European Stocks at Bargain Prices says Alken's Walewski

There is an historic value opportunity in European equities says Alken's Nicolas Walewski, but make sure you are selective about the sectors

Alken Asset Management 17 August, 2016 | 4:09PM
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Morningstar's "Perspectives" series features investment insights from third-party contributors.

European equities are today offering investors one of the most powerful value opportunities in history. There is an extremely rare two standard deviation valuation differential between cyclical and growth stocks – which was last witnessed in the 1930s. In addition, the valuation discrepancy between US and European stocks is also at an all-time high, again two standard deviations away from the norm.

One of the most compelling investment areas in Europe currently is in the auto sector. The automotive sector has been one of the poorest performers in Europe this year and investor scepticism remains high. However, we believe the industry offers some compelling value.

The market is currently fixated on the environment for the US manufacturers, but investors need to realise the auto market is not just the US – it is global. While the US auto market is rolling over, this only constitutes 18 million cars out of a global market of about 73 million. With no excesses in the overall global car market, we are witnessing strong tailwinds for the fundamentally sound French auto giants, such as Peugeot (UG).

Why We Like Peugeot

Peugeot’s share price fell 35% during the recent market volatility, drawing parallels to its drop in the global financial crisis. However, Peugeot has vastly superior fundamentals than it had back in 2008. Peugeot had €2 billion of net debt in the crisis; today it has €6 billion of net cash. This is out of a market cap of about €10 billion. There was also huge overcapacity in Europe during the financial crisis, with utilisation rates of 60%. Over the past eight years 25%-35% of capacity has been cut, which had a positive impact on pricing. In addition, Peugeot had poor strategy in China back in 2008. This has now been rectified, with the company outperforming the broader market.

Even if Peugeot witnesses a major 30%-50% fall from its €300-€400 million of current UK profits on Brexit – a highly unlikely scenario – it is still on track to generate €2 billion of overall net profit. Considering Peugeot’s €6 billion of net cash, its €2.6 billion stake in parts manufacturer Faurecia and its €2 billion of earnings potential, the company is trading at an extremely attractive and irrational valuation. Its strong Q2 trading numbers validated our optimistic thesis on the company.

In addition to Peugeot, we are also bullish on the opportunity in French automotive supplier Valeo (FR), which the market also sent sharply lower recently on its perception of being highly cyclical. However, 75% of Valeo’s growth in prior quarters has not been linked to overall car market growth – it has been outperforming global car production by 8%-10% due to its advantage in technological innovation.

If global car production was cut to zero or 1%, Valeo would still have the ability to grow earnings per share at about 13%-14%. With its price to earnings ratio recently falling from 10x to 8x, it is an example of the extreme value on offer in Europe today.

Value in UK Housebuilder Stocks

In addition to the French auto stocks, we also see a strong value play in UK housebuilders. These stocks were hit hard by the Brexit and many are now trading at liquidation value. Again, many investors reacted with echoes of the global financial crisis after the Brexit vote.

However, housebuilders had about £5 billion of net debt on balance sheets in 2008; today it is £1 billion of net cash. New residential housing transactions fell by 50% and prices fell by 13% during the crisis, but the situation today is again vastly different.

Transactions in the crisis plummeted because of the lack of mortgage availability, which is not the case today. While London could witness some difficulties following Brexit, many of the major housebuilders have little exposure to the capital.

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The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
Valeo SA18.78 EUR0.91

About Author

Alken Asset Management  Alken Asset Management is an independent investment firm focused on European equities.