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Undervalued Europe Offers Great Investment Picks for 2014

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If 2013 was a year of fragile convalescence for Europe, 2014 will be one in which the battered region continues to regain strength, bolstered by improving underlying fundamentals and much-needed, long-term changes.

For fund managers who specialize in the region, Europe presents numerous attractive investment opportunities that despite the general improvement in the region remain untapped. That’s because many investors are still concerned that European GDP numbers are weak, says Rory Bateman, head of UK and European equities at Schroders, and this has led them to stay away from Europe, albeit that 2013 was a far better year for the region overall.

“We are finding that valuations even in the markets most affected by the crisis are compelling, and performance is still 40% to 70% below the 2007 peak,” Bateman said. “There is a lot of value contained within the markets in Europe.”

Many also have not yet factored in the prospects for an end to Europe’s woes and in 2013, expectations for the region were still low, according to Stephen Peak, director of international equities at Henderson Global Investors. The risk premium in Europe is still at elevated levels despite the market appreciation, which means that the valuation of European equities remains compelling versus history and as compared to other equity markets around the world.

As such, “exploring more eurocentric ideas reaped rewards as the recovery took hold,” Peak said, and this year, Henderson expects to selectively increase its exposure to Europe.

“Europe has travelled a long way, however, there remains some navigating to be done and we expect the ‘saw tooth’ pattern of markets to continue,” Peak said. “We still believe in recovery within Europe but judge that some form of pause or pullback might be in the offing and we are awaiting earnings upgrades. Political noise will still be a factor, tapering risk comes in the form of the US, European Union reform is needed to support long-term stability and banks still need some work.”

This area is particularly important, since the improvement of Europe’s corporate sector depends largely on banks’ ability to extend credit, or not.

“However, on balance, our view is that Europe is under-appreciated and there remains valuation upside, particularly versus the US, and we suspect positive earnings surprises if recovery takes hold,” Peak said. “We believe the overall case remains a good one and offers upside for the portfolio.” Through the course of last year, Peak added several European names to his portfolio, including European Aeronautic Defense and Space Company (EADS) in the industrials sector and Amadeus IT Holding, a technology company.

“EADS had a strong year, initially driven by strong company performance along with its share buyback program and latterly benefitting from several orders for its A380 superjumbo and new long range A350 as well as a rise in third quarter net profits,” he said. “Production outlook remains strong with rising delivery volumes underpinned by a record backlog.”

Amadeus’s profit, revenue and EBITDA grew robustly over the first nine months of the year. Most importantly, the firm was recently selected by the European Travel Commission (ETC) to develop an innovative solution to promote Europe as a destination—a move that will increase its global reach and add to its existing portfolio, Peak said. In 2014, investors expect that the consumer cyclical and consumer discretionary sectors, both of which were badly affected by the sovereign crisis, will improve across Europe.

“We have been seeing activity coming out on the consumer side even in countries like Spain, after several successive quarters of negative spending,” Bateman said. “We expect to see more recovery this year in the consumer cyclical are— hotels, travel, leisure etc – albeit a gradual one.”

As an example of the improvement in the consumer discretionary sector, one of Peak’s most successful acquisitions in 2013 was French car manufacturer Renault. “It has done very well and has strengthened positions in its main markets and continued to expand internationally,” he said. “Renault also received a rise in group registrations in November despite cautious forecasts from most carmakers.”

Nevertheless, both Peak and Bateman remain cautious in their approach to European corporate names, and going into 2014.

For Bateman, the biggest unknown is still the effect that the US Federal Reserve’s actions could have on all markets, Europe included.

“Europe still hasn’t experienced a particularly robust recovery and we have to be mindful of the fact that there is a tapering effect coming from US,” he said. “Of course, this will impact emerging markets more than it will Europe, but still, the global equity markets are vulnerable to tapering and if the US were significantly and adversely impacted, then Europe would suffer from the knock-on effect of that.”