Europe’s companies do not reflect its politics, says GAM’s Gallagher

According to Niall Gallagher, investment director at GAM, it is unwise to equate the troubles in European economies with its corporate sector and the generally bleak macro headlines do not mean a bleak future for Europe’s companies.

“European equities are a poor proxy for European earnings.”

Gallagher (pictured) said Europe’s large caps derive half their earnings from outside Europe, including 30% from emerging markets and 15% from North America. Over the last 20 years there has been a significant increase in the non-European component of revenue.

By 2015 European earnings from Europe will be less than 50% of the total base, he notes.

Among Gallagher’s holdings deriving less than half their earnings from within Europe are SGS, Kone, Atlas Capco, Swatch, AB Inbev and LVMH. “They all have double digit earnings per share growth, typically most have little or no debt and substantial cash balances. For most, you are paying 13 to 14 times unlevered free cash flows.”

European equities overall trade at approximately right times trend earnings. Interestingly, over the last 30 years trend earnings growth for the European market has been approximately in line with that of the US equity market, at almost 7%, but the differential in valuations between Europe and the US on a price-to-trend-earnings basis is now over 30% – “the largest it has been over the past 30 years”.

Gallagher said it was important not to slavishly adhere to benchmarks. His fund holds just 35 stocks out of the available investment universe.

In a deleveraging environment where European economic growth is likely to be low, it is important to target companies with good free cash flow growth prospects strong balance sheets and decent structural growth opportunities, he says. “For active investors like us, there are fantastic opportunities.”

Companies in Gallagher’s portfolio have a 10-year EPS growth rate of 13.2%, five-year sales growth of 7.5% – “well in excess of global GDP” – a forward PE ratio of 14 and prospective dividend yield of 3.1%. Their unlevered free cash flow yield is between 7% and 8%.

“There are some truly great businesses in Europe trading on attractive valuations,” said Gallagher.

But he adds that “certainly not all is good in Europe. A passive investment strategy is incapable of avoiding the pitfalls, that is areas which will be impacted by deleveraging and the general turmoil affecting Europe’s periphery.”


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