Europe's overlooked gold

Mention “international equities” and the average Australian investor probably thinks of the world’s biggest market '” the US '” or the world’s most exciting: Asia. Europe often somehow manages to miss out.

That can be an expensive oversight in an international portfolio because Europe’s stockmarkets have offered some very good results for canny investors despite the overall European economic picture being less than exciting.

Perhaps more importantly, Europe offers types of companies that are simply not available in the Australian market. Eureka Report has been a big fan of Australian equities since day one, and remains so, but a “buy Australia only” view would ignore a significant class of company that simply doesn’t exist in Australia: major international industrials.

International funds manager Platinum Asset Management has done very nicely out of Europe, particularly in riding the rollercoaster of Germany's DAX market in recent times. At one stage in 2003, Platinum had about 20% of its funds in Germany when that market was judged to be particularly cheap after the tech wreck took it down. Platinum’s total European weighting now is 25%, with the German portion well down on that high point and France and Scandinavia gaining attention.

As Platinum’s European funds manager, Toby Harrop, tells us, the funds’ main interest now is in the major international companies whose valuations have come back while their businesses continue to boom from the globalisation of the manufacturing industry. German companies last year had their most profitable ever, despite the German economy remaining flat.

It’s not just Europe. America’s uncertainties also have Platinum looking at big names that were judged too expensive just a little while ago, such as Cisco Systems. Although Harrop’s title is European funds manager, Platinum’s investment process has portfolio managers looking across borders. As you can see in the accompanying video, there are interesting opportunities simply not available in Australia with global corporations that can be expected to continue to be performing well when the commodities boom has run its course.

The interview

Michael Pascoe: Has the world become a more nervous place for an international funds manager over the past few weeks?

Toby Harrop: In the past few weeks '¦ well, I guess we’ve seen more of the same. We’ve seen a mixed picture perhaps '” continued softness in some of the growth indicators in the US. Just last Friday night we had the eagerly awaited employment number, which was a bit softer than the pundits had in mind. Initially a sort of a rally in stockmarkets in Europe, for example, on Friday afternoon before the US rolled over and finished flat for the day, and it is this combination of worrying about growth and the lack of it. So the market doesn’t like to see rate rises.

On the other hand, it doesn’t really want to see growth coming to an end. We’ve had a terrific reporting season in the big US stocks, the big US names. I think earnings up 19% or so. That’s 2½ years or so of fantastic earnings. I think the sense of it in this latest few weeks of reporting, though, was that probably that’s been the best of it; the next three to six months and perhaps into next year looks more difficult, earnings-wise. So in this complicated market environment '” of a modest P/E (price/earnings multiples) but cyclically, and indeed structurally, very high earnings, I think the data and the market moves for the past few weeks give you more of the same. It is tricky to know quite what to do.

So what do you do?

Indeed. Well I mean, from our point of view, more of the same. Very much stock by stock. In many senses it’s an appealing environment for us: lots of good quality companies, as defined by strong track records, strong market positions, have come back in their valuations a lot in the last year or so.

That should and does give people like us some interesting names to look at. Cisco Systems, which is a name we used to be astonished at the valuation of '¦ often impressed by the position and the track record, has come back to 14–15 times earnings. That’s a very interesting proposition for a business of that quality.

It’s changing but, you know, there’s little reason to doubt that they won’t manage it as well as they have in the past. Ericsson, and we have in Europe a similar sort of proposition, we think 12–13 times earnings for very much the market leader in the mobile systems infrastructure business. That’s what we’re talking about when we say that the higher-quality companies have come back in valuation.

The complexity in the market is this issue that the cyclical companies have come up so far. So when you look at last week’s numbers, names that perhaps are just peripheral to a lot of mainstream investors, (oil refiner) Volaro Energy, Marathon Oil '” they’re reporting $25 billion of sales for the quarter and $2 billion of after-tax profits for the quarter. Volaro is the largest of the US refineries now '” I think perhaps one seventh or so of the US refining system in capacity terms, but I mean they had sales of $20 billion for the whole year in 2001 and we’re saying they’ve bought one or two things, but it’s $25 billion per quarter now. It’s a $100 billion company.

That is bidding up or pushing up the level of the cyclicals in the earnings basket by some measures if you believe that to be lower quality earnings therefore the S&P at this 15 or so times, is a lower-quality 15 times than it may have been when it was more dominated by Procter & Gamble and Pfizer and indeed Cisco Systems. So that’s where it’s a tricky market but one where we think it makes sense to pick stocks.

Now we don’t own those energy stocks. They’ll have a better quarter still probably than the one we’re in now, than the last three months but where are they in 2007, 2008, 2009. It’s a difficult proposition to really put a big valuation on it.

So Platinum remains more comfortable with quality stocks that have become cheaper rather than cyclicals riding the resources boom?

Very much so. I mean it’s been a trend that we’ve been following for a few years. In France, names like Karpor and L’Oreal '” which were some of the really outlandish valuations of mid and late-1990s '” they’ve come down to levels having gone nowhere in stock price terms for eight or 10 years and the businesses have continued to grow. They’ve come down to levels that are very ownable and we think pretty interesting low-risk propositions.

The great time to own cyclicals '” the deep cyclicals of the mining type and the energy type, you know '” was a few years ago. Whether it’s still great today is a bit of a moot point for us. The market is long and the story’s very well told. There’s risk there to the extent that there is a lot of ownership and a lot of expectations built into those prices. What we’re saying is we don’t have to look at that. What we can say is that there are some pretty interesting high-quality companies that we can own.

While you’re involved in Platinum’s overall investment and stock picking, you’re a specialist in Europe. Is Europe something that Australian investors tend to overlook?

I guess so. I guess there are more tempting morsels for them elsewhere. There’s the dream of the growth in Asia. There’s the preponderance and the daily '¦ the overnight news of Wall Street, which takes up a lot of consciousness.

Europe, though, been much more interesting than you may think, both in business terms '¦ and you have a sort of stagnant and flat economies and yet you have record high corporate profitability in all of the, pretty much all of the markets. Germany’s the classic, where very low domestic growth but fantastic export performance with the globalisation of manufacturing that plays into the hands of Siemens and (vehicle manufacturer) MAN and Bosch and these sorts of names. And the stockmarkets have been all over the place.

The DAX has come from 8000 in the boom to slightly over 2000 in the wipeout of 2002-03 and has subsequently tripled so there’s a lot of opportunities. The small stocks have had a boom in Europe in the last several years and we’re out of those now. We think the larger ones are where the action is or where the safer investment option is. But I think Europe is overlooked. It’s far away. You don’t have the obvious dream of domestically generated growth, which people seem to associate with good prospects for equities ,and yet you have lots of large exporters there that are very much international companies.

What specifically do you like in Europe at the moment?

Again, and we’ve been surprised how soft the prices of these stocks have been, names like Ericsson, Alcatel, Siemens, these tech, I suppose, loosely, but I mean telecom suppliers. In the case of Siemens, somewhat broader than that and in fact they’ve pushed their telecoms business out into a joint venture with Nokia in the past couple of months so it is now more a '¦ it’s a heavy engineering business, electrical engineering businesses, the transportation, the power generation and transmission businesses, the medical. It is a big industrial. So those sort of names in the big end; Credit Acricole in France, a very large bank there with lots of regional subsidiaries, it's a very low risk, modestly rated bank.