3 European Stocks for Income

Alice Gaskell: Hi.

Wall: So you are here today to give me your three stock picks. What's your first? 

Gaskell: Well, let's start with Givaudan (GIVN), which is a flavours and fragrances businesses based in Switzerland.

Wall: That sounds a bit like a modern-day apothecary.

Gaskell: Absolutely. So, it's a very high tech business, with high margins and steady growth as demand for consumer products grows, particularly in emerging markets. The company has today a 3% yield, which is around the market yield. We think it can grow that double digits over the medium term.

What we really like about it, it has the strong balance sheet. So after doing a very successful deal a few years ago, the company has deleveraged, and this year, increased its dividend not by what we expected 10% to 15%, but by 30%.

We think that unless they find significant tech positions in the next few years, which are hard to find because these are very specialist businesses, we might see some of the excess capital return to us again, either by a special or through strong dividend growth.

Wall: The people uninitiated with this sector, I would imagine, as one of those. That some of the bigger houses, so people like L'Oreal, people like LVMH, have their own scientific labs that do this for them. So, who is this company servicing and is that market not restricted?

Gaskell: No, servicing is actually the kind of the companies that you're talking about and in addition, you’ll see a lot of the food manufacturers and the personal care, companies like Unilever and Nestle. They are absolute experts in the spaces and the chemicals that they're using.

And it is much better for the companies that need their products to benefit from the scale that they have by servicing across the whole industry, rather than being fixed on their own in-house suppliers.

Wall: What's the second stock?

Gaskell: The second stock is Swiss Re (SREN), something very different; an insurance company with a very long history, based again in Switzerland. This is one of the financial stocks that we've bought at a time when we felt that the risks on the bond market were falling in Europe. The balance sheet is extremely strong, it's a AA company. It is paying an ordinary dividend of around 5%, trading below net asset value, so very attractive fundamental valuation.

On top of that, it's paying back spare capital. Over the last two years, it's paid double the ordinary dividend, so a total return in cash distribution of nearly 10% in the last year. So we expect that to continue going forward for at least another year.

Wall: One of the things that's impacted the big insurance companies in this country is reform, regulation, politics, like with the recent annuity scrap. Is that a concern in Europe? How much does sort of politics and regulation impact that sector?

Gaskell: Absolutely. The life sector has been the most affected by the changes to some savings regulations. Swiss Re is a non-life company, so it's backing the risk that major insurers take and that's a much less political area.

Indeed, European insurance sector had its crisis five or six years ago, when the equity markets collapsed in 2003 and '04 and they were far to geared to that. Since then, these companies have restructured and reformed and no longer taking on de-risk on their balance sheets. So, they've already been hit by a lot of the regulation. The non-life sector is pretty stable, it's the life sector that has more of these risks, and we don't have much exposure to life insurance in the fund.

Wall: What's your third stock?

Gaskell: The third stock is Unibail (UL). So, Unibail is a very high quality property company focused on Northern Europe, say France actually is the core of its business. It is a company that investors tend to find a little bit boring because it's just too good and steady.

It has a very strong management who have paid good dividends and specials over the last 10 years. Who sold a lot of the assets at the top of the market. They had a really strong balance sheet to get through the bottom market, so their dividend was very secure at that time. And they have a really high quality portfolio of modern shopping centers, which are taking market share in a very difficult environment in terms of the consumer over the last few years, as the consumer recovers we think they'll do really better than the market expects because they have the best assets in Europe in terms of shopping.

Wall: This is a rental income that you are getting rather than link to sort of property prices, which can be a little bit more risky?

Gaskell: Yes, absolutely. So, yeah they – their rental income is linked to turnover. That's the way it works in Europe, so if they get more shoppers in and the shoppers spend more money, their rental income grows. And they have been in a market that has probably been slightly negative over the last couple of years. They have actually been growing their rental income and outflow in the market by around 200 basis points.

So, they have demonstrated that they are really great managers of property in a very difficult environment, as we could move into a better environment we think we will benefit from better growth, and you start with a 4% yield. So, it's really good starting point, and if we think the growth can sort of accelerate from around 5% to 6% to something a little bit more, your total return again is something attractive around sort of double digits.

Wall: The retail sector in this country is very sensitive to interest rate movement, because obviously, as consumers have less to spend, because they are spending more on their property or paying back their credit cards, so they have less to spend disposable income. The ECB has just cut rates and they've been not something for the near future concerns in Europe, but something for the medium to long-term?

Gaskell: We get such a long way away. I mean Europe is close to deflation which is why the ECB has been taking this sort of action. And it's the first time in our life time, in fact that Germany has really seen negative real rates at the short-end and that's really very positive for property assets in particularly, so low interest rates aren't good and we just see no possibility in the next two to three years, that you will get rising rates in Europe.

There is just too much bad capacity. Unemployment is way behind what we are in the U.K. U.K. is already seeing quite good performance in terms of employment. There is a lot of structural reform. We still have debt issue. We just think Europe is a place where you will see low yields and low interest rates for quite some time to come.

Wall: Alice, thank you very much.

Gaskell: Thanks.

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