Eurozone 2013: Crisis or comeback?
Invesco Perpetual’s Adrian Bignell on growth opportunities in the Eurozone and why the worst is behind us…
Fears of a euro collapse dominated the economic landscape in 2012. Can investors expect a more stable outlook in the coming year?
Our starting premise is that Europe holds together with a break-up of the euro not being in anyone’s interest, least of all Germany, which is currently benefiting from the weak currency and cheap funding costs.
Labour reform is an important element for believing that Europe is changing – we follow this closely and so far we are encouraged by progress being made, particularly in Spain and Italy. France has been disappointing but there are signs of change following the Gallois Report which recommends reducing labour costs.
In Europe labour reform is crucial. For years, Europe has traded at a discount to the US on account of its rigid labour laws. We are thinking that Governments in Europe are taking advantage of the crisis to change labour laws and make them more flexible. Italy and Spain have made huge steps forward in terms of making their labour laws more flexible and market friendly.
Whilst we arrive at most stock ideas via bottom up analysis, the macro-economic environment clearly matters. The macro is likely to remain fragile and dependent on central bank support, I think that we are past the worst. So things are getting “less bad”. Government de-leveraging and fiscal drag in 2012 took about 1.5% away from European GDP and whilst governments have more de-leveraging to do in 2013, it is likely to be more like 1%, rather than 1.5%.
In the financial sector, the pace of de-leveraging is slowing; whilst a large part of the sector is still shrinking its balance sheets, many banks including BNP Paribas, Société Générale, Unicredit and some Swedish banks, are close to being Basel 3 compliant.
There are two positive consequences we’d highlight, and these are reasons for us going overweight in banks in our Invesco Perpetual European Opportunities Fund in comparison to the FTSE Europe ex-UK index;
Firstly, the pace of deleveraging is slowing in Europe. And secondly, for those better capitalised banks, we think that we should get positive dividend surprises as their strong free cash flow will not be eaten up by making new loans and therefore, in the absence of Merger & Acquisitions and regulatory fines, we should see dividends rising. It is worth highlighting that only 30% of the banking sector in Europe is currently paying a dividend, something we also expect to improve.
So, to conclude, beyond Q1 2013, we hope we’ll get some positive growth surprises as we pass the low point in growth expectations.
There are probably four key themes we are looking to invest in. The first is secular growth stories. We are looking for companies that can grow organically above the rate of GDP.
Secondly, we are looking at multinational growth stories. They are European listed companies that have large sales abroad: Nestlé has over 50% of its sales in emerging markets and Unilever is the same. These companies can access international growth rates that are still attractive to us.
Thirdly, we are looking for restructuring stories: companies that understand the macro is going to be tough, that top line growth is difficult to come by, and what they can do to improve earnings is restructure their cost base. The airlines are a really good example of this. Lufthansa has a cost cutting programme called Score. Air France has a cost cutting programme called Transform 2015. We believe these programmes are going to have meaningfully positive effects on earnings per share by holding capital expenditure (capex) steady by reducing headcount.
The last group of companies we are looking to find are those bombed out cyclicals where we think the market has mis-rated the potential for a return to growth. A company we have found in that space is automotive supplier Faurecia.
There are two sectors we have a growing preference for. Firstly financials, where we have been underweight relative to the FTSE Europe ex UK Index for a number of years. Recently we have moved in line and are now slightly overweight banks because I believe we are past the worst2. We think deleveraging is less of a headwind for the sector going forward and, as a result, that free cash flow has a huge capacity for dividends to surprise on the upside next year and the year after.
The second sector I would highlight is oil and gas. However I am not talking about the big international oil and gas companies, but the oil and gas service companies beneath them. The reason we like that sector is that the capex that BP and Shell spend has been going up as they try and prove new reserves and increase production. This sector has benefitted from that rise in capex.
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