Are Eurozone Equities good value? Part 1

In many of my posts thus far, I have commented that the European equity indices are becoming more attractive in terms of long-term valuation – specifically in terms of P/B and Graham & Dodd PE. In spite of this apparent value, I am not anyway near fully invested with my own funds. The reasons for this are simple:

(i) I am of the view that we remain in a secular bear market for equities that began in 2000. In secular bear markets, equities typically spend at least a decade if not 15+ years de-rating until the valuation is low enough.

(ii) On the basis of prior valuation lows, I am not sure that we are there yet in terms of overall market valuation. Getting there, but not there.

(iii) I have had a suspicion that the reason European indices look so attractive from a valuation stance is that financial equities still make up a large proportion of many European regional/country indices. If much of the valuation of European equity indices is being driven by a combination of the weigting of banks in the index and exceptionally low valuations for banks, then it might just be the case the a valuation argument for European equities in general is illusory.

The purpose of this post is to ask, do European equities represent good value? The first post will concentrate on Austria, Belgium, Ireland, the Netherlands and Portugal. The second post will look at the major equity indices in Germany, France, Spain and Italy. Greece is not represented, simply as I do not want to take the currency risk that I feel is coming their way. There will be a time to look at Greece.

As it stands today, the P/B for MSCI Europe is 1.3x and the Schiller PE is 12x.

Source: Morgan Stanley, European Equity Strategy, 28 Nov 2011. Secker, Carr, Garman & Lim.

It would appear that we are at or below average valuations for Europe. The P/S graph reproduced from the Morgan Stanley strategy report is interesting. It specifically excludes financial stocks, revealing that MSCI Europe is trading at its long run average multiple. The Schiller PE is below average and includes financial equities. This supports my assertion that when the stocks of Banks and Insurance companies are excluded, that the average European equity is not compelling in terms of valuation.

Country Analysis

Austria

Graham & Dodd PE: 12x

Price/Book: 0.8x

(This portion of the post has been edited. An eagle-eyed reader has pointed out to me that some of the valuation data for some previously mentioned Austrian stocks was incorrect. Having checked this I have found that the feed for market capitalisation that I used only accounted for the protion of the market cap in the index, which differed materially from the actual market cap. Apologies for this).

Of the seven stocks with single digit PE10 ratios, there are two banks (Erste & Raiffeisen), two are construction stocks (Strabag & Wienerberger), the remainder are utilities and energy companies. MOV maybe worth a look at. But I am not that interested in adding Austrian banks to my research list presently. Other than these stocks, which also appear on the low P/B list – the other low P/B stocks in Austria are predominantly real estate vehicles.

Belgium

Graham & Dodd PE: 13.2x

Price/Book: 0.99x

Stocks with lower PE10 ratios than the market include:

Dexia 0.4
KBC 2.9
Solvay 8.1
Belgacom 10.0
Mobistar 10.3
Ackermans Van Haren 11.9
Bekaert 11.9
GBL 12.5
Delhaize 12.8

 Two of these stocks are financial holding companies, two are banks, two are telecom operators.

In terms of P/B multiples, we get the following picture,

Dexia 0.08
KBC 0.18
Ageas 0.40
GBL 0.54
GDF Suez 0.71
Cofinimmo 0.81
Solvay 0.81
Befimmo 0.81
Delhaize 0.88
Bekaert 0.99

Three stocks here catch my eye, namely Delhaize, Solvay and GBL (Groupe Bruxelles Lambert). It would appear that Solvay and GBL have large net cash positions and are trading on low book and earning multiples.

Ireland

Graham & Dodd PE: 15.2x

Price/Book: 1.2X

The Irish market was one of the strongest performers in Europe during 2011, recording a 0.6% decline on the year. Not bad considering that many markets fell over 10% during 2011.

I terms of what stands out is that Ryanair, Kerry Group. ARYTZA and Paddy Power all trade on a PE10 of greater than 20x. Hardly appealing in terms of valuation. Many of the companies have grown successfully over the past decade. This growth in revenue and earnings is naturally reflected in a higher rating. Much of this is deserved, but how much I don’t know.

CRH is valued at 1.1x P/B and a PE10 of 13.2. Significantly more appealing in terms of valuation.

The real bargains in the Irish market are to be found in financials, where Bank of Ireland is presently trading on a P/B of 0.31 and a PE10 of 4.3. The leading Irish non-life insurer, FBD Holdings is trading on a P/B of 1.2 and a PE10 0f 3x.

Elsewhere , Grafton Group, Independent News and Media, Total Produce and Abbey all trade on single digit Graham and Dodd PE’s.

Netherlands

Graham & Dodd PE: 13.2x

Price/Book: 1.39x

Once again the low PE10 ratio stocks are dominated by financials (Aegon, ING Group and Corio).

Aegon 3.8
ING Group 5.1
ArcelorMittal 8.7
KPN 9.1
Corio 9.8
Philips 9.9
Wolters Kluwer 10.4

At the other end of the valuation spectrum there is Heineken NV (23x), Fugro (24x), Unilever NV (31x) and ASML (48x). All in all, there are some fine companies in the main Dutch index, but there is nothing that I am particularly attracted to.

Portugal

The Lisbon Index finished 2011 down 19%.

Graham & Dodd PE: 16x

Price/Book: 1.03x

The high PE10 for the Portuguese market is down to the high weighting and high valuation of retailer, Jeronimo Martins in the index (PE10 = 65).

What is immediately striking about the Portuguese market for me, is that other than the banks, many of the non-financial equities are very highly leveraged.

Company P/B Gearing ROE G&D PE
BCP 0.14 1439% 7% 2.11
BPI 0.55 5051% 24% 2.31
REN 0.52 237% 11% 2.81
Banif Financial 0.19 1687% 4% 4.24
Semapa 0.64 108% 14% 4.44
BES 0.29 1334% 6% 4.85
Mota Egil 0.54 287% 10% 5.49
Sonae 0.70 218% 11% 6.28
EDP   1.11 214% 18% 6.34
Brisa 0.94 142% 14% 6.65

Of the 10 stocks with single digit Graham & Dodd PE’s, 4 are banks (BCP, BES, BPI, Banif). REN and EDP are utilities, (as is BRISA for that matter). Given the low through the cycle RoE combined with high amounts of leverage, there is nothing that stands out to me as being particularly appealing.

Conclusion

In terms of secondary equity markets in Europe, only Austria as an index offers highly attractive valuations across the board. The other indices are trading close to or at a premium to the MSCI Europe average. This post, is not however about trying to ascertain what is cheap relative to a particular index. Instead, its purpose is to lift the lid of the index, and find out what is driving the valuation. In remain with the impression that it is largely financials, telecoms/utilities and construction stocks that are responsible for the low valuation present in European equity indices.

There is nothing necessarily wrong with that. Many value investors will choose to simply follow the value. In this regard however, it is worth recalling that financials typically trade at a discount to the overall market due to wafer thin profit margins and the highly leveraged nature of the business. This is not a recent phenomenon, but a historical one. The question for investors in financials to answer is that has the level of discounting been overdone and what are the risks to the business case going forward.

In terms of other areas, the amount of construction stocks appearing is a constant. I accept that they are cyclical in nature, but that does not mean that the businesses are inherently low quality or highly risky per se. Unless I see another compelling stock in the construction arena, I will more than likely add Heijmans NV to my portfolio. I am also keeping a close eye on Grafton Group plc and Morgan Sindall plc.

On the basis of the screens undertaken thus far, I am minded to do some more digging around in the following

Group Bruxelles Lambert – Belgian holding company with significant cash firepower trading at deep discount to book value.

Delhaize – Belgian retailer with a presence internationally. Appears to offer reasonable value and a good track record.

Solvay – Belgian listed chemicals company with low valuation, reasonable returns history and strong track record.

Part 2 of this post will look more deeply at the valuation of stocks in Germany, France, Spain and Italy. Some of these markets in particular have some very high weighting of financials in the index. Hopefully there is more on offer to a value investor than some bombed out European banks.

8 Responses to “Are Eurozone Equities good value? Part 1”


  1. 1 Gregory P January 5, 2012 at 3:10 pm

    No way would I be touching most things in Austria. Too much cross currency exposure to bad assets in banking, housing, and energy. The P/E’s are low for a reason. Most of those banks and real estate companies are toxic from Eastern European property exposure. Most of the rest in your list are housing and construction related. It is more a case of the stocks being in the wrong industries rather than them just being cheap. Look elsewhere for value.

    I think Telecom Austria would be one of the only ones I would think would be ok.

    • 2 jmcelligott January 5, 2012 at 3:25 pm

      I think that that is the point to the post. I keep reading that European markets are good value. My point is that when you actually look at the index composition, it is the valuation of the financials component that is influencing market valuation. Excluding these stocks, my point is that the genuine valuation opportunities are few and far between.

  2. 3 memyselfandi007 January 5, 2012 at 3:10 pm

    Hi John,

    interesting post as always. Howver I think your data source seems not to be always reliable.

    I personally own EVN and OMV and I follow Verbund.

    Based on my sources, EVN trades at 0.7 book, OMV at 0.8 and Verbund at 1.7.

    I would love to buy Verbund (Hydropower pure play) at P/B 0.4 and G&D P/E of 3..

    mmi

    • 4 jmcelligott January 5, 2012 at 3:21 pm

      Thanks for being alert to that. I have had a quick look at me spreadsheets. It would appear that mkt cap link is incorrect. I will go through them all to ensure that they are current.

      Post will be edited when I find all of the glitches.

  3. 5 kelpiecapital January 5, 2012 at 9:21 pm

    Given the inherent macro risks I think you have to worry about currency expsoure and you have to apply a further discount to whatever you would normally assume is fair value for any euro equity.
    I am however, long term, mildly bullish on EuroZone equities.

    http://kelpie-capital.com/2011/12/12/europe-be-greedy-when-others-are-fearful/

    • 6 jmcelligott January 5, 2012 at 9:33 pm

      Hi. Thanks for the comment. I live in the EZ, so I have less of a currency issue (that is making the rather large assumption that the currency block holds together in its current format, which I dont assume will be the case).
      I started out by being mildly bullish also on EZ equities, however upon closer inspection I find very little that satisfies my valuation criteria outside of financials and utilities. There are some small pockets of value, but they are just that, small.


  1. 1 Market Musings 5/1/2012 « Philip O'Sullivan's Market Musings Trackback on January 5, 2012 at 5:32 pm
  2. 2 Are Eurozone Equities good value (Part 2) « valuestockinquisition Trackback on January 10, 2012 at 9:30 pm

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John McElligott

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