Emerging-markets exposure in mature markets

Templeton's Peter Moeschter cites bargains among expansion-minded global giants.

Sonita Horvitch 9 February, 2011 | 7:00PM

Peter Moeschter, executive vice-president of Templeton Global Equity Group in Edinburgh, says that a number of large-cap established companies in the developed world are successfully expanding into high-growth emerging markets, yet are trading at bargain valuations.

"It's a way of getting the best of both worlds," he says. "You can invest in companies with strong franchises in mature markets that are leveraging this to expand into the robust emerging markets, and you are not paying a premium for this growth."

Also, he notes, large-caps globally have tended to underperform small-caps in the rebound in the equity market since March of 2009, so there are opportunities. Within the developed world, European companies continue to offer good value, says Moeschter, who moved to Scotland in July 2008 from the Toronto office of Franklin Templeton Investments, and is scheduled to return to Toronto this summer.

Sovereign-debt problems of the so-called PIIGS -- Portugal, Ireland, Italy, Greece and Spain -- weighed heavily on the performance of most of those countries' equity markets last year, he says. Greece was the biggest casualty.

In 2010, the MSCI World Index, which includes select developing countries, produced a total return in Canadian-dollar terms of 6.5%. The Pacific region and North America (the United States and Canada), each with a total return of approximately 10%, were well ahead of Europe, with its negative 1% return.

Moeschter notes that the top-performing sectors in the MSCI World Index last year were industrials with a return of 18%, consumer-discretionary stocks with 19% and materials with 15%. Financial services and utilities were the two weakest performers, with negative returns. "We have been finding bargains among the European financial institutions and in the European utilities sector," he says.

 
Peter Moeschter

Applying its traditional value style, Templeton combs the world for bargains, based on financial models that look ahead five years and assess each company's ability to grow book value and earnings over that period. At Templeton, Moeschter is responsible for managing assets of $1.5 billion in a number of institutional and retail mandates.

The global portfolio, he says, continues to have a large overweight in Europe and an underweight in North America. In Asia, the portfolio is underweight in Japan but has an overweight position in the Asia ex-Japan region. "It's tough to come by new ideas in Asia."

The U.S. equity market does offer some pockets of value, says Moeschter. For example, brand-name global technology giants such as Microsoft Corp. MSFT and Cisco Systems Inc. CSCO trade at reasonable valuations. "They are cash-rich leaders in their field and yet they trade at price/earnings multiples of some 10-12 times current earnings-per-share estimates."

In its sector weightings, the global portfolio has a substantial overweight in the telecom-services industry, a more modest one in health care and a slight overweight in technology. It is underweight in both materials and consumer staples. "Normally it's tough to find bargains among consumer-staples stocks, but there are exceptions," Moeschter says.

He considers that London-based Tate & Lyle PLC is one such exception. It produces sweeteners and other ingredients that are used by food and beverage manufacturers. "The company has embarked on a dramatic change in strategy under new management and is becoming more global," he says.

Tate & Lyle is an example of a company that is using its developed-market base to expand into new markets, including those in emerging economies." It has also sold its legacy sugar-refining business, which is subject to market volatility since sugar is a commodity, and is now concentrating on its higher-margin, more value-added businesses, Moeschter says. "This will produce a more stable revenue stream."

The company is a strong cash-flow generator, and has reduced the debt on its balance sheet without issuing equity. It trades at 13 times earnings-per-share estimates for its fiscal year to the end of March 2011. "This P/E multiple is lower than that of its peers, and there could be a multiple expansion in light of its new strategy," says Moeschter. The stock has a dividend yield of around 4.5%.

A major French tire manufacturer, "which has been able to use its strong developed market franchise to expand into emerging markets," is Compagnie Générale des Établissements Michelin.

The industry is cyclical and Michelin suffered declining volumes during the recession, says Moeschter. "But volumes are stronger now as the auto sector is improving." Last fall, Michelin announced a "surprise" 1.2-billion-euro rights issue to help the company finance its expansion in developing markets such as India, Brazil and China.

This issue represented 10% of Michelin's market capitalization, and the stock fell sharply since the issue was a lot for the market to absorb, says Moeschter. The stock currently trades at 10 times earnings per share estimates for 2011, "which represents good value." The dividend yield is 1.7%.

Moeschter has been finding opportunities in the underperforming European utilities sector. An example is E.ON AG, which is based in Germany. The company operates in the power-generation (including nuclear power) and in the gas-production businesses. Power prices, he says, collapsed during the recession, reflecting reduced industrial demand and overcapacity in the industry.

A further blow to E.ON, says Moeschter, was the German government's introduction last year of a special tax on nuclear power. "This has taken a material slice out of E.ON's net income." The company cut its dividend as a result.

A positive, he says, is that industrial power demand is improving in Germany and the company has a program to cut costs. The stock trades at 10 times 2011 earnings estimates and 1.1 times book value per share. The dividend yield is 5.3% on the reduced dividend. "This stock is for the patient investor."

In the health-care sector, Moeschter sold his holding in Bristol-Myers Squibb Co. BMY. "This pharmaceutical company is more vulnerable to patent expirations than most of its rivals, yet the stock trades at a similar multiple to the rest of the industry, despite these risks."

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Sonita Horvitch

Sonita Horvitch