinical application areas including osteoporosis.    

Initiator Pharma is a biotech company which has been in our portfolio since April 2021. Early October, it released data from a Phase IIb study with its drug candidate pudafensine (IP2015). The study data demonstrated statistically significant and clinically relevant efficacy for erectile dysfunction (ED). The unmet medical need is big, 30-40% of the patients do not respond to the current drugs in the PDE5i class such as Viagra and Cialis. In June, the company released data from a Phase 2a trial for another compound (IP2018) demonstrating statistically significant results in psychogenic erectile dysfunction. Moreover, the company recently announced that both drug candidates mentioned above have shown significant efficacy in preclinical models for Female Sexual Dysfunction (FSD). The company is currently doing a strategic review to potentially include both ED and FSD in its commercialization strategy. This review is being executed in Q4. The company is funded well into 2025, hence we expect the company to discuss with potential partners from a position of strength. We see significant potential in the share as the current market cap is below USD 50 million.

A new holding in the fund is the bearing producer SKF (Industrials). The company has been in a transformation mode since CEO Mr. Richard Gustafson took charge during spring 2021. Our opinion is that this could result in higher and more stable margins with a subsequent increase in valuation multiples. Over the years, SKF has been viewed as the ugly duckling in the "great" Swedish family of engineering companies. Historically it has reported lower margins, higher cyclicality and lower ROE compared with peers such as Atlas Copco, Alfa Laval and Sandvik. Interestingly, SKF improved its operating margin from 8.5% to 11.5% (Y/Y) despite having a negative organic growth. The third quarter is normally the weakest quarter for SKF which makes the improvement even more impressive. We believe that Mr. Gustafson, with a fresh set of eyes, is challenging the organisation in a positive way. The strategic overview of its business within the aero industry is an example of this, another example is the fact that SKF has left certain contracts in the automotive industry as they did not meet the level of profitability needed. SKF currently trades at EV/EBIT of 7 and a P/E of 10 (2024e). This is significantly below the "great" companies mentioned above but also at a substantial discount to companies such as Trelleborg. We see a good potential for a re-rating over the coming years.

Finally, we would like to thank you, our co-investors, for your continued trust!