Value Investor Steps into Europe
07/15/2015 10:00 am EST
Despite near-term headwinds related to Greece, long-term value investor Matthew Castel—money manager for Logos LP—believes now is the time for investors to consider gaining exposure to select European markets and stocks.
Steven Halpern: Joining us today is Matthew Castel, value investing expert and money manager for Logos, LP. How are you doing today, Matthew?
Matthew Castel: I'm doing pretty well, Steven, just weathering this storm of uncertainty.
Steven Halpern: We've seen some incredible market volatility in Europe, in large part due to events in Greece. Before we look at the longer-term bullish case that you make, could you give our listeners a brief overview of the concerns facing European markets?
Matthew Castel: Absolutely, absolutely. So, a lot of the concern facing European markets right now are really the fact that as time passes without a deal, Greece is suffering not only from lack of funds to pay for public services and pensions, but its main industry, tourism, is also suffering, with a loss of more than 50,000 visitors in a week, and banks remain closed, as well as the stock market.
Greek banks are already requesting further liquidity from the ECB. Greece is also facing bankruptcies in the private sector, where most companies are small shops and small- to medium-sized enterprises suffering from a complete lack of credit, so where the fear and uncertainty stems from is because no one knows where things are going.
There is just complete—we're in unchartered territory—with analysts and pundits making different predications every day, so questions are circling around like, will the no vote and a possible Greek exit validate other fringe parties' aspirations around Europe, leading to further EU disintegration? Will this ongoing tension surrounding Greece change European public perception about EU membership? Will other nations want to get out because they're tired of paying for laggards like Greeks?
In any scenario, Greeks are facing a prolonged period of recession, and very likely, implementation of much harsher cuts then what they have voted against as the country moves to default and potential institutional implosion, so investors are worried about contagion.
What will the spillover effects be? These are the worries that are sending European markets into a bit of a tailspin right now.
Steven Halpern: Now, as a long-term investor, particularly as a value investing expert, you're willing to look past some of this, and in fact, you suggest that it may be time for prudent long-term investors to now consider gaining exposure to European equities. Could you walk us through the bullish cases?
Matthew Castel: Well, absolutely. So, at Logos, LP, we're certainly a value investing platform where we like to look for inefficiencies in the market, you know, mispricing of things and so we think that Europe is potentially one of those opportunities right now because we actually see, overall, improving European fundamentals.
We see a recovery of Europe's banking sector, coupled with increasing bank lending to companies. We also see encouraging signals from companies themselves. In fact, economic activity in the EuroZone grew at the fastest pace in four years in June, providing the latest sign that a recovery in the region is gaining traction.
Information from Markets Compensate/Flash Purchasing Managers Index actually rose to 54 from 53 in May boosted by momentum in Germany and France, the bloc's two largest economies. The data adds to the evidence that the ECB's massive stimulus program is taking effect and paints a brighter outlook for EuroZone activity.
Sales and profits have been improving and sales growth hasn't just been driven by a weaker euro. In fact, stronger organic growth linked to stronger underlying demand, we're seeing evidence of that. So, the second issue is that we think that we think that there is attractive European profit margin expansion relative to United States.
So, improving EuroZone profit margins relative to the United States where margin expansion seems to be slowing and we also believe that the Greek cotangent fear that I talked about before, well, we think it might be overstated because the economy in Greece is actually not very large. It's the size of the state of Georgia, in fact.
And if Greece were to descend into greater financial difficulty, its imports constitute roughly less than 1% of the total imports for its largest trading partners, which are Russia, Germany, Italy, Saudi Arabia, and China, and in addition, the bulk of Greek government risk has been removed from European balance sheets on to those of European governments and the ECB.
Furthermore, if Grexit causes any market deterioration in peripheral spread, we think the ECB's policy of whatever it takes would most likely lead it to intervene aggressively with further stimulus from its QE Program.
Steven Halpern: So, let's walk through a few individual investments that might benefit from a rebound or a brighter outlook in Europe and two well known firms that you point to are Anheuser Busch Inbev SA (BUD) and Unilever NV (UN). What's the outlook for these companies?
Matthew Castel: So, these are two companies that we have in our current portfolio which are classic consumer non-cyclical plays.
So, when it comes to Budweiser, this is a brewer that has one of the widest economic motes and is among the most efficient operators, so this is a company that has vast global scale and near monopoly dominance in several Latin American markets, which give AB Inbev a significant cost advantage even over the brewing giants like SAB Miller.
This plays out in the firm's excess returns on invested capital and best in class profitability with steady mid single average top line growth year over year.
So, here we're expecting enhanced profitability and enhanced growth by volume increasing in emerging markets. So, we think this is an attractive buy here because it's trading well below our intrinsic value estimate.
As for Unilever, this is another wide mote play, so we see strong fundamentals. Very high return on invested capital at 36%. Also, saw 12% growth top line last quarter.
It's got excellent management. Unilever's wide mote stems from its expansive global distribution platform and portfolio of essential products.
But despite these competitive advantages, the firm is still remaining on the offensive continuing to plow dollars into R&D and product innovation and Unilever's new products are winning with consumers as volumes are up.
We think that the company is currently undervalued here and the stock pays a nice dividend yield around 3% while the stock appreciates.
Steven Halpern: Now, you also have some specific recommendations for general country exposure and you like the prospects for both Ireland and Germany. Can you share your thoughts on these markets and highlight the respective ETFs that you recommend for investors seeking exposure there?
Matthew Castel: Definitely. Well, our first play, I think, has been a bit under the radar. We think that Ireland is a market that's particularly interesting.
The Dow Jones Ireland Index is actually up 37% in the past year and 24% year to date, because Ireland is set to remain the fastest growing economy in the European Union with growth of 3.5% predicted for 2015.
Ireland's trade links with the United States and heavy presence of multinationals in the country, we believe will continue to benefit the economy.
We see net exports continuing to grow in 2015 and 2016 in spite of slowing growth in the UK and other low growth in the Euro area. We also like Ireland because it's had an extremely smooth transition after the EU bailout.
So, the ETF we like here would be the iShares MSCI Ireland Cap Investable Market Index Fund (EIRL) on the New York Stock Exchange. This seeks to track the investment result of a broad-based index composed of Irish equities.
The other market that we like is Germany, of course. So, the falling euro due to QE is great news for German exporters. Germany is by far the biggest exporter in Europe and cars created by BMW, Volkswagen, and Daimler among the most visible examples of the success.
We also like the fact that a declining euro makes German products simply look cheaper to other countries and this should boost sales and earnings for German companies. So, the ETF we like here is the iShares Currency Hedged MSCI Germany ETF (HEWG).
This seeks to track the investment results of an index composed of large- and mid-cap German equities, while mitigating exposure to fluctuation between the value of the euro and the US dollar because we believe that going forward the euro is going to continue to go lower versus a strengthening dollar as a safe haven and also in light of a possible rate hike.
Steven Halpern: Now, on that same topic of currency hedges, and we only have a minute here, but you recommend a pair of hedge ETFs, the Deutsche X-trackers MSCI Europe Hedged Equity ETF (DBEU) and WisdomTree Europe Hedged Equity ETF (HEDJ). Could you briefly explain the benefits of a hedged portfolio and who would want to consider this?
Matthew Castel: Absolutely, so, I mean, these are just two ways to get broad exposure to Europe and so we believe that to do so in a hedged product is key in order to protect against the falling euro relative to a strengthening dollar.
By hedging, these foreign exchange risks are taken out of the equation, and therefore, the benefits from an appreciation in those individual stocks can be taken outside of any risks to the downside based on a depreciating euro.
Steven Halpern: Again, our guest is Matthew Castel of Logos, LP. Thank you so much for your insights today.
Matthew Castel: No problem.