Europe bargains for the brave at heart

Bina Brown

As the barrage of conflicting news continues to flow from the epicentre of the sovereign debt crisis, it may be hard for investors to get excited about directing their money to Europe.

But given the forward looking nature of investment markets and the fact that some of the world’s largest companies are based in this part of the world, the rewards should be there for those prepared to take the risks.

While growth in Europe is likely to prove tough in coming years, a number of sound European companies are continuing to bet their future prospects on the significant exposure they have to the faster-growing emerging economies and the United States.

It is hard to see names like Nokia, BMW, Nescafe and Danone suffering too much just because parts of Europe are.

Russell Investments investment strategist Andrew Pease points to the halving of the price-to-book value of companies in Europe over the past five years as a sure sign there is value among listed equities.

In January, the euro area as a whole was trading at 1.2 times book value. That is, the value of shares trading in Europe was 20 per cent higher than the value of the net tangible assets of the companies in the sharemarket.

Pre-GFC, the same companies traded at 2.5 times book value.

Among the euro financial stocks, the value drop is even more compelling. In January, bank and insurance stocks were trading at 0.6 times book value with a dividend yield of 7.5 per cent. In 2007, the same stocks were trading at two times book value.

While Pease says there are risks around the measures being taken to support parts of the euro zone, there are definite opportunities. “The financials is where the real value is but obviously you’d need some high conviction that things are better before you buy them, given where we have come from and what potentially lies ahead.”

In true market style, by the time the market fundamentals start to show the recovery is under way, the horse may have already bolted.

“By the time many investors realise things are better in Europe, the market will be six months ahead of them,” Pease says.

Fidelity Worldwide Investment commentator Andrew Webb also believes that much of the bad news has been priced into European markets and there are plenty of European-based companies which are in good shape.

“Dividends may fall if economies falter and those high corporate margins come under pressure. They would, however, have to fall almost a third for the aggregate dividend yield on European equities to return to the long-term, multi-decade average,” Webb says.

As an equity investor, he says he is putting money into European companies, not governments or economies.

“European companies are not, of course, restricted to doing business in the countries in which they are listed. Many of the companies I own in my fund are large, multinational enterprises whose fortunes are tied to the global economy rather than just the euro zone area,” Webb says.

Many European companies have continued to grow earnings and dividends throughout the sovereign crisis, such that valuations ended last year at a historic extreme with an aggregate dividend yield approaching 5 per cent.

Webb says investors should look to cash-generative companies that have sound balance sheets, good business prospects and therefore the potential to deliver consistent dividend growth.

“That a company is able to reward shareholders with a consistent and growing dividend is a sign of its good health and such companies are the bedrock of my investment philosophy because they deliver a consistent track record of outperformance.

“These sorts of companies may not sparkle in a sharp rally but they will deliver superior returns over any sensible investment horizon,” he says.

Two company picks are the German-based Hugo Boss and Norwegian online advertising company Schibsted.

Australian Stock Report senior equity analyst Benny Sada says the hunt for investments requires some sifting across a diversified area.

Sada is avoiding countries that have imposed hard austerity measures to fix their debt problems, notably Greece. The belt tightening remedy in those countries is likely to choke economic growth, he says.

Sada says the value is in German stocks given the inherent strength of that economy. Germany’s main index, the DAX, slumped 14.7 per cent last year and is trading at a 13.8 per cent discount to its historical average. “Amid the panic selling of last year, investors have appeared to lose sight of the country’s strong economic fundamentals,” Sada says.

As well as historically low unemployment, Germany has one of the lowest government debt to GDP ratios. Sada says the German market boasts some big names that are unjustifiably trading at steep discounts to their average and the market. His top picks: Siemens, a multinational technology conglomerate that provides solutions for the energy, health-care, industrial and infrastructure sectors; global provider of health-care and crop protection products Bayer; and the world’s leading chemical company, BASF.

Whether you take the direct approach to equities or property, or leave it to the professional via an exchange traded or unlisted managed fund, opportunities exist, according to the experts.

“Of course there are risks involved in investing in Europe, but, as noted before, risk and reward go hand in hand,” Webb says.

Managed funds

Country or even region specific unlisted managed funds have been a dying breed in recent years.

According to independent research provider Morningstar, there are six providers of dedicated European funds including Platinum Asset Management, BT Financial Group, Fidelity and BNP Paribas – all with relatively small funds under management. Beyond that, there are dozens of diversified international funds with varying exposure to Europe which is where the bulk of investor funds lie.

The Five Oceans World Fund is one such fund, with its exposure to Europe now at about 12 per cent.

Chief investment officer Christopher Selth says while the jury is very much out on what shape Europe will be in by the end of the year, there are opportunities among some European global export companies.

“There are a number of cheap European global exporters like Nestle, L’Oreal and BMW. They are cheap because they are domiciled in Europe,” he says.

Much of the growth in these companies is based on the continued recovery of the US economy. Selth says that if the fiscal austerity measures in Europe start to work and growth kicks in, then his fund will start buying European domestic stocks which stand to benefit from economic recovery.

These include domestic construction companies, the French electrical equipment company Schneider, WPP advertising company and UK retail giant Tesco.

Selth says the European market needs more visible signs that things are going to get better before the market breaks out of its current malaise and offers the real possibility of making money.

Meanwhile, there will be lots of cheap stocks. “The cheapest stocks are cheap because they are the ones with the greatest risk,” he warns.

ETFs

A variation on the direct equities and unlisted managed funds theme is the entry to some great names via an Australian Securities Exchange- listed exchange traded fund (ETF). A couple of conventional ETFs cover the European markets. Conventional means they seek to replicate the performance of an overseas index and are traded and settled on the ASX in Australian dollars.

For a pure European ETF, issuer iShares has the iShare S&P Europe 350 ETF. The index measures the performance of 350 stocks in continental Europe and the UK. The stocks have been chosen for market size, liquidity, industry group representation and geographic diversity and include Nestle, HSBC Holdings, Novartis, BP, Vodafone Group and Royal Dutch Shell.

iShares managing director Mark Oliver says there has been a modest take-up of the product recently. The total Australian investment in the ETF is about $21 million.

Oliver says exposure to Europe is also popular through the iShares MSCI EAFE which seeks to provide investment results that correspond to the price and yield performance of publicly traded securities in the European, Australasian, and Far Eastern markets. “The top holdings are global names which just happened to be domiciled in Europe. All these corporates have very healthy balance sheets,” he says.

The top 10 holdings are the same as the iShare S&P Europe 350 ETF with the addition of BHP Billiton.

Oliver says the strong Australian dollar against most major currencies means Australian investors are buying a lot more of the big names than in recent times. He says while diversification is a major reason for investing in an international ETF – you get exposure to a lot of sectors which are under-represented in Australia, such as pharmaceuticals and telecommunications – a more tactical advantage comes from the strong Australian dollar.

Another way to gain exposure to Europe is via the Vanguard All-World ex-US Shares Index ETF which tracks the benchmark FTSE All-World ex-US Index. About 45 per cent of the fund is invested in Europe and the UK, 30 per cent is in emerging markets, 14 per cent in Japan, 7 per cent in North America and 6 per cent in the Pacific.

The top 10 European-based holdings include Royal Dutch Shell, Nestle, Novartis, Vodafone Group, HSBC Holdings, BP, Roche Holding and GlaxoSmithKline. The loss for the year to December was 13.96 per cent, compared with a fall in the benchmark of 13.77 per cent.

Property

Whether it is pied-à-terre in Paris or a stone cottage in the Italian hills, there are plenty of property bargains.

Michael Bula, international lawyer, notary and French translator who specialises in European property acquisitions, says he has seen an explosion in interest among Australians seeking property abroad.

“Prices are flatlining in Europe and with the Australian dollar where it is, it is a wonderful opportunity for Australians,” Bula says.

Besides individuals, there has been a rise in syndicates, or like-minded friends, buying their dream.

“Whilst capital city purchases maintain strong interest, the dream of a village house is also popular,” he says.

A two-bedroom apartment in the heart of Paris which was €500,000 a year ago could now be down to €350,000 ($426,000). A rundown 17th century stone house could be found for €50,000.

Bula says that for historical as much as economic reasons, the most popular countries are France and Italy but Belgium, Switzerland, Spain, Portugal and Eastern Europe were gaining popularity.

Given that buying property in Australia can come with its own issues, it makes sense to seek some good advice before negotiating and purchasing in a foreign country.

The first thing you will need is a notary – a non-litigious lawyer who specialises in the area of deceased estates, companies and property. No property can be bought or sold without one in European civil law countries.

The biggest pitfall facing Australians who buy overseas property is succession and the incorrect assumption that it will be governed by their Australian will in the event of death, Bula says.

“Problems occur because of the interface and conflict between Australian and European law,” he says.

“Every property conveyance must take into account the specific present and future circumstances of the individual.”

The Australian Financial Review