Recent profit-taking has left many European mid-cap stocks attractively-valued, against an increasingly favourable backdrop for European stocks.

June 2014

Key points

  • Earnings outlook for stocks to improve.
  • Many mid-cap stocks now look attractive post recent profit-taking.
  • Biotech & technology remain a focus.
  • We avoid utilities and reduce financials.
  • Interesting IPO opportunities.

How are your portfolios positioned?

Our European equity portfolios are focused on companies with high and sustainable profitability which are able to reinvest for future growth. Typically this leads us towards companies that are investing heavily in innovation, frequently in the healthcare, biotechnology and technology sectors. We also look for companies with strong brands and heritages, such as auto manufacturers and luxury goods companies. Finally we look for companies with internet-based business models which are thriving in the fast-growing service sector.

Which areas of the market are most appealing today?

At the start of 2014 we were reasonably comfortable with the level of European markets but many of the mid-cap stocks which we believe have strong long-term investment potential had already performed well, clouding the short-term outlook. Since then we have seen significant sector rotation, as well as profit-taking across the mid-cap area, and this has created interesting buying opportunities in some great businesses.

Examples include Azimut and Anima. We added to positions in these Italian asset managers after their shares fell. Over the medium term, we expect the shares to appreciate as both companies gather assets and win market share from weaker competitors.

We topped up a stake in French advertising agency Publicis. We did not expect the planned deal with Omnicom to come to fruition and when Publicis shares tumbled after the deal fell through we bought them.

Biotechnology companies are a particular area of interest, although many were looking richly-valued given their outperformance in 2013. However, biotechnology stocks have been subject to heavy profit-taking.

Now shares, in Morphosys and Basilea for example, look attractive. Other biotechnology companies which we hold for the long term include Genmab, Swedish Orphan and Skyepharma. 
Have you participated in recent IPOs?

Yes. There are many IPOs in Europe at the moment and therefore successful flotations need to be priced sensibly. We have participated in some attractively valued deals including Applus+, a fast growing Spanish testing and certification business, and also German auto-parts company Stabilus.

Which other areas look attractive?

Technology stocks remain an important part of our portfolios. Examples include financial software company Temenos, which should benefit as bank finances ease and spending picks up.

SAP is a large-cap share we like (we don’t just like mid-caps). The software giant is transforming its business model, and its prospects are not yet properly valued by the market.

Other large-cap stocks we like include pharmaceutical giant Roche, luxury goods manufacturer Richemont, budget airline operator Ryanair, and support service groups Sodexo and Compass

What is the earnings outlook?

European stocks have rallied sharply after selling off in 2012. However, company profits have not kept up with either stock prices or the economic improvement. Indeed while stocks rose in 2013, earnings estimates for European companies fell. This trend has continued in 2014.

But we expect the trend of falling profit forecasts to reverse during 2014 as earnings start to benefit from slowly improving economies in Europe and the US, and still reasonable growth in several emerging countries. Indeed, it is possible that stock prices rise sharply as investors realise the full potential for earnings to recover.

What is the outlook for M&A activity?

In recent years, merger and acquisition activity has been subdued despite an improvement in corporate balance sheets outside of the financial sectors. More recently companies have started to try and deploy resources more effectively, led by deals between Novartis and GlaxoSmithKline, Merck Inc and Bayer as well as Pfizer’s attempted bid for AstraZeneca. If companies can improve the efficiency of their corporate structures at sensible transaction prices then deal-making can support share prices. Furthermore such large scale corporate activity likely represents more confidence on the part of managements in the economic outlook.

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