International equities markets have shown strength this year, thanks to continuing solid growth in Europe and robust conditions in Asia. And although fund managers remain upbeat about the ability to find attractively priced stocks, some believe there are better opportunities in Asia, while others prefer Europe.
The fundamentals, however, are buoyant for both. “Economies are in very good shape. We haven’t seen the over-the-top growth at this stage of the game,” says Don Reed, manager of Templeton International Stock Fund and president of Toronto-based Franklin Templeton Investments Corp. “Europe is still sorting through reforms in health care, pensions and tax levels. It is a work in progress, but it’s made tremendous advances. We’re already seeing results in the profitability of companies.”
Reed acknowledges that interest rates are creeping up in Europe and Asia. “But the levels they have moved to are not that onerous for many companies. It’s not causing them to change direction,” he says, adding that inflation fears also seem subdued. “Every time there is a rate hike, there is a short-term impact on the markets. But where are the markets now? They are higher than when the rates increased.”
Valuation levels are a concern, Reed admits: “If they go a lot higher, that can be a risk. But you have to look at it company by company. And if I compare Europe with the U.S., it’s about two multiple points less. It’s a cheaper place to invest.”
Japan, he notes, is very expensive, although other Asian markets are still reasonably priced.
A bottom-up, value-oriented investor, Reed has allocated about 25% of the fund to Asia, vs 24% for the MSCI Europe Australasia and Far East index. He is bearish on Japan, however — it has a 4.6% weighting (vs 21.3% in the index) — but bullish on China, which represents 5.9% of the Templeton fund but is not in the index. There is also 5.4% in Hong Kong and smaller weightings in Taiwan and Australia.
Reed’s concerns about Japan stem from uncertainty about corporate margins. “The margin assumptions that analysts are using are too high,” he says. “We can’t make those assumptions work.”
Still, some Japanese companies are attractive and Reed has long favoured Sony Corp., one of the 74 names in the fund. Reed notes that the consumer products manufacturer is under new leadership that has instituted job cuts and boosted profitability. “They are running the company much more the way that we expect them to, along Western lines,” he says.
Bought in 2002, when the Sony stock was trading at about 5,000 yen a share, it was recently trading at 6,530 yen. The price/earnings ratio is 49.6. Reed has no stated target.
Within China, Reed favours China National Offshore Oil Co., the world’s largest oil exploration and production firm. It is active in Asia and Russia, and has an interest in Canada’s Athabasca oilsands.
“It has the ability to replace its production. It is reaching out to different places to ensure the supply of oil for China,” he says. The firm has a reserve life of about 20 years. Bought initially in 2001, the Hong Kong-listed stock was recently trading at HK$9.35 a share. It trades at about 12 times earnings.
Europe, which accounts for 66% of the fund (vs 69.5% in the benchmark), is dominated by larger holdings such as Compass Group PLC, Vestas Wind Systems Co. and Rolls Royce Group PLC. Referring to the last, Reed bought the jet engine manufacturer in 2003 when the airline industry was in a slump.
“Our feeling at the time was that we were going to see good movement in that industry,” he says. “Rolls Royce was well positioned.”
A Rolls Royce share was recently trading at 565 pence, vs about 150 pence four years ago. The P/E multiple is about 9.3.
The run-up in markets has resulted in similar valuations, regardless of a company’s quality or origin, says Jason Holzer, a senior portfolio manager at Austin, Tex.-based AIM Capital Management Inc. and co-manager of AIM International Growth Class.
“There has been a severe valuation compression among all manner of stocks, be they foreign vs North American, or small-cap vs large,” he says. “Many things are selling for the same multiples. The real opportunity is to make quality distinctions: buy quality and buy growth.”
@page_break@Although Holzer is reluctant to make market calls, he says companies are in the later stages of the profit cycle: “Stocks are more expensive than they look.”
Europe, for instance, has seen multiples expand by one or two points in the past 12 months. For instance, the Dow Jones STOXX 600, a broad European benchmark, is trading at 14 times earnings, vs 12 to 13 a year ago. “Stocks are getting more expensive and are not as attractive as they used to be,” he says.
Strategically, Holzer and co-managers Clas Olsson, Shuxin Cao and Barrett Sides have reduced the fund’s Asian weighting in the past year to about 20% from 25%, and have eliminated some Japanese names. “Japan is where we’re seeing fewest opportunities,” Holzer says.
Meanwhile, the managers have shifted into other Asian names and into Europe, which accounts for about 65% of the fund. There is also 5% in Latin America, 4% in the Middle East and Africa, and 5% in cash.
From a market capitalization standpoint, the managers have increased the large-cap weighting to 47% from 40% a year ago. “On a relative basis, valuations look more attractive there,” Holzer says. The remainder is split between mid-caps and small-caps. “It’s harder to find attractive small- and mid-caps because the overall valuation levels have caught up and, in some cases, surpassed large-caps.”
Running a fund of almost 100 names, Holzer continues to favour USG People NV, one of the largest temporary employment firms in Benelux and the fifth-largest in Europe.
“The underlying Benelux market is attractive and still growing in the double-digit range,” says Holzer, adding that USG’s market share in Germany and France has accelerated. “It’s still cheap: 11.5 times 2008 estimated earnings.”
Its peers — Adecco and Man-power — trade at more than 14 times and 16 times earnings, respectively, and both have more geographical exposure to the weak U.S. market. Bought in late 2005 at 35 euros a share, USG recently traded at 37 euros on a split-adjusted basis. Holzer believes it has about 50% upside over the next 24 months.
Another favourite is Porsche AG. One of the top sports-car makers in the world, it is benefiting from growing affluence around the world. “Sales in places such as Latin America and Asia are booming as the number of wealthy people increases,” Holzer says. “This plays into Porsche’s hands. It commands a premium and has tremendous brand equity.”
The company has boosted its operating margin to 22% from 17% by outsourcing some of its manufacturing (such as the Boxter model). Bought in 2005, the Porsche stock recently traded at 1,370 euros a share, or 15 times estimated 2008 earnings. The stock, Holzer believes, has about 30%-40% upside over the next two years.
One of the AIM fund’s newer picks is Italy’s Cementir Cementrie del Tirreno SA. “It’s one of the cheaper cement companies in Europe,” says Holzer, adding that the family-controlled firm has expanded into Turkey and Denmark. The stock trades at around 11 times 2008 earnings, or about two multiple points cheaper than majors such as Lafarge SA. CCT’s share price is 11.3 euros; the fund’s managers paid eight euros early this year. Holzer anticipates another 40% gain in the next two years.
Asian markets have become expensive and better opportunities exist in Europe, says David Ragan, an equities analyst who works on Mawer World Investment Fund, which is managed by Gerald Cooper-Key, honorary chairman of Calgary-based Mawer Investment Management Ltd. In the past year, the Asian weighting in the Mawer fund has declined to 22% from 27.1%, while the European weighting has risen to 58.5% from 53%. There is also 6.1% in Australia, 2.7% in South Africa, 7.8% in Latin America and 3% in cash.
“Everyone is over in Asia,” says Ragan. “With money flooding into the region, valuations are getting pricey, to say the least.”
As a result, the Mawer team sold Guangdong Investment Co., a water utility, as the market was pricing in too much upside. They also trimmed some Indian stocks and remain underweighted in Japan, with an 8.7% holding.
“We just don’t find the quality names at reasonable prices,” Ragan says.” But we’re quite happy because Japan is a big part of the index, and lots of investors are there in a large way. When we’re elsewhere, this gives us an advantage.”
Despite their aversion to Japan, Ragan and Cooper-Key continue to favour Canon Inc., one of the fund’s largest holdings. “It has a great position in the copier market and, along with Nikon, shares the high-end single-lens reflex digital camera market,” says Ragan. “The margins are higher [in the high-end digital market] and Canon has even been able to keep its point-and-shoot cameras at the premium end.”
Bought initially in 1997 at 1,960 yen a share, Canon’s shares recently traded at 7,190 yen. Ragan has no stated target.
Another favourite is Fugro NV. The Netherlands-based civil engineering firm collects and interprets geological data and also studies seabed surveys for the oil industry. “Easy oil is pretty much gone,” says Ragan. “The industry is forced into looking offshore or in politically unstable areas such as Sudan.”
Acquired in 2003, Fugro’s average cost was 16 euros a share. It recently traded at 49.9 euros. The stock is trading at 17.5 times earnings, but boasted 35.8% earnings growth for the year ended Dec. 31, 2006.
A new addition to the Mawer fund is Umicore SA, based in Belgium. Formerly a base metals firm, it has been transformed into a diversified metal-technology player that makes catalytic converters, recycles precious metals and makes lithium-ion batteries for laptops and cellphones.
“It is very good at working with these elements, and working with customers that utilize these elements,” says Ragan.
Bought in late 2006 at 123.5 euros a share, Umicore’ shares recently traded at 171.4 euros. The stock trades at 13.8 times earnings, compared with 16.2 for the benchmark MSCI EAFE index. IE
Fundamentals buoyant for international equities: Includes Chart
But money managers differ on where the best opportunities lie
- By: Michael Ryval
- July 31, 2007 October 30, 2019
- 11:12