As investors face challenging markets, an investment manager highlights his firm’s top stock picks this month.

Adrian Bignell, portfolio manager at the Geneva-based asset management company Quaero Capital, talks about ideas that he has included in the recently launched Quaeronaut Small and Mid-Cap fund. The fund, which comes under the Article 8 category of the EU’s Sustainable Financial Disclosure Regulation, invests in European small and mid-cap stocks.

Here are his top stock picks:
 
Borr Drilling: an international drilling contractor
There’s a magic number in the jack-up drilling rig market that, once crossed, gives vertical lift off for pricing power in the sector. It’s 90 per cent. Once capacity utilisation goes above 90 per cent, the jack-up rig operators can start to walk away from tenders in the knowledge that such a tight market will usually bring the client back to the table offering a sweeter deal.

In the final quarter of 2022, the jack-up market tightened and utilisation appears to have crossed the level, causing a rapid rise in day rates in the sector. For the market, this positive news more than offsets any lingering concerns over debt levels and re-financing risks. It looks as if the market is just stepping into the early innings of an upcycle. As a shareholder this is a re-assuring progression. First, the risk premium on the stock can justifiably fall as the prospect of equity dilution fades away. Secondly, the market starts to plug in the new day rates and factor in a jump in profits. Consensus is lagging and a new upgrade cycle is getting underway.

But as any shareholder in a cyclical industry knows – the good times don’t last forever. How long does this benign cycle last and how much further can rates run? If one takes an average of where rates reached in the good years of 2006 to 2014, it implies that the stock could have a free cash flow of more than 50 per cent in a couple of years if they can fix the rigs at those rates. We think there is more upside to hold on for.
 
X Fab 
Where are we in the semi-conductor cycle? Is it really time to buy back into technology already after so many years of outperformance? Has the dollar peaked, and will it be a headwind for X Fab in 2023? These are big questions that I have views on, but my conviction levels are low compared with the conviction I have in X Fab as a bottom-up idea.

This European foundry for analogue semi-conductor applications is all but sold out for the next three years with strong demand coming from the auto sector. With the strong demand and high-capacity utilisation comes pricing power. Additionally, having invested into silicon carbide in recent years, X Fab is well placed to reap the benefits now as higher margin silicon carbide sales are forecast to grow from 8 per cent of sales in 2022 towards 25 per cent in 2025. Trading at a little over 10x 2023 forecast earnings, the stock has potential to be re-rated.