Last updated: 17:58 / Wednesday, 3 April 2013
Richard Pease, Henderson GI

Henderson: Identifying value in Europe

Henderson: Identifying value in Europe

As we are bottom-up stock pickers, macro views are not a key determinant of how we shape our portfolio. That said, a more positive macro backdrop will support our convictions. Although eurozone headwinds continue in the form of political deadlock in Italy, the Cypriot banking crisis and rising peripheral bond yields, a number of global equity markets remain close to five-year highs. Clearly, the recent Italian election result has provided a setback to Europe but this seems unlikely to cause an imminent return to euro fragmentation. On the contrary, there have been a number of recent positive signals for European equities; the return of Portugal to the debt market and signs that funding conditions continue to ease for European banks. Accelerating merger and acquisition (M&A) activity and a surge in buy-back announcements has also lent support to equities as corporates have put excess cash to work. Global M&A volumes in February surpassed that of last year’s while buy-back announcements in 2013 currently stand at a 20-month high.

Looking at the IMA monthly fund flow data, there has been a steady increase in the level of gross sales into the European ex UK equity sector – see chart. As Europe’s recovery gains traction and as gross domestic product growth forecasts increase, we would expect investor sentiment to improve and for fund flows to increase further, which should in turn drive up capital values.

Chart 1 – IMA: Gross sales to the Europe ex UK equity sector

Source: Investment Management Association (IMA), total gross sales by period (retail and institutional), in sterling, Jan 2012 to Jan 2013.

While we do not like to adopt a macro view, we do have a focus on buying good quality global players which originate from Europe but which are not entirely vulnerable to the region’s woes. Our portfolio is largely composed of companies with lots of free cash flow generation, on low valuations and with a good history of delivering strong results and value for shareholders. These companies should prosper even in tough times thanks to their exposure to faster growing economic areas and robust pricing power.

Currently, industrials are a particularly appealing sector and we are attracted to service companies due to their strong balance sheets and recurring revenue streams, such as Kone and Schindler. Kone, the Finnish lift company, has been able to tap fast-growing emerging markets as well as the developed world. The company’s servicing arm, which maintains and refurbishes lifts, accounts for more than half of Kone’s sales. At the other end of the spectrum, we have avoided financials. We remain underweight the sector and do not currently hold any banks. Banks have bounced sharply over the last six months but we continue to prefer service-related businesses with high levels of recurring revenue. However, we do own some high yielding insurance stocks such as Nordic-based general insurance provider Tryg, which is paying an attractive dividend yield, and non-life insurer Gjensidige.

European stock markets have recovered this year and are not as cheap as they once were. However, the Henderson European Special Situations Fund has a portfolio of companies with minimal balance sheet debt, strong underlying cash generation and most stocks have enjoyed excellent track records due to quality management who, in most cases, have significant exposure to their own shares. The underlying portfolio is yielding around 3.2%, and has an adjusted free cash flow yield in excess of 8% compared with other asset classes whose real value may be impaired by government initiatives to generate economic growth. Looking at the 1.9% yield currently earned on 10-year UK government bonds, European equities appear to be a much more sensible and attractive option.

Richard Pease is manager of the Henderson European Special Situations Fund, the Henderson European Growth Fund and the Henderson Horizon European Growth Fund