What to avoid when investing in Europe

By Paloma Almoguera

Added 13th October 2017

Big brand names in Europe used to be reliable performers, but online businesses have been making them less attractive investments, according to Martin Todd, manager of the Hermes European Alpha Fund.

What to avoid when investing in Europe

 

 

A sector that is being disrupted is European consumer staples, said Todd, who leads a six-man London-based team who look at European equities. 

Large caps such as Nestle and the big tobacco firms, for example, have historically been reliable performers, “but we think that they are too expensive for the growth they deliver. You pay a very high multiple and yet we don’t think earnings are that strong”, he said.

The brand power of consumer goods in terms of generating sales is not as strong as it used to be, he said. The old consumer model that focused on massive TV advertising to build a brand and marketing spend to maintain it has lost relevance.

“Online provides an alternate route to market, so distribution is disrupted. It therefore becomes easier for local or challenger brands to take share, and at the same time some consumers are moving to private label products – generally a lot cheaper – as brand loyalty weakens.

“It is only so far that you can take margins. We think it is an expensive scenario”.

A second area to avoid is telecoms. “The problem of telecom is that it suffers from overcapacity in Europe,” he said.

Consequently, telecom revenue has been on the decline for years. The industry needs consolidation, but “mergers haven’t really happened or they haven’t been allowed to happen. As result they are not making very big margins”.

Additionally, investment needed to upgrade Europe’s telecom infrastructure to move to 5G, for example, is lacking. The telecom companies themselves don’t necessarily earn enough to invest in the upgrades.

The telecom situation could improve if more companies merge, he added.

Euro strength

Todd also highlighted some general risks that may prompt bad results in any sector in Europe.

“One thing people have to be aware of is currencies. The euro has strenghtened quite considerably since the start of the year so a strong euro will make European exports more expensive. If you are making a lot of revenue in dollars, you don’t get as much in euro terms. That is a bit of a headwind for European companies in general.”

He added that political issues could surface, creating investment risk. Investor confidence could be hit by upcoming events such as the Italian election or the evolution of Brexit.

Todd sees less impact coming from the European Central Bank’s decision to start winding down its monetary easing policies, and has confidence in Mario Draghi’s cautious approach. Last September, Draghi postponed a decision on when to wind down these policies, something that he most likely will address now in October.

“He won’t start tightening monetary policy until he is sure that Europe businesses and the economy are back in recovery mode.”

Quantitative easing in Europe hasn’t had clear benefits for the market, he said. “When you look at the numbers, some money has gone into Europe, but it hasn’t really moved the [stock market] much.”

 


 

The Hermes European Alpha fund vs its benchmark, the FTSE World Europe, on a three-year basis.

Source: FE. The fund and benchmark are denominated in euros. The fund is for sale only to professional investors in Asia.

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