This article is part of Morningstar's "Perspectives" series, written by third-party contributors. Here Dean Tenerelli, portfolio manager in the Equity Division at T. Rowe Price, discusses why domestically focussed stocks offer investors the best chance at growth.
The recent pickup in European macroeconomic reports has helped rekindle optimism in the European economy as of late. And as growth concerns begin to temper, we are seeing investors exhibiting growing interest in domestically oriented European companies.
Over the last 12 months, I have also shifted somewhat toward companies with greater revenue exposure to Europe, where I have taken advantage of attractive entry points. Simultaneously I have reduced my exposure to globally exposed companies that had performed well and seen valuations run ahead of fundamentals. A prime example of this was Inditex, the La Coruña-based fashion retailer. Despite its unique business model and significant international growth potential, particularly in Asia, I decided to sell the stock early this year because I felt the valuation was no longer attractive.
In the meantime, it appeared to me that many quality domestically oriented companies had been unduly punished by the market amid excessive concerns about the state of domestic economies. I found that either investors were discounting overly pessimistic scenarios, notably for cyclical groupings, such as broadcasters—often overlooking the structural improvements that some companies had been able to achieve during the downturn—or were simply ignoring the quality of the companies’ assets and the resiliency of their returns, in the more defensive areas of the market. For example, within the real estate industry, Land Securities and Gecina, UK- and France-based commercial property companies, have been among my holdings. Both these companies offer exposure to high-quality office investment portfolios and have made significant progress in restructuring their operations, however, their stocks have been trading at a discount to history. Even if they face lackluster economic conditions, I believe these companies remain well positioned to deliver sustainable rental income growth as they boast enviable development pipelines in the tight London and Parisian markets.
Looking forward, with the recent market correction and emerging market growth jitters, globally exposed companies are starting to look attractive again on valuation terms. For instance, following macro-related concerns in Brazil, highly exposed Edenred (issues prepaid vouchers for meals, childcare, and other basic needs) de-rated rapidly over the past couple of months, creating, in my view, an interesting entry point for what remains a high margin generator, particularly as it transitions from paper-based vouchers to digital solutions, driven by secular growth trends. Similarly, signs of weakness in China’s economy have weighed heavily on many quality, export oriented stocks, particularly premium car manufacturer BMW, which generates about 30% of its sales in the Middle Kingdom, causing the stock to lag its peers. While I am aware that recent macroeconomic developments in the Far East could dampen car sales growth, I am confident that BMW's dealership expansion plans could support volumes and help cushion the slowdown. In addition, the company has one of the best product launch profiles in the sector, this should help support earnings volatility.
While I continue to navigate these stock market fluctuations and strive to take advantage of inexpensive entry points, I remain heartened by the range of high-quality European companies that I can currently identify at attractive valuations.
