From the September 2011 issue of Investment Advisor • Subscribe!

North Stars

Opportunities in Europe abound for investors who look to the north

Conventional market wisdom has always dictated that investors who stick their necks out at a time of great crisis reap great rewards further down the line. David Marcus, CEO and CIO of Evermore Global Advisors and portfolio manager of the Evermore Global Value Fund, has proven this true many times, and he’s convinced he can make it happen again by increasing his investments in Europe, where equities have been hammered as a result of the sovereign crisis.

“As deep value investors, we see a lot of opportunities in Europe and, more importantly, we believe that the crisis has served as a catalyst for an amazing transformation that many European companies are going through,” he says.

The crisis had been largely overshadowed through the summer by a relentless deluge of headlines about a possible U.S. debt default, but, says Marcus—who in addition to the Global Value Fund, also manages a purely European value fund—the Eurozone’s troubles are far from being resolved. Panicked investors have been indiscriminately dumping their European stocks and they are likely to continue doing so. But Marcus can pinpoint a number of European companies that are well worth taking bets on for the long term, because despite the crisis, they have been completely metamorphosing and changing the way in which they do business.

They really have no choice but to do so, he says, “because the world has shrunk and competition is fierce from all quarters.” But those firms that have decided to seize the bull by the horns, have undertaken aggressive restructurings and are refocusing their business models with a view to making themselves stronger global players going forward are the ones that will stand out from the pack in the long term.

To boot, they are very cheap right now.

“The crisis has held everyone accountable—corporate boards, shareholders, managers—and many companies have realized that they just won’t be bailed out and that they will have to survive on their own,” Marcus says. “They have also realized that the world has shrunk and that in order to be globally competitive, they have to change.”

Marcus gives the example of Siemens, one of Germany’s top companies. The CEO of this electronics giant has taken the approach that Siemens will never be No. 2 in any of its business areas, Marcus says, and if there is a chance of that happening—well, Siemens will sell out and focus on strengthening the businesses in which it is or can be a leader.

Of course, taking advantage of opportunities like Siemens—albeit a top-quality European name—when markets are in turmoil and the macro picture is so shaky still calls for a certain sangfroid, one that most investors, even those who focus on value and who know Europe well, just may not possess at this time. But investors like Philippe Brugere-Trelat, vice president of Franklin Mutual Advisers and lead portfolio manager of the Franklin Mutual European Fund, are nonetheless buying in Europe based on the view that the macro-level instability is purely a question of politics and nothing else.

Philipe Brugere-Trelat, Vice President, Franklin Mutual Advisers“One must remember that the Euro block is the largest economic block in the world, with over $16 trillion of GDP,” Brugere-Trelat, (left), says. “With Switzerland, it’s close to $17 trillion, so it isn’t a matter of Europe not having the means to deal with the debt issues, it’s a political issue—not dissimilar to the debt ceiling issue in the U.S. Everyone who runs a business in the Eurozone knows this and is convinced that the euro is here to stay, because since its introduction, it has ushered a great period of prosperity and stability, and every company in Europe has benefited from that.”

Most investors are confident that European policymakers have started to take steps toward preserving the stability of the Eurozone. But, says Martin Jansen, head of international equities at ING Investment Management, they will need to see much more in terms of leadership and concrete moves before markets stabilize and investors regain greater confidence in the longevity of the economic cycle.

But what’s continuing to support equities in Europe are interest rates, which at their present levels leave most investment firms with the underlying need to look at equity markets, even if they do so with gritted teeth, since equity market valuations are far more attractive than their bond market counterparts. This dynamic, he says, will support the European equity markets, too.

Here’s how Jansen, Brugere-Trelat and Marcus see the map of Europe and where they believe the best opportunities lie:

Northern Versus Southern Europe
Northern Europe will prop up Southern Europe and bail out the countries in crisis; there’s little doubt about that, not least because Germany—the political kingpin—has benefited the most from exports to Southern Europe since the introduction of the euro, Brugere-Trelat says. Throwing Southern Europe to the dogs would mean that Germany would lose millions.

Yet the crisis has resulted in what seems to be a clear and lasting separation between Northern and Southern Europe. Despite a forthcoming aid package for Greece that will stem its troubles, the fallout for the south of the continent remains grave and will have repercussions for investment into the region going forward.

“Whatever sector you take in Southern Europe, it’s going to be tough going for many companies, and even if valuations are cheap, most investors would not be willing to consider the region,” Jansen says. “Going further north, into Germany, Switzerland, France and Holland—that’s where the opportunities are and that’s where investors will focus.”

Jansen likes companies in a range of industries, including health care and pharmaceuticals (names like Glaxo, Novartis and Sanofi have strong cash flow and high dividend yields) and consumer staples (multinationals like Unilever have a good global footprint that will serve them well as emerging market economies continue their shift toward consumption). Germany’s Volkswagen is also attractively valued and despite the slowdown in demand from countries like India and China—a dynamic that has buoyed most European car makers over the past couple of years—is poised well for future growth, he says.

Brugere-Trelat believes that companies like Volvo, Daimler and BMW will continue to fare well from the growth in demand in the emerging markets. He also likes Siemens and exporters like France’s electric company Schneider.

The northern part of Europe is growing very well, and the strong economies of countries like Switzerland, Norway, Germany and Sweden continue to support many companies that are already quite healthy, says Brugere-Trelat, who is a conservative yet value-oriented investor and considers strong companies with low debt, strong cash flows and good business models.

“Companies in a range of different sectors in Northern Europe are operating in a very favorable interest rate environment and because of the problems in Southern Europe, rates are remaining low, so this is where you can find the most attractive opportunities, in sectors ranging from capital goods to media to chemicals and so on,” he says.

Italy? Spain? Yes, indeed.

David Marcus, CEO/CIO, Evermore Global Advisors“Call me a contrarian and I am taking some bumps in the short-term, yes,” says Marcus, (left). But in the countries of Southern Europe where even the daring don’t dare to go, Marcus has found what he believes to be some of the greatest investment opportunities.

Italian carmaker Fiat is one of them. Like Siemens, it’s a company that has really taken the pressures of global competition seriously and it is transforming rapidly by consolidating production around the world and moving people to where its customer bases are, Marcus says.

“Being aggressive on these and other processes means great productivity and a more streamlined business for Fiat,” he says. “The company is aggressively restructuring its business models and pushing back against the unions by saying ‘you have to work with us.’”

Marcus’s largest holding is Spanish media conglomerate Grupo Prisa.

“Spain, media, conglomerates—people hate them all,” he says, but Grupo Prisa happens to own El Pais, Spain’s largest newspaper, which is a global name. It also owns radio stations and the country’s largest cable company. In addition, Grupo Prisa has a large education and business publishing division, whose chief revenues are now derived from places like Colombia, Mexico and Brazil.

“That’s what I love about opportunities like this, that I can get a great stock like Grupo Prisa at 7 times earnings and get exposure to emerging markets at the same time,” Marcus says. “People are terrified about countries like Spain and Italy, and this has really pushed stock prices down, but if you’re looking at the nuances of a company like Grupo Prisa, you’ll quickly see that a company like that won’t go out of business. I mean, recession aside, it takes a lot for folks to give up their cable TV, and Grupo Prisa has actually seen an increase in the number of subscribers.”

Marcus believes investors need to have the gumption to drill below the headlines, but, he acknowledges, that’s far easier said than done, even for those who have a great familiarity with Europe, and most of them are staying away from Spain, Italy, Portugal and the like.

Telecom
While the sector overall is one that most investors going into Europe at this time believe is not only strong, but also has the potential for continued growth, Jansen nevertheless would still not venture into any of the Southern European telecom companies. He believes it’s important to look at every European telecom stock on a case-by-case basis. Germany’s Deutsche Telecom, for instance, has its home market in the stronger part of Europe and because it owns a stake in T-Mobile, stands to benefit from a possible link-up between T-Mobile and AT&T, he says.

A company like the United Kingdom’s Vodafone also makes for a good buy right now because it gets most of its revenues from outside markets, says Brugere-Trelat. To boot, Vodafone has a 45% stake in Verizon Wireless and a great interest in India, where it is already heavily represented.

Overall, European telecoms are trading at multiples of cash flow and dividend yields that haven’t been seen in a long time, says Brugere-Trelat.

“Given the economic prospects of the regions in which these companies operate, they are even cheaper and more attractive,” he says. “The crisis in Europe aside, many people sold telecom stocks because they saw a structural decline in old-style telephony, but Vodafone continues to expand on cell phones and there is a huge explosion in the data phone business.”

Financials
The European financial sector is the most maligned of all industry sectors on the continent, but one that could, according to Brugere-Trelat, prove to be the sector that separates “the winners from the losers.”

Entering into the European financial space at this time is really something that only those with an immense appetite for risk would even consider, even if European financial stocks are selling for less than half of their book value—something that hasn’t happened in decades.

“With respect to financials, there are two big questions for people like me who are fully averse to risk: the macro environment and regulation,” Brugere-Trelat says.

Both issues, he says, make him decidedly uncomfortable.

In the first case, banks are the main holders of sovereign debt and their current valuations reflect the depth of the sovereign crisis. Then, European banks are just entering a brave new world of regulation under Basel III. “The rules are going to make it tough for a large number of banks to recap, so the last place I would want to be is in the equity of a bank that will have to do diluted rights issues,” Brugere-Trelat says. “The era of the super profit is over—this is going to be a much more regulated industry from now on and the returns are not going to be so good.”

Nevertheless, there are some bright spots in the bleak horizon: Norwegian and Swedish banks.

Jansen likes them because they are well-capitalized (largely because of the strength of Norway and Sweden’s economies) and, more importantly, they have already complied with Basel III, so they will not have to raise equity going forward.

“These banks may even be able to buy back shares because they are operating with quite attractive valuations and against a strong economic backdrop,” he says.

Jansen also finds opportunity in Swedish and German property and casualty companies. But like most investors, he draws the line at any kind of financial institution in the southern part of Europe. That also includes French banks, which have come off a lot, but are, in Jansen’s opinion, too exposed to Italy.

Page 1 of 5
Single page view Reprints Discuss this story
This is where the comments go.