Like other global markets, Europe has been climbing out of the depths of last year’s credit crisis and ensuing market meltdown. And although fund managers are optimistic about the prospects in the European market, they also express caution about the quality and speed of the recovery.

“We are bottom-up managers; but over the past few years, we have been looking at the macro picture,” says Paul Musson, lead manager of Mackenzie Ivy European Class and senior vice president with Toronto-based Mackenzie Financial Corp. “Markets have responded to a couple of things: people are not as worried about a global financial collapse and trillions of dollars are going into the market in one form or another. When you throw trillions of dollars at the situation, you will get some sort of response.”

Yet, Musson fears the massive fiscal and monetary stimuli are bound to have consequences, such as inflation or people losing faith in their currency. “You don’t know if, or when, that will happen. But we still have worries about what may happen in developed economies,” says Musson, who works alongside senior investment analyst Matt Moody.

Because of the uncertainty, Musson wants to protect the Mac Ivy fund against possible negative developments and has adopted a more defensive stance. This is not merely favouring defensive names over cyclical ones, he says, but also making sure all the valuation models rely on conservative inputs: “When we are increasingly concerned about the macro world, we are even more conservative about our assumptions for cyclical companies than defensive ones. If our worries about the health of economies are well founded, our unitholders will be better protected.”

Running a highly concentrated fund with 19 names, and with about 17% of assets under management in cash (a byproduct of the stock selection process), Musson and Moody are favouring companies that meet several criteria. These companies tend to grow their earnings consistently, have competitive advantages, operate in less cyclical sectors and have products that are less affected by difficult economic conditions. Should the concern about the economy be unwarranted and Europe rebounds quickly, he says, “These companies will also benefit, although not as much as deep cyclicals. But the fund’s absolute returns will improve.”

One top holding is Colruyt SA, a Belgium-based supermarket operator and a so-called “soft discounter” that tends to provide the lowest prices for its products. “It’s not very economically sensitive, and [it’s] a business that is fairly easy to understand,” says Moody, adding that the company has a strong balance sheet and a conservative growth strategy.

“It does have a strong competitive advantage: because it is so cost-consciously run, it has a low cost base, which allows it to charge low prices,” says Moody. “It defends its position very aggressively — and has been able to increase market share steadily.”

Acquired about three years ago, the stock’s price is 157 euros a share. There is no stated target, says Musson: “Our focus is on absolute, not relative returns.”

Another large holding is Reckitt Benckiser Group PLC. The Britain-based consumer-products firm operates in global markets with brand-name cleaning products such as Air Wick, Lysol and Woolite.

“A large proportion of its products are either No. 1, or No. 2 in their respective categories,” says Musson. “It’s very cost-conscious, and reinvests a good portion of its savings back into the business through [research and development] and advertising and promotion supporting the brands. Then, you get the top line growing from that. It’s a very well-run business.”

Acquired seven years ago, the stock is trading at £30.94 a share. “It’s not as cheap as it was,” says Musson, “but the valuation is still OK.”



Although impressive in itself, the market rally may be running too hard and too fast, argues Ian Scullion, manager of CIBC European Equity Fund and vice president and head of the Europe, Australasia and Far East team at CIBC Global Asset Management Inc. in Montreal.

“We’ll have a reality check over the next six or seven months,” says Scullion. “Companies won’t be able to deliver a lot of growth, because the cost-cutting initiatives will slow down, and the top line will not really grow.”

Although Scullion concedes that the bad macro news — such as significant job losses — will slow at some point, he argues it could take some time before Europe sees reasonable economic growth: “On a year-to-year basis, the deceleration will stop. But we will still be at a very low base, which will not translate into higher growth for a lot of industries.

@page_break@“Obviously, when you inject a massive amount of money into the system, things will level out,” he continues, noting that his concerns are based on conversations with many companies. “If I give you $150 to spend on school supplies, what will you do afterward? You won’t have any money to spend. So, we have lot of questions about the sustainability of this economic upturn. At best, economic growth will be ane-mic. I’m quite nervous, in terms of what people are expecting from the economic rebound.”

Yet, as a bottom-up investor, Scullion remains positive about the 50 names in the CIBC fund. “We still see lots of sectors, such as medical technology and consumer staples, that are trading at historically low multiples, whatever measure you happen to use,” says Scullion, a stock-picker who favours companies with strong franchises and balance sheets that are leaders in growth sectors. “We still see lots of value for the next few years.”

Ironically, Scullion says, valuations are reminiscent of a year ago, when even quality stocks were being dumped en masse. “We see the same potential today,” he says. “We see them trading easily 30%-40% higher in three or four years. Traditionally, many trade around 15 to 17 times potential earnings. Now, they are around 10 to 11 times earnings. And at the same time, these companies still deliver, from an operational perspective. They haven’t been whacked by the crisis.”

One top holding is LVMH Moet Hennessy Louis Vuitton SA, the French luxury goods and premium beverage firm. “It’s the biggest and best positioned firm in the luxury segment on a global basis,” says Scullion, adding that the company’s leather goods revenue is the main driver. “The spirits division has slowed down a little. But, overall, the company [has] continued to grow and improve margins nicely.”

This growth is attributed largely to increasing numbers of wealthy consumers in emerging markets. Although the company’s share price fell to 40 euros a year ago, Scullion has added to the CIBC fund’s position in the firm. The stock is now about 72.70 euros a share. Scullion has no stated target.

Another favourite is BBV Argentaria SA, the Spain-based retail banking firm that has extensive operations in Latin America. “We do not go for corporate bankers, the Morgan Stanleys of the world. We’re targeting business models in which people go for their everyday banking needs. And these banks have a physical presence, with points-of-sale to defend their business models,” Scullion says, adding that BBVA, as it is known, escaped the derivatives craze that hit many of its European peers. “It’s one of the few that has not been hurt, in terms of profitability.”

Acquired seven years ago, last year BBVA stock hit a multi-year low of five euros a share, but has since rebounded to 12.40 euros. “It’s fairly valued today,” says Scullion. “But the stock price should increase, in line with growth of operations. We don’t see any reason why it can’t grow [earnings] by 11%-12% a year.”



Equally concerned about the market getting ahead of itself is Parus Shah, a portfolio manager with Fidelity Investments International’s London office who oversees Fidelity Europe Fund. A privately owned firm, FII is associated with Boston-based FMR Corp.

“There’s been no discrimination; everything has gone up,” says Shah, who assumed the Fidelity fund’s management a year ago. “Some stocks don’t deserve to go up as much as they have.”

Some sectors, such as engineering, have risen appreciably, even though it’s uncertain how quickly the economy will recover. “The market is effectively starting to say, in many cases, there will be a V-shaped recovery and [that] margins, which are close to peak, will happen next year. It’s a bit difficult to believe this will happen,” says Shah. “For the market as a whole, the consensus is looking at 24% earnings growth in 2010. There are similar expectations for the following year. Some of these earnings estimates are ‘punchy’, I’d say.”

Although Shah believes an economic recovery is taking hold, he questions how strong it will be and how quickly it will unfold. “You need a quick recovery to justify the valuation of some of these stocks,” says Shah, who has concerns that many underlying macroeconomic problems that emerged last year have yet to be resolved. “I am cautious, but there are enough investment opportunities in Europe, and valuations are still attractive. You need to pick your spots, and avoid stocks or sectors that have gotten ahead of themselves.”

Running a 50-name fund, Shah favours the financial services sector, which accounts for 29% of the Fidelity fund’s AUM, compared with 25% for the benchmark MSCI Europe index. However, his focus is on retail banks, which have not been as damaged as investment banks or those caught in the subprime mortgage debacle. One favourite is BNP Paribas, a leading French bank.

“What I was looking for is high [return on equity], dominant market position, a bank that is not overextended with real estate, and good management, which BNP has,” says Shah. “And I am quite positive about its acquisition of Fortis Bank.”

(BNP acquired Fortis SA’s higher-quality assets, leaving the lesser assets with the governments of Belgium and the Netherlands.)

The Fidelity fund acquired BNP this past April at 33 euros a share; BNP’s stock price is now 56 euros. Shah has no stated target, but he sees more upside, based on higher earnings from the Fortis acquisition.

Another favourite is Anheuser-Busch InBev SA. The world’s leading brewer as a result of last year’s merger between Belgium’s InBev SA and U.S.-based Anheuser-Busch Co., the firm could grow bigger still if it acquires Fomento Economico Mexicano SA, a leading brewer in Latin America that is up for grabs.

He adds that after years of fierce competition and market fragmentation, pricing should improve as the industry is reduced to a handful of players. “What you may have [in Latin America] is similar to what you have in North America — you have two companies dominating the beer market. You will get pricing power after that,” says Shah. “If you look at the valuations of the stocks, they are very cheap, whichever way you look at them. I don’t think the new industry culture is reflected in the valuations. Whoever acquires FEMSA will see significant cost savings and benefit from pricing power.”

A-B InBev’s stock trades at 10 times cash flow, which Shah notes is cheaper than some of its peers. Acquired a year ago, when the stock was 15 euros, it is now 33 euros. Although Shah has no stated target and is uncertain who will win FEMSA, he believes the FEMSA deal will improve A-B InBev’s situation: “This [scenario] will help everyone in the market.” IE