Emma Wall: Hello and welcome to Morningstar. I'm Emma Wall and I'm joined today by Stuart Mitchell, Manager of the SWMC European Fund to give his 3 Stock Picks.
Hi, Stuart.
Stuart Mitchell: Morning.
Wall: So what's the first company you'd like to highlight today?
Mitchell: I want to talk about Intesa Sanpaolo (ISP), Italy's largest bank. It's a fabulous franchise. Largest market share, great access to cheap deposit funding, a very highly developed asset management business, where basically as deposits roll off at low rates, customers are then being encouraged to invest in mutual funds or in specialist bond portfolios to get slightly high yields. It's a wonderful, wonderful business.
Wall: But it's been hit quite hard recently, hasn't it, with all the sort of negative sentiments around European financial stock?
Mitchell: It has, and in Italy worse than any others. There is a view that the stock of NPLs is kind of too large at this stage of the cycle and it's going to need more urgent action to start to – to reduce – to get control of it. Intesa, of course being the largest and the best quality, for them it's not really an issue, but for some of the smaller banks, regional banks, it's quite a significant problem.
But again there are all sort of interesting new rules being put in place to help that whole process of sorting out the bad debts, and there is another – we hope plan which is going to be announced in the next few days where, basically all the largest banks will pool together their bad debts and then this will be managed as one large kind of entity.
But you know looking at the micro, nonperforming loans are falling in Italy at the moment. The economy is beginning to recover very nicely. Remember that nonperforming loans are extremely highly leveraged to the growth rate in the economy, and…
Wall: Which is kicking in…
Mitchell: Which is kicking in. So very roughly we think that Intesa Sanpaolo is comparable with a company like Wells Fargo in the U.S. We think it should be trading near 1.6, 1.7 times book. At the moment it trades 1 times book. And we think as confidence comes back to the financials in general and the Italian economy that their share prices should rise to reflect that.
Wall: And what's the second stock today?
Mitchell: Second stock is Orange (ORA). It's an old friend of ours. We think telecom is a very compelling industry within Europe. And it's all about subtles of shifts in emphasis from the politicians and the regulators. In the past it was all about breaking up monopolies, supporting the consumer, giving choice and now there is a realisation that the regulators have to encourage investment. And of course to encourage investment, you got to give a little more slack to the operators themselves, allow them to create a bit more profit.
So, number of very important things have happened, and most crucially is whole consolidation in the mobile sector. And Orange is right in focus in that, because it looks as if they are about to buy Bouygues Telecom, which would take out the fourth player, leaving three players. And well that's happened before, we've seen pricing has begun to increase quite significantly.
Wall: And one of the things that's happening in the telecoms industry across Europe is that they are moving into this sort of quad-play format offering television, landlines, Internet and indeed mobiles. Are Orange looking at that sort of…?
Mitchell: They are. I mean you're absolutely right. That's kind of the second crucial thing convergence and it's quite difficult to understand how it's been so successful, because at the end of the day most converged products, they aren't really converged. You have one bill, but they don't kind of relate or link to each other except in the most crudest way, and it seems what's happening is that because you have the packages so complex and there are so many different parts to it, consumers basically can't compare to other packages and so it reduces churn, and there's the ease of having one bill. But it's not obvious yet that there's really such things as a properly converge products.
Wall: So good for the share price.
Mitchell: Yeah.
Wall: What's the third stock today?
Mitchell: The third stock is Orpea (OPA), which is a retirement home business in France. We all think it's a horrible industry based in the U.K. because it's not regulated and all these terrifying stories of old people have been horribly abused in homes. But in Europe it's very different. You have to get a license to operate a retirement home, pricing is fixed. So there is some kind of control from above, there's a quality control. And of course, if you are the largest then you have really advanced share of everybody else. You understand the whole process of getting the licensees, you can be much more clever on costs, you can have – you can transfer employees around different homes.
So, Orpea have made the dash to become the largest. And of course, as we all know the world is getting older and older and older and the number of post-85-year old, 65-year olds is rising very, very fast. And so that should mean that the industry itself is growing at 3% or 4%, 5% organically anyway in the next few years.
Wall: Industries which are regulated often behave like utilities which is good for investors because it means that they have visibility over the future earnings of a company. Is that the case with this stock?
Mitchell: It is, it's a great observation, I mean it's always kind of tricky one because when they get obviously overly regulated and they become political footballs and there's a risk of things being changed retrospectively and as you've seen in the gas industry in the U.K. But I think in healthcare it's – the regulation is relatively light-touched that is just enough to keep the competition out, but it's not too much I think for it to become something kind of politicized and risk of further severe regulation being introduced.
Wall: Stuart, thank you very much.
Mitchell: Thank you.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
