European Values: Long-Term Trio

10/20/2014 10:00 am EST


Europe has been down for so long that value-based investors are now starting to take an interest, observes Tom Petruno. In Kiplinger's Personal Finance magazine, he highlights a trio of potential long-term winners, representing the financial services world, the food sector, and a leading commodity play.

Steven Halpern:  Our guest today is Tom Petruno, of Kiplinger's Personal Finance magazine.  How are you doing today, Tom?

Tom Petruno: Very good, thank you.

Steven Halpern:  Well, thank you for joining us.  Since the end of 2010, European markets have significantly underperformed the US market and the latest news seems to be getting even more dismal, but you note, optimistically, that Europe is now beginning to track the attention of some value investors.  Could you expand on that?

Tom Petruno:  Right, well Europe has really been an economic basket case, as many people know.  They really are-again-teetering on the brink of recession. There are just horrible unemployment rates across much of Europe, and the economy just cannot get going, and the headlines are just relentlessly grim.

But, this is an environment where value hunters typically love to tread because that's sort of the mix that you need to really get stocks down to value levels, so American value hunters, among portfolio managers, many of them are very intrigued with Europe-not as a short-term play-but as the idea of picking up bargains that will pay off pretty nicely over the next few years.

Steven Halpern:  Now, a lot of attention is focused on the European Central Banks and the possibility of them providing additional monetary stimulus. Can you just give a brief overview of that situation>

Tom Petruno:  Right, well, what the European Central Bank is facing is a reluctance on the part of a lot of governments in Europe to take steps that might, in fact, help their economies.  The governments have been, sort of, paralyzed.  

There are structural reforms that many investors think should happen to make the economies more dynamic.  That has stalled out-that effort has stalled out-and so, it really leaves the European Central Bank as the institution that people rely on to, say, do something, help the economy.  

So, as in the case of the US, short-term interest rates have been kept very, very low in Europe and there's now pressure on the European Central Bank to copy what the US Federal Reserve has done with so-called QE-quantitative easing-which would involve the ECB purchasing government bonds to help drive down long-term interest rates.

But, frankly, long-term interest rates also have fallen very sharply, so people are looking to the ECB for more help but, as in the case of the Fed in the US, it's sort of like, "well, what more can we do?"  

This is really an issue more for government and for stimulus, or tax reform, or something at the government level that could turn things around.  

So, there is still, I would say, a really good chance that if, in fact, the European economy weakens much more substantially in the next few months, you will see the ECB-the European Central Bank-try to do something because they will feel as if, if we don't do it nobody will and we just don't want the entire continent to fall into another very deep recession.

Steven Halpern:  Now, in your latest article, you highlight some specific investment ideas where value hunters are starting to look and one stock you highlight is Credit Suisse Group (CS).  What's the attraction there?

Tom Petruno:  Credit Suisse is a major investment bank, worldwide, and it's a favorite stock of Oakmark Global, a fund company fund in Chicago, and what they're looking at is, obviously, since the financial crash, many people just hate investment banks of any stripe and they don't want to invest in them.

Well, that's part of what has beaten down a lot of these companies.  Credit Suisse sells for about less than ten times estimated 2015 earnings per share so the Oakmark people look at this and say, "we're getting a very high quality bank that operates worldwide for less than ten times earnings," and they look at the company, which has really rebuilt its capital base since the 2008-2009 financial crisis, focusing on private and investment banking.  


They think there is a decent long-term growth picture here and if you can pick up a stock like this for less than ten times earnings, they think it's a real bargain.

Steven Halpern:  Now, another very familiar name you highlight is Nestle (NSRGY).  What's the outlook for that company?

Tom Petruno:  Nestle is very interesting.  I think most Americans probably don't know Nestle is the world's largest food company.  It's bigger than all the US food companies, individually, so Nestle is a gigantic, brand name food company worldwide.  

It owns brands in the US like Lean Cuisine, Gerber, pet food, Alpo; I mean, the list goes on, and on, and on.  It's been a phenomenal performer over the last ten years. The stock has quadrupled over the last ten years and a big part of the appeal is that Nestle is huge in emerging markets.  

That's where it's getting a lot of its growth and 45% of its sales already are in emerging markets, so, to think of Nestle as a European stock is actually not quite right because it operates truly globally, so that stock-when I wrote about it for Kiplinger-was about $77.  It's now down to $71 in this latest sell-off.

This is a franchise that isn't going anywhere.  I mean, people worry about the stock market taking another huge hit here.  They're going to want quality and companies that they're going to know are going to be around.  Well, certainly, Nestle is one that's going to be around and it's priced, I think, very attractively relative to earnings looking forward.

Steven Halpern:  Now, you also highlight a London-based resources firm known as Rio Tinto (RIO).  Could you share some background on this commodities play?

Tom Petruno:  Rio Tinto is one of the world's biggest mining companies, particularly for iron ore, and what's happened is that that business, like so many businesses in-what we call-basic materials, has consolidated.  There aren't many players left.  

Rio Tinto, again, a huge name in iron ore and, actually, they have slashed costs so much as demand for commodities has weakened over the past year, that in the first half of the year, they actually reported a surprise rise in operating profit, even with demand for a lot of raw materials depressed, in particular, because China is using less as their economy has slowed down.  

Interesting thing with Rio is there's another mining company called Glencore that revealed a few weeks ago that they were interested in buying Rio Tinto in the summer and Rio Tinto rebuffed them, said we're not interested in a merger, but what it tells you is that RIO has a very enviable position as a mining company looking forward.  

Again, at this point, the stock was about $53 when I wrote about it.  It's about $51 now, about a 3.6% dividend yield.  The idea here is not that there's a quick turnaround.  What you really need for the mining companies to do well-again, to do very well-is for the global economy to improve.  

Well, we don't know when that's going to happen but in the long run is Rio going to be around and is Rio going to be a player in mining, particularly iron ore?  More than likely, they are going to be, and the fact that Glencore is interested in them, I think, tells you that this is an interesting business.

Again, it's not something that people can count on a turnaround very quickly.  We know the global economy really needs to turn here and we're not seeing that yet.  Other than the US and Britain, most of the global economy has slowed down pretty significantly but as a long-term play, as a value play, I think Rio is quite an interesting name.

Steven Halpern:  Well, thank you so much.  We really appreciate you taking the time today.

Tom Petruno:  Thank you.

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