Peter Moeschter, executive vice-president, Franklin Templeton Investments, says that investors are pricing in a persistent European recession in evaluating the region's equity market.
"Although it will take a while, Europe will recover and, in the meantime, there are some solid investment opportunities that are being ignored." A traditional value manager, Moeschter runs both global and EAFE (Europe, Australasia and Far East) portfolios for retail and institutional investors.
Of the macroeconomic challenges facing Europe, Moeschter notes that the second bailout arranged for Greece, of 130 billion euros, toward the end of February was an important step forward.
The region is making progress, he says, but it is going to be a tough grind. "A number of countries will have to swallow some bitter medicine over the next few years, so as to reduce their huge deficits and help to restore confidence." The upside, he says, is that this widespread fiscal restraint will result in a "healthier long-term economic picture for Europe."
Stock markets in most of the developed world, including Europe, took a beating in 2011, says Moeschter. The MSCI World Index, which includes stocks from all developed countries, had a negative total return of 2.7% for all of 2011, wiping out gains in the first half of the year. (All returns are total returns expressed in Canadian dollars)
The United States, says Moeschter, was one of the few countries in this index with a performance in the black, with a positive return of 4.5%. By contrast, the European stocks included in the index had a negative return of 8.5%.
The MSCI World Index country breakdown for Europe shows that of the 17 constituent countries, 16 were in the red in 2011, with some more so than others. Greece was by far the worst performer, losing 61.8% in 2011, coming on top of its 47.6% loss in 2010.
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| Peter Moeschter | |
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Moeschter notes that investors distinctly favoured the defensive sectors of the market in 2011, "given their fears about macro growth." This defensive stance, he notes, shows up clearly in the MSCI World Index's breakdown of sector performance in 2011.
Consumer staples produced a return of 12.1% and health-care stocks put up a robust 12.9%, in the context of an index in negative territory. "In the process of chasing these defensive stocks, investors abandoned many worthwhile cyclical companies that deserve attention," he says.
Applying its traditional value style to stock selection, Templeton combs the world for bargains. The worldwide research team constructs financial models for companies that look ahead five years and assess each company's ability to grow book value and earnings over that period. This is then compared to the current valuation on the stock.
Templeton's global portfolio has some 57% in Europe (an overweight position relative to the MSCI World Index) and 25% in the United States. The remainder is in Asia. When it comes to sectors, the portfolio is underweight in consumer staples, utilities and materials.
It holds market-neutral weights in financial services, consumer-discretionary stocks, industrials, information technology and energy. It has an overweight position in telecommunication services and health care.
In the consumer-staples sector, Moeschter took some profits in two holdings: Nestlé S.A. and Unilever PLC. The latter has an American Depository Receipt, and trades in New York under the ticker (UL/NYS). Nestlé's stock has done well, he says, "this global company is good at managing its wide range of businesses."
Of Unilever, Moeschter says that this global manufacturer of branded and packaged food and household/personal-care products is in the "late stage of a long-term restructuring program."
Most of Unilever's global operations have been reshaped over the past five years, he says. "The company is now more competitive in its key markets, including emerging markets, which represent more than 50% of total revenues." The equity market, he says, has recognized these improvements and has pushed the stock to new highs. "It is viewed as a defensive grower in a volatile market."
By contrast, he says, Procter & Gamble Co. PG, another leading global manufacturer of branded household products, is in the early phase of a restructuring and turnaround process. The company's growth over the past few years has been "disappointing," he says.
In response, Procter & Gamble has "streamlined" its product mix, including selling off leading food and beverage brands, and has been regaining market share. There is room for further cost savings, says Moeschter, as Procter & Gamble's profit margins remain well below those of its peers.
| Procter & Gamble Co. | Unilever PLC | ||
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| Feb. 28 close | $67.39 | $32.60 | |
| 52-week high/low | $67.72-$57.56 | $34.55-$28.45 | |
| Market cap | $185.6 billion | $98.6 billion | |
| Total % return 1Y* | 10.2% | 14.0% | |
| Total % return 3Y* | 15.0% | 23.4% | |
| Total % return 5Y* | 3.7% | 7.3% | |
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| *As of Feb. 28. All figures $US Source: Morningstar |
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It takes time, he says, to turnaround a company of this size. "But there is potential for a substantial increase in earnings and dividends, as the process unfolds." The stock currently has a dividend yield of 3.25%.
An "abandoned cyclical" which Moeschter considers warrants investor attention is Rentokil Initial PLC, a business-services company, operating mainly in Europe. Its key divisions are facilities management, the provision of supplies and maintenance uniforms for a wide range of businesses and parcel-delivery services.
"There is weakness in its UK parcel-delivery business, as there are too many companies fighting for the same business," says Moeschter. But the industry is rationalizing and Rentokil is cutting its cost base to be profitable at lower volumes, he says. "A turnaround in this division is one of swing factors for this stock."
Rentokil's stock trades at a discount to the company's break-up value, he notes. "The stock will benefit from a revival in European economic growth over the next few years."
European airline stocks, which have been out of favour with investors, will also benefit from an improvement in the region's economy, says Moeschter.
Here he likes Deutsche Lufthansa AG, which is "one of the largest airlines in Europe." In addition to passenger and freight services, the company offers repairs and maintenance services mainly to other airlines. This business accounts for almost 25% of its total revenue.
Lufthansa is also in the throes of selling its loss-making subsidiary, British Midland International, he notes, which is a plus. It is also rationalizing some of its routes in Europe with lower-cost, no-frills subsidiary, Germanwings. "Deutsche Lufthansa has a solid balance sheet and is only trading at 60% of its book value."
