In an environment where market sentiment swung between risk-on and risk-off with little warning or justification, the economic woes of Portugal, Ireland, Italy, Greece, Spain and elsewhere saw companies listed there punished on the basis of geography alone.
More recently we have seen elevated correlations across global markets decline, and with them volatility. Companies are once again being judged on their own merits rather than the macroeconomic environment, so peripheral Europe is more appetising than it was, as sentiment no longer outweighs fundamentals.
This means opportunities now exist, albeit on a very stock-specific basis.
Part of the reason that we now see opportunities in peripheral Europe is the phenomenal job some countries have done to restructure from a competitive perspective. For example, in Ireland wage costs have come down by 25% since before the financial crisis, so unit labour costs are now at a level that makes it attractive for companies such as Amazon to base themselves there.
Some of the biggest car manufacturers have moved into peripheral EU countries as wage costs have become more competitive with non-EU locations, and countries such as Portugal are seeing strong benefits from this.
In the balance
The latest trade data from Germany suggests that one of the primary causes of the euro crisis may be waning. Slowly but surely, the long-standing intra-eurozone trade and current account imbalances are disappearing. The progress is not immediately evident: Germany’s global trade surplus increased by 6.5%, to €80.3bn, in the first five months of 2013. This is almost as large as it was in 2008, on the eve of the global financial crisis.
But what you do not see in the headline numbers is that Germany’s trade surplus versus the rest of the eurozone was 33 times larger in 2008 than it is today.
While this is partly a result of austerity measures in the periphery weakening demand for German goods, it also reflects the increased competitiveness of the periphery, with Germany now importing far more from the rest of the eurozone than it did five years ago.
Rather than considering Europe at a country level or even a sector level, as bottom-up investors we prefer to look at individual stocks. The macroeconomic picture as a whole has improved sufficiently that we can once again consider the merits of companies in the periphery on their fundamentals, with less likelihood of a blanket de-rating caused by negative sentiment.
What we see is that companies in peripheral Europe are now more attractive on a stock-by-stock basis. Austerity has meant the strong have got stronger while the weak have in many cases disappeared, so we maintain a stock-specific focus in search of companies that display the right combination of quality, value and momentum factors.
An example is in paper and packaging, where the Irish cardboard maker Smurfit Kappa has survived the crisis, reduced costs and focused on profitability rather than volumes, allowing it to gain market share and pick off some smaller, less efficient businesses – that is an example of restructuring at an industry level benefiting investors at the stock level.
Austerity has meant the strong have got stronger while the weak have in many cases disappeared, so we maintain a stock-specific focus in search of companies that display the right combination of quality, value and momentum factors
Banks back in the good books
We are starting to become more positive on banking and financial stocks in general. Examples include asset gatherers such as Azimut and Banca Generali in Italy. They are domestically focused and have seen strong inflows.
Across Europe, low interest rates have meant investors in search of real returns have had to look beyond cash. In addition, the Cyprus banking crisis has made people elsewhere in peripheral Europe nervous that their own cash on deposit could fall victim to a future bail-in.
These factors together have driven the trend for savers to move from deposits to investment vehicles, such as mutual funds, and these Italian asset managers have benefited from a great pick-up in management and performance fee income, driving revenue and profits significantly higher.
Also in the financials sector we favour Bank of Ireland. While the idea of holding an Irish bank might have raised a few eyebrows until quite recently, Bank of Ireland has benefited from the economic recovery in Ireland, where ratings agency Standard & Poor’s recently upgraded its outlook from stable to positive.
House prices have stabilised so the bank’s bad debt profile is looking healthier, and it has done a good job of recapitalising its balance sheet. Yet the stock is cheap relative to its European peers, with a price to book value of 0.8x, and it trades at a discount to much of the sector simply because it is listed in a peripheral European market.
We like Ryanair for the exact same reasons we like EasyJet in the UK: it has done a great job at benefiting from the shortcomings of more expensive, less efficient flag carriers, which have not made their business model work.
Ryanair et al have focused on profitable routes and taken advantage of the extra capacity they have been able to pick up as a result of some smaller names dropping out of the market.
In addition, the revenue contribution from dis-aggregating items such as priority boarding and allocated seating – whatever one might think of paying extra for these as a customer – has been highly beneficial for overall profitability.
Ferrovial is a stock we do not currently own but it is a great example of a good company that has been under-appreciated by the market because of the location of its listing. Our positive view of this stock has nothing to do with it being listed in Spain.
It has a highly diversified business mix – for instance, it owns Heathrow airport, in addition to a portfolio of toll roads in diverse countries – but it is looked down on by the market because it is listed in Spain, which means it trades at a discount to its peers.
Ferrovial is doing a good job: it is cash-rich on its balance sheet, so it can be tactically very smart in making long-term acquisitions. It does have some exposure to the Spanish building sector, which has had a negative impact on how it is perceived, but the bulk of its revenues come from outside Spain.
Keeping calm in volatile times
The final point to make is that the ability to maintain a long-term focus is key. Equity investing in any market should not really be undertaken on a short-term basis: the value of investments can go down as well as up but the longer the holding period the greater the chance of riding out any dips.
In an area like peripheral Europe, there will be some volatility around newsflow and political developments, but that should be seen as a good thing as it allows long-term investors to take advantage of short-term valuation anomalies by building or further increasing allocations to Europe during any future sell-offs.