Emma Wall: Hello, and welcome to Morningstar. I'm Emma Wall and here with me today is Stuart Mitchell, manager of the SWMC European Fund.
Hello Stuart.
Stuart Mitchell: Good morning.
Wall: So, we're here today to talk about three European stocks. What's the first one you have for us today?
Mitchell: I was very keen to talk a little bit about Orange (ORA) which is the old France Telecom, the former monopolistic telecom provider. We are fascinated by the industry because it would seem now there has been an acknowledgment by policymakers that the industry isn't profitable enough to go to support the development of new technology, whether it's rolling out 4G or high-speed broadband to every home. So, there has been the encouragement for consolidation within the industry which should lessen competition, enable cost cutting and allow these companies to become a little bit more profitable in the future.
There is also technological change as well. There is fiber-to-the-home which we're all aware of, Infinity, of course, in the U.K. and a similar technology is now being spread right across the continent. That means now the large incumbent providers like France Telecom are able to offer fast broadband services but at very competitive prices. It's just the matter of getting the fiber to the cabinet, the curb and then it's coppered for the last 200 yards.
So, our hope is that France Telecom revenues will stabilise, even begin to pick up. The share price at the moment is still very much discount, falling sales into the future with continued very aggressive vigorous competition. But we think it's more than likely their revenues will begin to start to recover perhaps as early as next year and if we see that then the share prices should be another 50% higher.
Wall: We've seen a lot of telecoms news recently, the news that Sky (SKY) is going to launch mobile, the news that Google might launch a wireless network. How much do these, sort of, new players to the market threaten the old monopolies?
Mitchell: It's a very, very good question. I think it's – I mean, there's all kinds of different forms of competition. From what we've seen over the past few years, the most disruptive has been when you have a large fourth operator which has got a weak balance sheet and is desperately just trying to raise cash in order to cover costs. So that means offering all sorts of highly competitive aggressive programs just to be able to bring in some customers to raise a little bit of cash to pay the bills and we've seen that's been right across Europe much more disruptive.
It's more difficult, when you've got a large highly profitable organisation whether they will be quite as aggressive and of course, operators like Sky are MVNOs and so they are – where they are renting spectrum from the large operators.
So, they haven't got that same capacity bandwidth as it where the three major operators we have in the market. Again, Google that kind of technology is still in the development phase, around connecting up together distant wireless networks. I'm sure there will be some kind of threat in the future, but again, we're not quite as nervous about those because they are still kind of small and in the development phase, but we're much more anxious, it's about the disruptive fourth player that really causes trouble.
Wall: What's the second stock today?
Mitchell: So, the stock is, Ocado (OCDO), very controversial. But our view is, we've had this for many years now and has been a great investment for us. But we think when you're looking across different industries in the world the last area to be penetrated by Internet is groceries and as we all know, we probably buy a quarter of our purchases now a days in using the Internet and grocery is still around 3% or 4%. So, we think there is an opportunity for that to really grow very fast and at the end of the day Ocado have the skill to be able do that very profitably.
Wall: They did come in – so they started out just sort of providing – provider of Waitrose and then when they added Morrisons to the book and that was sort of beneficial for both stocks because Morrisons (MRW) previously haven't entered the Internet shopping arena and the stock went up, but then it's been trouble since then. So, why has it fallen, why has it been volatile?
Mitchell: Yes. It's not quite. I mean, it's had a very strong bounce since Christmas, so it's back up to £4, £4.20 or so. So, it's not as high, but it's not that far off. It's 10% or 15% off its high. And I think there are a number of them – a number of people were anxious. I think the primary fear was the woes that people at Tesco are going through and many thought, well, that has to somehow affect Ocado.
And fascinating is if you look at the like-for-like data, the guys at the very bottom like Lidl have done, Aldi have done extremely well. The middle ground has been devastated and you've seen the Ocado – we've seen rather Tesco and Sainsbury and all that; but the top end, Waitrose and Ocado and others have done extremely well. So, there has been this kind of interesting development in the market where the two extremes have been thriving whereas the middle ground has been fallen apart.
I think the other thing is and this is for me the most fascinating question, it's around how do Ocado package this know-how and then sell it to other international companies or maybe even somebody in the U.K. and so far we haven't heard any announcements yet. I think some of the market was kind of – some people were kind of hoping for a big deal, whether it was with a French retailer or a German retailer and that hasn't happened yet.
Wall: But it's in the pipeline perhaps?
Mitchell: It's in the pipeline. I mean, they are very confident in their speaking to many people and that's really this thing which will bring the share from £4 now up to £10 or £15 if they are successful. I think many have underestimated the value of that know-how. I mean the technology is clearly off the shelf, but putting it all together and making it work is highly complex and they've been doing it longer than anybody else.
Wall: What's the third and final stock?
Mitchell: The third one is Glaxo (GSK), which again is kind of a controversial one and there are many people who thought the same for years and been incredibly disappointed by the kinds of returns they’ve generated. We've just been intrigued recently how – I mean, a number of things which happened which seem to us that the company is becoming a little bit more shareholder-orientated and of course, you saw that large deal with Novartis with the asset swaps which will create a vaccines business, it can create a consumer, pharma businesses which have scale now and can cut costs and become more competitive as it were, having more value as businesses.
The other idea is they’re thinking around floating off separate the Aids business and all the technology around there and arguably that could as a floated off separate entity worth much more than – it could highlight the value of that business.
But for us the most crucial thing is all around the cost structure, because if you look ta Glaxo's costs over the last five or six years, they have grown by £2 billion, £3 billion or so whereas revenues have stayed flat.
So, there are all kinds of opportunities for them to cut costs and get some back to best practice again and I think which is under enormous pressure now to do that.
There has been a change of Chairman and there have been many investors who are doing all the same calculations that we are who have been very critical in challenging and questioning of how tightly he has been controlling his cost structure. So, in our view, if some of these things can start to be addressed then the shares have got 20% or 30% or so to normalise with the rest of the industry.
Wall: Stuart, thank you very much.
Mitchell: Thank you.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
