The editor of Morningstar.es Fernando Luque interviews Philippe de Lavalette, Senior Product Specialist and Director of AXA Framlington and discusses European equity markets and corporate strategies in the current environment. “Actually when you look at the overall economy, it is difficult but when you look at companies, they are actually very healthy,” says de Lavalette. He explains that there are two approaches taken by companies with plenty of cash at the moment – to reinvest the capital or to give it back to shareholders. Investor should determine their specific needs before choosing which approach is more attractive to them.
Fernando Luque: Hello, I am Fernando Luque, Editor for Morningstar and I am joined today by Philippe de Lavalette, Senior Product Specialist and Director of AXA Framlington.
Thank you for being here Philippe.
Philippe de Lavalette: It's pleasure.
Luque: What we are going to talk about opportunities in Europe. I know that the macro situation is quite uncertain. So why do you think that the current environment is good for companies and good for the equity market in general?
Lavalette: Well, you're right the macro environment is difficult. It's true that when you look at the newspaper, when you watch television, probably you are thinking should I really invest in companies and are the companies doing well in this environment? We speak about a lot about deficits, we speak a lot about governments, we speak less often about companies. When you actually look at the companies, they have, they've gone through this crisis and come out actually very strong.
I have some data here which obviously you can't necessarily see, but when you look at what companies have done, they've been able to protect their margins comfortably. So the margins held up much better than they did in 2001 and 2002 and we're almost back to the top or we're getting back to the top. If you look at how much cash they have, they actually have a lot more cash than they did before. Part of it is because they're more efficient, part of it is because they have cut their study.
So, actually when you look at the overall economy, it is difficult but when you look at companies, they are actually very healthy. So the only problem they have is they have a lot of money, they have good margins, they are not going to have in short-term a very a strong growth. That's their one concern, but they are otherwise very rich.
Luque: So companies have plenty of cash. What do you think they can do with these cash or what should they do with these cash?
Lavalette: Well, there are a couple of strategies and when you look at what most companies are doing, the ones that are healthy and that are strong and have cash, there are two approaches. Some of them say we don't have any ideas right now, so we'll give it back to the shareholder. So one way is through dividend and you see that dividends are on average pretty high, they are close to 4% in Europe. I think around 3.8% to be precise. And companies can have a 4%, 5%, 4.5%, 5.5% dividend.
So some people are just saying, you know what, we'll give some money to the investors, it's a good way to manage it. Other companies are saying, well, in this environment rather than to give it back to shareholders we'd rather buy companies. So we're going to buy companies for two objectives, either because I want to buy growth for tomorrow, so it's a good way to position myself on growth markets or I am going to buy companies that are clear competitors or near competitors, and then I'm going to be able to reduce costs and improve my margins. So some people give it back to shareholder and some people use it to buy or to ensure future growth for the companies.
Luque: Let's try to see this in the investor perspective. What should investor focus on?
Lavalette: Well, looking at these two strategies, I wouldn't say one is better than the other. They're both good strategies, and it's the same for the investors. The investor has different needs. So one investor may decide that he needs income, and a good way is, there are companies that offer literally 7%, 8% dividends. So if you are interested in income, then you invest in a dividend or income oriented fund and you get that income. It's what I call "The Safe Strategy". Visibility is not necessarily great, so you say well, I'll take good dividends now. I am buying the time and I am waiting for the economy to improve. So it's really just a safety net until the economy improves.
The other option is to say, in this environment of M&A, when a company is bought out, usually there's a premium of 20-30%, maybe more and therefore since you know there's going to be some M&A, and we've seen it pickup and these are trends that usually last two to three years, so the M&A wave should last normally quite a few years. Then what you do is you try to identify or you invest in funds that identify targets.
And the trick is in the medium-term, the buyer is going to benefit. Short-term, you rather be in the target, the company is going to be bought out because of the premium. So if you are looking at the short-term, try to find the funds that focus on finding the targets and you can get that upside, and you can have some very strong performances in those types of funds.
Luque: How can the investors play these two themes or how are you playing these two themes in the AXA funds?
Lavalette: Well, in the funds, if you are interested in the funds you can look at those specific funds, but you've got both types of funds. So you've got European Opportunity Fund, that’s the name of the fund and it focuses primarily on M&A, on opportunities. So part of the fund is invested in solid companies for the medium-term, the winners and part of it is trying to find out those targets because that's where we have to leverage. And already since the summer, in the Fund we've had three or four M&As that took place, and again, every time with 20 to 30% premium. So that's one way of investing in the M&A theme.
If you are looking at the dividend there's actually couple of ways to play the dividend theme. One is to look at high dividend equity funds that focus on starts.
Luque: That's the traditional way.
Lavalette: The traditional way and you'll have some telcos and you have certain sectors that offer high dividends. I think one of the tricks in dividend for it to be really profitable is you want dividend, but you want companies that offer growth, meaning some companies have very high dividends, but they have no growth and that's usually not the best way to generate value.
One other sector, actually we think it is interesting in that notion of dividend and growth, is real estate. If you look at European real estate today there's about 4.5% dividends or good dividend and that's part of the story of real estate is, so most of the free cash flow is distributed back to the shareholders. Then when you look at the NAV, so the value of the assets, those actually were very far from the top. We actually went through a trough.
And in most countries, now I know Spain is in difficult situation, but when you look at real estate in most European countries it's not development, its retail. So it's shopping centers, shopping centers and offices. And actually it's a very stable business with very little new offer on the market. So it's a very different setup than what you're experiencing today in Spain, which is much more the retail, the homebuilder's issues.
So when you look at the medium-term for real estate in Europe, you see that these are long trends. We will get a pick up. We don't have very high inflation, which is a big plus to this environment. There's not much new construction. So demand is picking up slowly and supply is still very low. So we've got the dividend 4.5% and medium-term we have that appreciation of the real estate asset which will be a big upside and this in our view is the most efficient way to play dividend for an investor.
Luque: There is a good opportunity in this segment of the market.
Lavalette: We think that in real estate yes, the worst is behind us, and there's definitely some interesting opportunities.
Luque: Okay, Philippe. Thank you very much for this interview. Thank you.
Lavalette: You are welcome.
