Peter Moeschter, executive vice-president, Templeton Global Equity Group, at Franklin Templeton Investments, says that economically sensitive stocks based in Europe have sprung back to life over the last nine months after being heavily oversold.
A traditional value manager, Moeschter has been "modestly trimming" his weighting in these cyclical companies, but he still has "a sizeable exposure" to them. He considers that they have further to run.
"We were early in our enthusiasm for European stocks," says Moeschter. This is reflective, he says, of the finely honed Templeton discipline, which looks ahead five years in assessing a company and the stock. Europe, he adds, "was where we were finding value."
More recently, he says, general investor sentiment toward European equities has improved and the stocks are being re-rated. Investors appear to have been taking comfort from the fact that the European economy is "showing signs of stabilization and could see a resumption of modest growth."
The European Commission is forecasting an increase in real gross domestic product (taking into account expected inflation) of 0.4% for the European Union and 0.1% for the eurozone. "Despite all the naysayers, the eurozone has remained intact," says Moeschter.
In the 12 months to the end of February, the MSCI World Index produced a total return in Canadian-dollar terms of 15.6%. This index is the benchmark for developed countries around the world. Many of the constituent European countries also produced solid double-digit total returns for the 12-month period.
France, for example, had a total return of 14.5% and Germany, 15.3%. These are among the more heavily weighted European countries in the MSCI World benchmark, with France at 4% and Germany at 3.6%. The United Kingdom, which accounts for a hefty 9.2% of the benchmark index, had a total return of 10.7% over the 12-month period.
Of the Continental European economic recovery, Moeschter says the tough medicine taken by the more financially troubled eurozone countries in the form of tax increases and spending cuts "was a necessary step" to reduce their fiscal deficits.
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Also, the European Central Bank "has provided greater support for the beleaguered European financial-services sector." The banks have been building their capital bases, "which will eventually lead to more lending to fuel economic growth."
Providing further impetus to this recovery, says Moeschter, countries like Spain, Portugal and Ireland in peripheral Europe have seen their labour costs decline. This has resulted in an improvement in their competitiveness. "Their exports are recovering, with their products often destined for markets outside of Europe."
In all, Moeschter says, there are signs of a revival in consumer and business confidence in Europe. "Greater corporate confidence should lead to increased investment and hiring, which will help to reduce the European unemployment rate."
At Templeton, Moeschter is responsible for both the global and EAFE (Europe, Australasia and Far East) portfolios for retail and institutional investors. He has been with the company for some 15 years and returned to Toronto last year, after a posting in Edinburgh.
Europe currently represents almost 50% of the global portfolio versus its weighting in the MSCI World Index at 28%. The United States, which is a hefty 53% of the index, is underweight at 35%. Japan at 8.7% of the MSCI World is underweight in the portfolio at 7%. The portfolio does have an emerging-markets component, currently at around 8%.
When it comes to sectors, industrial and consumer-discretionary stocks are emphasized in the global portfolio, says Moeschter. The portfolio is market-weight in the financial sector, which is the biggest sector weighting in the MSCI World Index at 20.5%. In the more defensive sectors of the global equity market, the portfolio is overweight in health care, but underweight in consumer staples.
Two European cyclical stocks that Moeschter considers will benefit from the improving regional and global economy are International Consolidated Airlines Group SA and Randstad Holding N.V. International Consolidated Airlines (ICA) is the result of the merger between British Airways and the Spanish airline Iberia, a few years ago.
ICA operates premium trans-Atlantic routes, says Moeschter, and the operating profitability of the combined airline is improving. "The merger has produced material efficiencies." Although the stock has rallied recently, "it can continue to perform well as the European and global recovery continues."
Randstad, based in the Netherlands, provides temporary employees to a wide range of businesses with a focus on developed Europe, although North America accounts for more than 20% of revenue.
"Temporary staffing often increases in the early to mid stages of a recovery, before businesses commit to full-time personnel." The stock, says Moeschter, has risen over the past six months, but it still offers attractive upside and has a dividend yield of almost 4%.
Moeschter has sold his holding in another European cyclical stock, the global luxury car and motorcycle manufacturer, Bayerische Motoren Werke AG, which is based in Germany. "We have held the stock for years, it has performed well and there was better value to be had among the Japanese global automakers." The portfolio has holdings in Toyota Motor Corp., Nissan Motor Co. Ltd. and Mazda Motor Corp.
The global portfolio is underweight in the consumer-staples sector, says Moeschter, "because it continues to be expensive." A U.S.-based staple that Moeschter says does offer value is Mondelez International Inc. MDLZ.
Mondelez is "one of the world's leading snack and confectionary companies" with global brands such as Oreo cookies, Ritz crackers, Cadbury, Toblerone and Dentyne. The company, says Moeschter, was "carved out of Kraft Foods in the fall of 2012."
Snacks and confectionary products remain a fast-growing sector within the food industry, he says. The stand-alone earnings power of Mondelez is "not yet clear on a shorter-term basis," says Moeschter. But the longer-term potential for both revenue growth and margin improvement "should lead to substantially higher earnings power over a three- to- five-year time frame."
The overweight in the health-care sector, is, says Moeschter, a reflection of the fact that many major pharmaceutical companies are "successfully managing through their patent expirations and are producing earnings growth again." An example, he says, is U.S.-based Pfizer Inc. PFE, which is a "core holding in the portfolio."
Pfizer lost patent protection for its cholesterol-lowering drug Lipitor, which was a major drug for the company, says Moeschter. "Wyeth Inc., a large U.S. pharma which Pfizer acquired three years ago, is helping to offset the loss." Pfizer trades at 12 times earnings-per-share estimates for 2013 and the stock has a dividend yield of 3.4%.
| Mondelez International Inc. | Pfizer Inc. | ||
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| March 18 close | $28.31 | $28.04 | |
| 52-week high/low | $28.75-$24.06 | $28.38-$21.40 | |
| Market cap | $50.2 billion | $201.3 billion | |
| Total % return 1Y* | 15.5 | 31.9 | |
| Total % return 3Y* | 16.1 | 21.0 | |
| Total % return 5Y* | 9.7 | 9.1 | |
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| *As of March 18, 2013 All figures in $US |
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