The Morningstar Europe Core List features the most attractively valued European-domiciled companies that possess sustainable competitive advantages. This month’s list saw a moderate amount of turnover, with six new companies entering the list. These latest changes were evenly spread across multiple sectors.
Firms that left our list this month included Air Liquide, Burberry Group (BRBY), Banco Bilbao Vizcaya Argentaria, Bayer, Bureau Veritas, and ARM Holdings (ARM).
The FTSE 100 increased by 4.39% in June, while our overall European coverage became ever so slightly less expensive than last month and now trades at an average of 100% of our fair value estimates — in other words, completely fairly valued.
Turnover remained the same for our July pick list, and the big story of Europe was the result of the British referendum vote, in which the majority voted to leave the European Union.
Despite the momentary drag on share prices, the FTSE ended the month with a decent gain. While the referendum results did affect some fair value estimates, they also created opportunities for investors willing to brave some of the volatility.
Burberry and ARM are both leaving the list this month, partly as a result of appreciation in their share prices. Burberry is a famous London-based fashion house, and while some may initially be fearful of anything related to the United Kingdom right now, Morningstar analyst Paul Swinand believes Brexit should have a minimal net impact on long-run luxury demand. While uncertainty in Britain may cause some local consumers to delay purchases, weak local currencies have in the past proved positives for luxury goods companies that have significant local costs.
Increased purchases by foreign tourists should also more than offset drops in local British demand. Swinand believes the net impact of the referendum on Burberry’s fair value is neutral, as costs and overhead in pounds are offset by sourcing in euro and revenue and store operations, which are global. The markets seemed to agree, and after a brief drop, shares fully recovered and finished out the month with a gain of 8%, more closely approaching Swinand’s fair value estimate of £15.50 per share.
ARM shares have also traded higher recently. Last month, shares were some of the least undervalued on our list and yet have managed to trade even higher. Shares are now trading above analyst Abhinav Davuluri’s fair value estimate of £10 per share.
3 UK Stocks Make the Undervalued List
Petrofac (PFC)
Petrofac is a global engineering firm that designs, builds, and operates onshore and offshore oil and gas facilities. Most of its business is related to onshore projects, predominantly located in the Middle East, Africa, and the Caspian region. This segment typically contributes the bulk of revenue and net profits. Offshore work comprises the second largest source of revenue, but typically realises smaller margins and profits due to the type of contracts offered, mostly variations of cost-plus versus the more lucrative lump-sum contracts for onshore work. What makes Petrofac unique is its integrated services offering, which comprises about 10% of revenue per year on average.
Centrica (CNA)
Following a sharp decline in operating earnings, a 30% reduction in its dividend, and a seven-month review by a new chief executive, Centrica embarked on a revised strategy in 2015 that will focus on energy retailing and supply.
The company will remain an oil and gas producer, but production will likely decline to roughly half of 2014 production and Centrica Energy will likely contribute roughly 25% of consolidated operating profit in the future versus roughly 50% just a few years ago. Centrica plans to shed its exploration and production operations outside Europe. We expect the value received for these assets will be substantially less than what Centrica spent to acquire and develop these assets. The British Gas subsidiary is the largest natural gas retailer in the U.K., with a 35% market share.
SSE (SSE)
SSE's core business is its unregulated wholesale and retail segments, which together have historically accounted for about 60% of operating profits. The company's regulated networks segment, which makes up electric and gas distribution and transmission services, provides more stable earnings. Rounding out the company's earnings profile are its smaller noncore operations.
SSE's wholesale generation unit operates roughly 12 gigawatts of primarily thermal capacity in the U.K. Its portfolio of hydro, wind, and other renewable-generation assets is expanding because of aggressive U.K. renewable portfolio standards to be implemented by 2020. SSE projects renewable generation will account for 40% of its portfolio by 2025.
