By Darius McDermott, managing director of FundCalibre
The narrative on Europe has been largely negative. Many investors take the view that it is sclerotic, welfare dependent, low growth and lacking in innovation. As with all cliches, those labels have a kernel of truth, but they are not the whole picture. In the gap between perception and reality lies real opportunity.
It is worth busting a few of the pervasive myths about Europe. It is not, for example, a basket case of low growth. The recent eurozone GDP data showed growth of 0.4% quarter-on-quarter, accelerating from flat growth in the first quarter and ahead of economists’ expectations. Annual growth also strengthened, reaching 1.2% across the European Union. That’s not a million miles from US second-quarter growth of 1.5%.
Equally, European companies are tapping into pockets of global growth.
Robert Schramm-Fuchs, manager of the Janus Henderson European Focus fund, points out that for his large-cap universe, the majority of revenue actually comes from outside Europe. He says the wars in Ukraine and Iran are creating a renewed focus on energy infrastructure, for example.
See also: IG: European defence stocks surge 800% in half a decade
He says: “In oil and gas, not every molecule is the same and that it matters where it’s coming from and how reliable that source of supply is.”
He says that Europe continues to have leading companies in this area, adding “These sectors have been starved of capital investments for many years; in the case of oil and gas, almost a decade, in the case of mining, for more than two decades. We are seeing a resurgence in capital investment.”
There has also been a narrative that Europe is a technology desert, while all the real action on areas such as AI is in the US and Asia. George Cooke, manager of the Montanaro European Income fund, says this is a misreading of European capabilities. There are plenty of European companies making crucial components and innovating in key areas.
According to Cooke: “European universities are pumping out world leaders in their fields. Europe has a very strong industrial base, so that when it comes down to things like electronic equipment, and some of the hardware sectors, there are globally-leading companies.”
He gives the example of Kitron, which is an electronic manufacturing services provider and a key holding in the fund.
Kitron highlights another theme that is important for European companies – re-shoring. This is often seen in the context of Asian companies bringing manufacturing closer to home, but it is also a phenomenon in Europe. “People don’t really want all their electronics to be produced out in China anymore,” says Cooke. This is particularly true in areas such as defence.
“Kitron is a contract manufacturer of electronic products. They’ve been getting a big tailwind from defence end markets, but also areas such as EV charging and various industrial applications. The move to electricity is a major theme, but neither do people want the cheapest factory in China producing critical components.”
Italian electrical connectors manufacturer Cembre is another example. It is building a presence outside its core Italian market as European companies look to domestic suppliers.
Admittedly, with the exception of ASML, Europe doesn’t have the giant AI leaders. That was a disadvantage until recently, leaving European markets lagging behind Asian and US markets. However, it’s been a positive advantage more recently, because it has helped Europe largely avoid the volatility associated with the AI trade.
See also: Why the Middle East crisis reinforced the bull case for Europe
There are still plenty of European companies benefitting from AI.
According to Tom Livesey, investment analyst on the IFSL Marlborough European Special Situations fund, “There are companies that we’ve been able to find that fit into that AI bucket that are fulfilling our criteria of attractively valued, able to grow their earnings at an above-average rate, and well managed.”
He gives the example of Proact IT Group, a Swedish-based distributor of enterprise networking equipment: “Under a recent change of management, they have seen an improvement in margins of some of their weaker regions, and they’re also experiencing a benefit in terms of pull forward of demand from customers who are seeking to purchase equipment ahead of price increases expected as a result of the memory price surge.”
He says it is selling the “picks and shovels” to companies who are willing and ready to invest across Europe.
There are still risks in Europe. Livesey says they have seen some companies hit by the war in Iran, such as Delta Plus and EVS Broadcast Equipment. “For us, what we have to do at times like this, is ask whether it is temporary or permanent. If it’s the latter, we will sell and sell decisively. However, for these two, we believe the disruption is not permanent. We will hold and wait for normalisation,” he adds.
However, the lower valuation of European markets provides some cushion. Schramm-Fuchs says: “We are getting these valuation discrepancies where European stocks are just so much cheaper than their directly comparable counterparts listed elsewhere. If you had a blind test and get the P&Ls and the balance sheets of these stocks listed in Europe versus the competitors listed, for example, in the US, it wouldn’t really make sense why there is such a valuation discrepancy.”
The MSCI Europe ex UK index has outpaced the MSCI World index over the past 12 months despite having limited direct exposure to the AI trade. There is little froth in European markets and few elevated expectations as there are elsewhere.
That should provide a welcome cushion for investors if the current global volatility continues.
