3 European Stocks for UK Investors

Emma Wall: Hello and welcome to Morningstar. I’m Emma Wall and here with me today to give his three stock picks is Rob Burnett, Manager of the Neptune European Opportunities Fund.

Hello, Rob.

Rob Burnett: Hi.

Wall: So what’s the first stock you have for us today?

Burnett: I wanted to talk about Intesa Sanpaolo (ISP), an Italian bank with the number one market share in Italy. This company is exceptionally well positioned to benefit from the recovery in the Italian economy, and it's pretty cheap. It trades below its book value. It’s a good measure of intrinsic value and it also pays a great dividend, the dividend next year will be over 5%. In 2016, it could even be an 8% dividend.

So, a very cheap company, paying good cash return with good earnings growth that’s exceptionally well-run.

Wall: I think a lot of investors may think it’s cheap for a reason. We’ve been told over the last five years to be vary of Italy and to be vary of banks and here you are picking one that is, is both. Is the risk out of the way?

Burnett: It’s definitely one of the best risk/reward, kind of, moments probably in the last 20 years. And so there’s no investment without risk and there is certainly no bank investment without risk, but what can you lean on for support, mainly the capital ratio. This is a bank with one of the highest capital ratios in the world, not just in Europe, with a Tier 1 capital ratio north of 12%, nearly 13%, which is exceptionally strong.

So I would say there are, of course, risks investing in Italian banks but assuming the economy continues to recover and given how well-capitalized today is and given the dividend support you have today, not tomorrow, this is one of the lowest risk bank investments you can make in Europe.

Wall: And what’s your second stock?

Burnett: My second stock – I am going to choose a company called GDF Suez (GSZ), a diversified French utility, which does lots of different things, but one of its major areas of focus is in the gas subsystems. So they produce gas, they transmit it, they distribute it, they sell it in Europe and also in other parts of the world. They also generate some electricity and they sell electricity in France and have a Latin American business too.

Why is it interesting? It's also the dividend that’s very important. The dividend here is 6%, but importantly it’s returning to growth. This is a company that’s hasn’t grown really since the crisis, really since 2007. But this year and next year, it’s going back to growth of maybe 5% to 6% a year in terms of earnings growth. And it's really cheap relative to the security of those earnings and the dividend it’s going to give you.

So I think it's a nice balance with the previous company we discussed, Intesa. You have a more steady utility, you have a slightly higher risk bank, but in both cases they’re paying you big dividends, which is wonderful for anyone seeking income.

Wall: What’s your third stock?

Burnett: My third stock is a company a little less well known than the other two, a little smaller. It’s a company called Galp (GALP), which is a Portuguese-listed oil company, which has a series of different businesses. It has an oil refining and retailing business in the. Iberian area, but what's exciting about it is actually its production in Brazil – oil production in Brazil. And Brazil has this incredible reserve, this resource, in the Santos basin. It’s in the offshore Brazil and Galp’s production growth beginning actually last year, but going out to 2020 is phenomenal. It's growing production at least 40% a year to 2020 and it is meaningfully undervalued relative to its oil reserves.

And so that production growth that will accelerate this year, next year out to 2020, will deliver you great earnings growth and I think will deliver a higher share price.

Wall: You said why you think it’s going to deliver a higher share price. The sector in general, oil, has not done well over the last couple of years. The oil majors have underperformed. Tullow Oil is trading way below its fair value estimate. So, do you think these individual triggers are enough for investors to see upside?

Burnett: I actually think the integrated oil sector is moving into its sweet spot anyway. So you’re right. On a three-year view, the integrated oil companies, like Shell or Eni or Total haven’t performed that well, but actually in last six months they’ve done quite well.

And one of the reasons why I think that's the case is, whilst the old price itself hasn't moved that much, the market is now expecting a slightly higher oil price than we were thinking we are going to get a year ago. And so, without wanting to go too much into this sort of arcane details, oil in 2020 was priced at $85 a year ago. Oil in 2020 today is priced at nearly $95-$97.

So under the bonnets, the oil prices moved a bit higher, and that’s very important for integrated oil companies, but their future earnings are contingent on not the oil price today, but the oil price in the future.

So I would think – I should say I would expect even that the integrated oil sector, those huge oil companies are actually entering in a bit of a sweetest spot than they’ve been for a while. For that reason and the other reason is that we’re beginning to control that capital investment and focus on the dividends. We keep returning to the dividend argument and a lot of these investment opportunities that I’ve been talking about; oil does pay very high dividends. The concerns for the markets in recent years have been those dividends may not be sustained. Now they’re cutting CapEx and controlling spending. Those dividends are likely to be sustained, and therefore, integrated oil is not a bad place to be.

Wall: Rob, thank you very much.

Burnett: Pleasure.

Wall: This is Emma Wall for Morningstar. Thank you for watching.