European industrial stocks were one of the weakest performers in the region’s earnings rebound story this year, but a fund manager from Hermes believes that investors should not overlook the sector, thanks to the emergence of automation in factories.
European equities have enjoyed renewed investor enthusiasm this year. Following the victory of Emmanuel Macron in the French presidential election in April and a 25% profit growth in European companies in the first three months of the year, the Euro Stoxx 600, a benchmark for European equities, gained 10% by the mid of May.
Despite a rising euro that has hurt the competitiveness of European exporters recently, earnings growth is up 12.6% year on year in July, according to a published note by Morgan Stanley.
The banking sector delivered another strong earnings season. However, the general industrials sector suffered a notable slowdown in output in July, according to data from IHS Markit.
Tim Crockford, who manages the Hermes Europe Ex-UK Equity fund, admitted that European industrials stocks have had a fairly poor second quarter earnings season; but this is not necessarily a bad thing for the sector. From a valuation perspective, the industrial sector looks cheap thanks to the weaker earning results, while from a structural growth point of view, the sector is undergoing a significant change because of automation.
“KION Group AG (KGX), for example, is one of the unrecognised long term structural growth ideas. They are the world’s second largest forklift manufacturer, which does not sound very exciting. However, they are changing: they made an acquisition in last year with a US company called Dematic, which is one of the leading companies in automatic warehouse,” said Crockford.
Denise Molina, equity analyst with Morningstar agreed, saying that with Dematic, KION is ideally positioned to benefit from a structural shift to greater warehouse automation, offering a mid-single-digit revenue growth rate opportunity for the next several years.
The Rise of Automation Warehouses
As KION is very much perceived as a forklift business, it has not got the recognition it deserves as one of the global automated warehouse system leaders, Crockford argued, which presents an opportunity to invest cheaply in a growth stock.
“Amazon (AMZN) and Walmart are Dematic’s biggest customers. Instead of buying into the expensive popular global online retailing stock Amazon, KION is a cheaper alternative for investors ... in this automation theme,” said Crockford.
According to Morningstar equity analysts, Amazon is rated as a four-star stock, meaning analysts believe the company is trading above its fair value estimate. KION, on the other hand, is trading as a three-star stock, meaning analysts believe the stock is trading at its fair value estimate.
“We look for longer term structural growth ideas ... Typically those stocks look like value stocks, although we believe they are growth stocks ... these are unrecognised mid-cap growth stories rather than the popular high-quality growth names,” Crockford added.
Don Jordison, managing director of property at Columbia Threadneedle, echoed Crockford’s views on automation warehouses, saying that they are a fantastic investing opportunity.
“Amazon created a world where people expected goods to be delivered to their front door within three to four days. In order to do that, you need industrial estates to store in different areas of the UK. They are not called industrial estates anymore, instead they are called urban logistics. You can tell they are popular when they are given a new name- it’s fantastic,” said Jordison.
Amazon is looking for 1,300 warehouse units across Europe as consumers demand shorter delivery times, the Telegraph reported in April.
A Structural Story with Cheaper Valuations
When investors look at the US, growth in typical FANG stocks comes at a high cost, said Crockford.
“Everyone knows they are great companies and they kept on being great companies, and definitely larger companies in the future; but ... you have to pay double or even triple digit multiples for that,” said Crockford.
However, in Europe, investors still have the opportunity to buy into these huge structural themes, which are going to grow further in the future, even though we don't know when this will happen.
“But we do not bother about the short term timing, what we bother about is the end-point. Europe provides you the opportunity to buy into these great structural stories with a cheap valuation,” Crockford added.
