Investors should not get too excited by earnings growth in Europe and instead beware the plethora of value traps, according to Carmignac’s Malte Heininger.
After a bullish outlook at the beginning of the year, investors have begun to abandon European stocks as trade war rhetoric combines with political instability to create a worrying macro backdrop.
However, many European equity fund managers point to near-unprecedented corporate earnings growth – which in 2017 beat start-of-year forecasts for the first time since 2013 – as a reason re-engage with Continental stocks.
However, Heininger, who manages the Carmignac Long/Short European Equities fund, is much more cautious. “From a fundamental bottom-up point of view, I must say I’m not very excited about European equities,” he says.
Heininger notes that most stock markets have a divide between old economy stocks and new economy stocks. The former are ex-growth, value names – telcos, banks, insurers – “that are just getting cheaper and cheaper”. The latter, of course, have been the driving force of stock markets in many markets over the past two years, including the US and China.
The problem in Europe is that it is still an old-fashioned economy, he bemoans, so that bucket of companies is much bigger.
“If you look at the US or China, and all of this growth is coming from the FANG tech stocks and their little brothers and sisters; we have nothing here,” he says. Aside from chip maker ASML (ASML), some food delivery companies and online fashion sellers, “You run out of exciting tech businesses very quickly” in Europe, and “that’s a huge problem.”
Another problem is that those few companies that have seen high-single-digit earnings growth over the past few years are dominated by commodity-reliant businesses that are having a cyclical rebound thanks to recovering copper and oil prices. “Does that make me more excited about Europe? No," he adds.
Europe's Tech Scene
Europe does, however, have a thriving venture capital scene, which has recently borne out online music streaming service Spotify (SPOT) and food delivery firm Delivery Hero (DHER) among others.
And this is one place Heininger is finding opportunities. He says: “There are a couple of bright spots where we have some good, disruptive, well-run companies with that US mentality.”
He’s excited about a few medtech and biotech names, as well as some local tech champions in the food delivery and online fashion space. Aside from Delivery Hero, Heininger points to UK firms Just Eat (JE.) and ASOS (ASC), as well as Dutch company Takeaway.com (TKWY) and German ecommerce brand Zalando (ZAL).
Of course, most of these companies are trading on what many would consider ludicrously high price/earnings multiples, but Heininger says you need to value them in a different way.
The four factors he considers are: How big is their addressable market? How penetrated is that market? How big is their moat and how high are the barriers to entry? How strong is the management?
“It’s the same structural framework for all the big disruptors,” Heininger says. “If you look at Amazon, the tangible addressable market is the whole retail market; the penetration is still relatively low on a global basis, their market position is a clear number one and their moat is almost untouchable; and you’ve got a management team that’s incredibly strong.
“Our European funds don't invest in Amazon, but that’s the same thing you look for in all these types of companies. Wayfair (W), Netflix (NFLX), ASOS, Facebook (FB), GrubHub (GRUB) – you can put all these business into this framework and they tick all the boxes.”
He sees plenty of upside for ASOS in particular over the next five to 10 years: “These things can easily double on a three year view and triple on a five to seven years view. I would rather go to sleep owning that than owning a stock that’s good value on first view but who knows what will happen in five years.”
However, “we’re not stacked up with the ASOSes; it’s a pretty diversified portfolio”.
While Heininger is conscious that almost every sector is being disrupted right now, there are some more established areas he sees as immune to disruption due to high barriers to entry.
These are companies that make and sell luxury goods and sporting goods. These two areas are European strongholds, with firms such as Gucci, Louis Vuitton (MC), Puma (PUM) and Adidas (ADS) leading the way.
Heininger is a big fan of German sportswear maker Puma, which he says has 90% brand recognition but only 3% market share. “It has the sports heritage, but it’s a challenger brand with a very strong and agile management team,” Heininger continues.
“Structural change is helping them because they are faster paced in terms of consumer behaviour, having good brand ambassadors on Instagram. They are perfectly positioned.”
