Even though European stocks have surged in the past year, Dominic Wallington believes that they have more upside, since they are trading well below their historic average valuations.
"There is room for a continued valuation re-rating in Europe," says Wallington, manager of the $2.8-billion RBC European Equity and CEO and chief investment officer at London, England-based RBC Global Asset Management (UK) Ltd.
On the basis of data going back to 1980, and excluding the 2000-2001 telecom-media bubble, stocks are trading about one standard deviation below the long-term average, adds Wallington. "The long-term average is 14 times price-to-earnings, but we are currently at 9.2 times trend earnings."
Wallington expects to see an average 6% earnings growth rate, year over year. "I believe that's prudent, because that is the long-term average. The other thing is that the profitability of the typical European company is much higher [than in the past]," says Wallington. "And even though markets are up, expectations are still low. I still see leading indicators turning up."
Wallington notes that the Purchasing Managers Index, for instance, is trending up, indicating renewed growth in Europe. In addition, GDP expectations have been steadily revised upward. "They all show an upward bias. To me, the combination of cheap valuations and stabilization of the political environment is a sweet spot for equity investors," says Wallington. "Despite the strong equity run, I'm still pretty upbeat for next year."
In the 12 months ended Nov. 30, RBC European Equity returned 35.1%, ahead of the median 29.8% return in the European Equity category. Looking ahead, Wallington suggests returns will normalize, while remaining in double-digit territory, based on a 3.5% dividend yield and 6% to 7% earnings growth. "I would not expect the kind of explosive market we have seen this year."
A growth investor, Wallington favours companies that have so-called "positive spread" businesses that enjoy high earnings rates over the cost of capital. Although he is a bottom-up stock-picker, with about 60 names in the portfolio, he has a bias in favour of consumer-discretionary companies. They account for about 18% of the portfolio.
"Europe has a great degree of soft power, such as the attractiveness of its cultural areas," says Wallington. "And, significantly, nine of the top 10 global luxury brands are European. Some of them, such as Louis Vuitton, have been around for 150 years. They have done very well irrespective of the headlines around Europe."
Indeed, Wallington likes Christian Dior SA, a French holding company which owns, through its operating subsidiary LVMH, brands such as Louis Vuitton, Hennessey and Moet, a champagne producer. "It's a very high-return business. Pricing is constantly positive and growing about 5% per annum. I would expect that to continue," he says.
"I feel very comfortable with Christian Dior as a high-return, long-term growing franchise," says Wallington, adding that LVMH earned an average return on capital employed of 19.4% over the past three years.
 |
|
 |
|
| Dominic Wallington | |
|
|
|
|
|
A London native, Wallington is a 22-year industry veteran who began his career in 1991 after he graduated with an MA in finance and investment from the University of Exeter. He started working on an income and small companies fund for Credit Suisse Asset Management.
In 2000, Wallington joined Invesco in London as a UK equity manager. Later, he was transferred to its operations in Henley-on-Thames, where he managed several continental European funds for institutional clients. That opened up his interest in Europe. "It wasn't a grand career design. Just a consequence of what happened when the company re-organized."
In 2007, Wallington joined RBC's London office as chief investment officer. Beside assuming RBC European Equity in August of that year, Wallington also became co-manager of the $169-million RBC International Equity.
Although he adopted a more defensive stance in RBC European Equity, 2008 was challenging nonetheless, as the fund lost 34.9%, versus a 34.3% median loss in its category. Performance was also weak in 2011, when the fund lost 11.4%, versus a 9.7% loss for the median. Lately, however, the 2-star-rated fund has turned a corner and in the past 12 months was in the first quartile. Over three years, it had an annualized return of 13.2%, one full percentage point ahead of the median.
Wallington limits individual holdings to about 4% of assets. Portfolio turnover has been moderate at 58.7% for the six months ended June 30.
Wallington currently likes the prospects of selected financial-services providers, which account for 21% of the portfolio. However, he is shunning the banks and instead owns asset-management companies such as Italy's Azimut Holding SPA.
"Asset managers are well above the cost of capital, but most European banks are below the cost," says Wallington. "And Azimut has done very well, because the Italian banking sector has lost credibility. The aging demographics are in its favour, and the savings rate is quite high. Therefore, assets under management have grown 19% year over year. That's much more attractive than the banking sector."
:quality(80)/cloudfront-us-east-1.images.arcpublishing.com/morningstar/Q3KIND5VXRCNHHH6JQHCCYBSSA.png)
