Sector Watch: Do European stocks measure up?

“Things are priced in for a continuous recovery. But it’s very challenging to find new ideas because the European market is up by almost 50% in aggregate from the bottom,” says Feng, who shares portfolio-management duties with Invesco Canada vice president Michael Hatcher.

“The euro has also been strong against the dollar and other currencies,” Feng adds. “However, the European Central Bank has said that a strong euro is not good for the recovery. [The central bank] introduced an unusual, negative interest rate policy, which is used to encourage banks to lend.”

However, the U.S. and U.K. are looking at raising their interest rates, which is bound to put pressure on the euro.

“You have a combination of high equities valuations and a potentially weakening currency,” Feng says. “On top of that, there are still challenges in terms of growth that European countries face. That’s why we are much less optimistic now versus a year ago. There were a lot of macroeconomic issues, but valuations were attractive.”

Asia is a mixed picture. Although Japan’s government has introduced a host of reforms, in Feng’s view the domestic private sector has not matched them or gone far enough – especially in corporate restructuring and capital allocation.

“The clock is ticking,” says Feng, noting that few Japan-based companies have a more open attitude to mergers and acquisitions. “They don’t have another 20 years to make gradual shifts. They have to work quickly.”

However, China looks more promising, despite all the negative headlines about its so-called “shadow banking” industry and the overheated property sector.

“Valuations have priced in most of the negative things,” says Feng. “But look at the fiscal situation of China – its gross domestic product growth [GDP] and debt/GDP ratio are in better shape than its peers.”

Feng, largely a bottom-up investor, favours emerging markets, which account for an over-weighted 35% of the Trimark fund’s assets under management (AUM). In contrast, there is an underweighted 48.5% of AUM in Greater Europe, 7% in Japan, 2.5% in Australia and 7% in cash.

From a sectoral standpoint, consumer-defensive names account for 31% the Trimark fund’s AUM, followed by financial services (17%) and technology (14.3%). There are smaller weightings in sectors such as industrials.

One favourite name in the Trimark fund, which holds fewer than 40 names, is Samsung Electronics Co. Ltd., the South Korea-based maker of a wide array of consumer products.

“Investors are concerned about [Samsung’s] cellphone business and its sustainability of profits in the face of cheaper competition from China,” Feng says. “But the current [share] price more than discounts all the negatives.”

Samsung stock is trading at about KRW1.35 million ($1,207) a share, or nine times price to earnings (P/E). There is no stated target, although Feng believes Samsung deserves a double-digit P/E multiple.

it’s getting much tougher to find attractive European companies, agrees Richard Jenkins, managing director and chairman of Toronto-based Black Creek Investment Management Inc. and lead manager of CI Black Creek International Equity Fund.

“Multiples have expanded about 40%, and gone from below average, or around 12 times earnings, to 16,” says Jenkins, who shares portfolio-management duties with Evelyn Huang, director, global equities, at Black Creek.

Jenkins notes that the reverse has happened in most of Asia because that region has lagged the U.S. and Europe. This trend is partly attributable to investors flocking to developed markets in which valuations were low.

“But some of it,” adds Jenkins, “is a recognition that profitability in the emerging markets is far harder than people thought. People rushed to build factories in China and woke up one day, saying, ‘Hey, we’re not making any money.’ On average, the returns on those investments in large-scale projects are not as profitable as what people thought a decade ago.”

Many companies are finding that they have to invest more capital just to maintain their market position, Jenkins says: “You can apply this to [South] Korea and Japan, which have been on the wane for 20 years. That’s why investors have been going back to developed markets.”

Jenkins, a bottom-up investor who seeks leading companies that are growing their market share and trading at inexpensive prices, has been taking profits within the CI fund’s European allocation and has reduced that portion to about 55% of AUM from 64% a year ago. At the same time, he’s found more value in Greater Asia and raised that region’s weighting to 30% from 26%. The balance is in Latin America and the Middle East, plus about 4% in cash.

The CI fund holds shares in 27 companies. Jenkins likes Paris-listed bioMérieux SA, a France-based, multinational biotechnology firm whose main shareholder is Institut Mérieux.

BioMérieux, which is renowned for developing and producing a wide range of diagnosis systems for medicine and industry, is involved in making equipment for food safety testing and bacteriological tasting.

However, the firm’s stock price has been flat for the past year, largely because many clients -namely, government agencies -have been cutting costs.

BioMérieux stock is trading at about 78.5 euros ($116.50), or 18.9 times earnings. There is no stated target.

“In the long run,” says Jenkins, “we expect the business should grow at twice the rate of the global economy. But that’s not recognized.”

Another favourite in the CI fund is Kunlun Energy Co. Ltd., a China-based utility that is poised to benefit from the switch from coal-fired energy plants to natural gas-fired plants and the gradual switch to compressed natural gas from diesel for vehicles.

“Kunlun does not have the major trunk pipeline from the west of China, but it is building the offshoot to other cities in China,” says Jenkins. “[The firm] has lots of cash that it’s reinvesting in natural gas pipelines. It’s a growth utility. Therein lies the opportunity.”

Kunlun stock, listed in Hong Kong, is trading at about HK$12.90 ($1.80) a share, or six times cash flow.

Peter Moeschter, executive vice president with Toronto-based Franklin Templeton Investments Corp. and manager of Templeton EAFE Developed Markets Fund, argues that Europe is still attractive.

“There are 40 analysts and portfolio managers on our global equities team who come up with stock ideas,” says Moeschter. “And, in the end, the cheapest bargains in world have tended to be in Europe. And we still find them now.”

Moeschter notes that 78% of the Templeton fund’s AUM is in Europe, an underweighted 7% in Japan (vs 20% in the benchmark MSCI EAFE index) and 2% in Australia (vs 8%). There also is about 10% in Asian markets, 1% in the Middle East and Africa, and 2% in cash.

P/E multiples have expanded, he acknowledges, although that is attributable to improving business fundamentals.

“Two years ago, banks were priced for distress and trading at well below book value. Now, the [share prices] have gone up. But are they expensive? I’d say they are ‘fair value’ and closer to the long-term averages,” says Moeschter, adding that the Templeton fund has invested in banks such as Lloyds Banking Group PLC.

Moeschter, who doubles as an analyst and follows Germany’s industrial companies, observes that although those industrial firms are very profitable and efficient, they’re lacking in growth:

“Until now, they’ve been focused on cutting costs and fixing their balance sheets. But they need to see the orders pick up. It’s not quite happening. And this is happening globally. It’s taking time; consumers and businesses are slowly going back to spending patterns.”

Moeschter, a bottom-up value manager, has allocated about 23.4% of the Templeton fund’s AUM to financial services, 16.1% to industrials, 14.8% to health care and smaller weightings to sectors such as consumer cyclical.

One top holding in the Templeton fund, which holds 70 names, is TNT Express NV, a Netherlands-based shipping and delivery organization that had to restructure after a bid to be acquired by United Parcel Service Inc. fell apart 18 months ago.

“TNT is just focused on Europe and is one of the largest providers,” says Moeschter. “[It] should benefit from general trends in industrial production and consumer spending because [it tends] to serve both parts of the economy.”

TNT stock is trading at about 6.7 euros ($10), and its price has been flat for a year. There is no stated target.

“Investors are waiting for Europe to grow a bit faster,” says Moeschter. “We have a chance to own TNT now, before its earnings become more visible.”

Another favourite is Suntory Beverage & Food Ltd., a spinoff from Japan’s Suntory Holdings Ltd. Says Moeschter: “[The firm] has a global management team that has done a good job at home, and they seem very practical in their expansion strategy. And the stock was priced right.”

The Templeton fund bought Suntory stock at about ¥3100 ($33) a share last year in the initial public offering, but the stock has risen to ¥3980 ($42.30) a share, about 34 times earnings.

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