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European equities roundtable: Part 3

U.K. stocks look cheap, managers say

Sonita Horvitch 26 October, 2012 | 6:00PM
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Editor's note: This week's coverage of Morningstar's exclusive roundtable on European equities concludes today with a closer look at the managers' strategies and picks in various industry sectors.

Our panelists: Paul Musson, senior vice-president and head of the Ivy team at Mackenzie Investments; Chuk Wong, vice-president and portfolio manager at GCIC Ltd., which manages the Dynamic family of funds; and Peter Moeschter, executive vice-president, Franklin Templeton Investments.

The three-part series was produced by Morningstar columnist Sonita Horvitch, who moderated the discussion.

Q: Let's take a further look at your global and European portfolios.

Wong: In Dynamic Global Value, I have about 23% or 24% in companies based in Europe. The U.K. is the biggest country holding in Europe at around 11% of the global portfolio.

 Dynamic European Value, has roughly 25% in U.K.-listed stocks, 15% in Germany, 11% in France and 11% in Italy. This is all the result of stock selection. The U.K. market is one of the cheapest in the world. It is cheaper than continental Europe.

 
Peter Moeschter

Moeschter: The U.K. is trading at a price/earnings ratio based on current earnings of 11.5 times. Most of Europe trades at 12 or 12.5 times. The world index is close to 15 times current earnings.

Wong: U.K.-listed stocks also offer much higher dividend yields than is the case in many other equity markets. It is not uncommon to see a U.K.-listed stock with a dividend yield of 3.5%.

Musson: We have about 40% in European companies in our global fund. Generally, we are seeing better valuation in our European high-quality names. Interestingly, even with our different investment styles, the U.K. seems to be the domicile where the valuations are taking all three of us.

Q: Strategy?

Moeschter: The economically sensitive stocks tend to be cheaper than the defensive ones. Defensive stocks have done well and when we trim, these tend to be the stocks to be trimmed. Over the last 18 months, we have been adding to European names in global portfolios and many of them are more cyclical.

Musson:  Mackenzie Ivy European Class and Mackenzie Ivy Foreign Equity tend to be defensively postured. It is reasonable to assume that over the next five or 10 years, economic growth in the developed economies will likely be slower than it has been historically. If we factor that into our valuation models, the more economically sensitive businesses generally do not rank as well as the defensive names. But we do have a number of high-quality German industrial companies on our radar screens.

Wong: If you look at the stocks, for example in Dynamic European Value, we have a greater exposure to cyclical stocks according to conventional definitions. We prefer companies, even if they are cyclical, to be benefitting from some long-term trends.

 
Paul Musson and Peter Moeschter

Q: Time to talk about European financials.

Wong: This is the most contrarian sector. There are still some well managed European banks that have good franchises, which have been overly punished by the market. We own a few banks in the European fund, for example Lloyds Banking Group PLC in the U.K. and BNP Paribas S.A. in France. Lloyds is a restructuring and turnaround story. The stock trades at a 45% discount to book value. BNP is a strong, profitable bank in the context of Europe and trades at a low valuation. It has a dividend yield of 3.5%. The European Central Bank is increasingly backstopping the financial-services sector. This gives me more confidence.

Moeschter: We are heavily weighted in European financials in the global portfolio, but it is across the board including insurers, banks and capital-markets players. Like Chuk, we have found that the European financials have been overly penalized. They do have some issues to work through. The sector is currently out of favour for good reasons. It is in the centre of the storm. But when you look out a few years, they should do much better and you are buying them at half tangible book value, in some cases.

Musson: I have no banks, at the moment. We have a U.K. car insurer, Admiral Group PLC. It is conservatively run. It consistently operates with underwriting profits and is not taking risks on the investment side. It is growing market share. I also own Partners Group, a Swiss-based global private-equity company. It has a great corporate culture, with a long-term mind-set.

Q: Industrials?

Moeschter: In Europe, a core holding is the global engineering and manufacturing company, Siemens AG, based in Germany. It is exposed to energy, industrial automation and medical equipment, all good areas. It trades at a reasonable multiple of 12-13 times current earnings and has a dividend yield of about 4%. There is room to grow its dividend.

Wong: Two smaller-cap industrials that I like are U.K.-based Spectris PLC and Duerr AG, based in Germany. Spectris is headquartered in the booming southeastern region of England. It is a leading global supplier of productivity-enhancing instrumentation and controls, serving a wide range of industries. We have owned the stock for some time. Even though it has done well, it still trades at about 12.5 times current earnings.

Duerr is a world-leading manufacturer of automated paint-finishing plants for the auto industry, with a dominant market share. U.S. automakers are investing in state-of-the art machinery. The emerging economies are growing their auto-making capacity. The stock trades at roughly 9.5 times current earnings.

Musson: I have a small allocation to industrials. One company that I would highlight is Germany's Wincor Nixdorf AG. It makes automated-teller machines for banks. This is a global oligopoly. It also makes cash registers for retailers. Management has carefully grown its business. It is navigating the headwinds it faces. Increasingly, more of Wincor Nixdorf's sales are coming from its after-sales services.

Q: Consumer stocks?

 
Chuk Wong and Paul Musson

Musson: We have significant weightings in this area. I referred earlier to Danone SA, the world's leading yogurt producer. Over the years, it has disposed of its more commodity-type or lower-margin businesses and reinvested in the higher-value-added, faster growing part of the industry. We have held this stock for 12-years.

Moeschter: It sounds like our holding in the British/Dutch consumer products global manufacturer, Unilever, which we have held for a very long time.

Musson: I also own Unilever. I have held it for about a couple of years. We bought it after Paul Polman left Nestlé, which we also hold, to become CEO of Unilever. We liked what Polman was communicating in terms of looking longer-term and reinvesting in the business.

Moeschter: Prior top management had done some of the heavy lifting. Polman was able to pick it up and run with it and then make some changes of his own. Unilever has been a great story. We have reduced our holding. It is no longer an undervalued stock. It is not expensive either.

Musson: The valuation is not as good as it was.

Moeschter: We are very underweight consumer staples. Nestlé and Unilever have been two long-term holdings. They have done well. We have trimmed them. A stock that we consider offers value is U.K.-based Tesco PLC, which is the largest food retailer in the U.K., with about a 30% market share. The stock is out of favour. The U.K. market is sluggish. Tesco's expansion internationally has had problems. Management is under pressure to show improvements.

Q: Consumer discretionary stocks?

Musson: Stockholm-based fashion retailer Hennes & Mauritz AB (H&M) has demonstrated its ability to be successful in just about every country it goes into. The valuation on the stock is reasonable.

Wong: A U.K.-based holding is Whitbread PLC, which has both a large budget-hotel chain in the U.K. and the Costa coffee-shop chain. We have owned the stock for some time. Using the usual valuation metric for hotels -- enterprise value to EBITDA (earnings before interest, taxation, depreciation and amortization) -- Whitebread trades at about nine times. This is attractive.

Finally, I would like to talk about Swiss-based Swatch Group Ltd., which is one of the leading luxury-watch manufacturers in the world. Its products are in strong demand in China, with the emerging middle class. Swatch has its own brands and is also the world's leading supplier of Swiss watch movements to third-party watchmakers. Swatch has a strong business model. The stock trades at 13 times current earnings.

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Sonita Horvitch

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