European equities roundtable: Financial stocks recover as fears subside

Chuk Wong, vice-president and portfolio manager at GCIC Ltd. Wong’s mandates include Dynamic European Value, Dynamic Global Value and Dynamic Far East Value.

Peter Moeschter, executive vice-president, Franklin Templeton Investments. A value manager, Moeschter runs both EAFE (Europe, Australasia and Far East) and global portfolios for retail and institutional clients.

Paul Musson, senior vice-president and head of the Ivy team at Mackenzie Investments. The team’s responsibilities include Mackenzie Ivy Foreign Equity, a global fund, and Mackenzie Ivy European Class. Musson seeks to buy high-quality businesses and not overpay for them.

Q: Can we identify some of the top-performing sectors in the MSCI Europe Index over the 12 months to the end of August?

Moeschter: The index had a total return in Canadian dollars of 28.3%. The heaviest sector weight in the index is financials. Its total return, led by the banks and the insurers, was 42.9%. As discussed, consumer-discretionary stocks, which represent a fair weight, produced a total return of 41.7%. Industrials, another fair weight, had a total return of 36.1%. Finally, information technology’s total return was 39.3%. This sector is a small weight. Energy, a fair weight, was the biggest underperformer, with a total return of 8.8%.

Q: Time to talk about your portfolios. Consumer-related stocks?

Moeschter: In our international (EAFE) portfolio, we have about 4% in consumer staples and 10% in consumer-discretionary stocks. A lot of our discretionary holdings are based in Japan, from the auto sector. We’re not buying them, at this stage. They’ve done well. Within Europe, a big holding for us is clothing, food and home-products retailer Marks & Spencer Group PLC. We find consumer-staples stocks to be generally expensive. They’ve done well. We’re out of Nestlé SA and Unilever.

Musson: We own both. But we have reduced both names, as well as pared back our holding in Danone SA, the world’s leading yogurt producer. We still have a high weighting in consumer staples.

We have two food retailers, WM Morrison Supermarkets PLC in the UK and Colruyt SA in Belgium, the lowest priced food retailer in that country. The company owns its own properties and has no debt. Colruyt and Morrison are domestic plays.

In the consumer-discretionary sector, we continue to like the global Swedish apparel retailer, Hennes & Mauritz AB (H&M).

Moeschter: Within the market-cap spectrum, we focus on large to mid-cap stocks. Some of the smaller to mid-cap stocks are offering better value. We have been active there.

Wong: Agreed. We have a significant exposure to consumer-discretionary stocks, financials and industrials in our European fund. We have a small consumer-staples exposure.

In the last couple of years, when the overall market was stressed, we spent some time looking at large-cap names. We own BMW AG and Swatch Group Ltd. These are multinationals with strong franchises. This strategy paid off. Some of these names have done well. I am with Paul and Peter, that the valuation on some of these large, global companies is no longer compelling. We’ve started to look more closely at European mid-caps and smaller-caps. The focus is on companies with regional and domestic franchises. A consumer discretionary example is the leading toy retailer in Greece, Jumbo SA. It’s a consolidator in its market and has no debt.

In the last 12months, we’ve been investing in companies in some of the peripheral or crisis economies — Italy, Spain, Greece and Ireland — which collectively now represent about 20% of the European fund. A recent addition in the consumer-staples sector is an Irish company, C&C Group PLC. This company makes cider and is a leader in this field in the UK and Ireland. C&C has made a U.S. acquisition. We’re finding valuations to be more compelling in the peripherals than in, say, Germany and even in the UK.

Q: What about European financials?

Wong: I own two Italian banks, UniCredit SPA and Intesa Sanpaolo. They are two of the largest commercial banks in Italy. They were trading at distressed valuations, at a discount to their underlying asset values. Both banks have recapitalized.

Moeschter: We own these two banks too. It reflects our view that many of the European financials were hit hard in the crisis. We invested in them. The stocks were priced for only bad news and the valuations were compelling. The stocks have gone up over the past year. But they are still cheap and we continue to hold a lot of them. Of the banks, big weightings include Lloyds Banking Group PLC, ING Groep N.V. and BNP Paribas. Financials are over 22% of the EAFE fund.

Wong: I own Lloyds and BNP.

Moeschter: Our bigger insurer holdings are AXA SA and Aviva PLC.

Wong: I own AXA. The financials have done well in the past year or so to reflect the fact that the systemic risk has subsided. On current valuations, the stocks are still cheap compared to their historic valuations and global peers. We still like them.

Musson: A major holding in Mackenzie Ivy European Class and Mackenzie Ivy Foreign Equity continues to be the property and casualty insurer Admiral Group PLC in the UK. It’s a high-quality company. It’s primarily in auto insurance and it’s starting to grow internationally, though its main business is still in the UK. Admiral consistently generates underwriting profits and is not taking risks on the investment side. The company has a great corporate culture.

Q: Industrials?

Moeschter: Industrials represent approximately 13% of the EAFE fund. Based in France, Compagnie de Saint-Gobain, a glass manufacturer, is a holding. The company has a lot of exposure to Europe and it was hit hard in the downturn. A lot of its business is dependent on construction and the automobile market. The latter has picked up. The company has cut costs. Earnings have not yet recovered. As the European economy improves, the company should see some revenue growth and margin improvement. The stock is still off its highs of five years ago. We have built some exposure in the materials sector, but it is more industrial-type companies. An example is cement manufacturer, HeidelbergCement AG, based in Germany. It’s a global player and dependent on building activity. It will be a beneficiary of global economic expansion. It doesn’t have to be runaway growth. We haven’t found great value in the metals and mining area. But we continue to evaluate this segment.

Wong: I own metals and mining global giant Rio Tinto PLC. It’s more of a contrarian call. The stock is cheap. The market is too pessimistic on commodities, in particular the demand coming from China.

A mid-cap German industrial stock that I would like to highlight is NORMA Group AG. It’s a leading global manufacturer of auto clamps and connectors. Its products assist in fuel efficiency and environmental protection.

Musson: A Swedish construction company that we added this year in both the European and global funds is Skanska AB. Construction can be a good business as the companies often work with their customers’ capital. Years ago, Skanska had a near-death experience with poor risk controls and a weak balance sheet. It brought in new management, which has addressed this.