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Richard Troue: Henderson European Special Situations continues to find value in Europe

Despite the strong returns of European equities in 2013, fund manager Richard Pease says many well run, cash generative companies continue to offer value.

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Looking at Europe today it is easy to forget that as recently as 2011 headlines such as Greek Tragedy and Acropolis Now were common as the debt crisis in Greece took centre stage. In the depths of the Greek crisis, just as during the worst of the global financial crisis in 2008 / 2009, shares in European companies looked attractively valued. As is so often the case the point of maximum pessimism proved the best buying opportunity.

Despair turned to relief in summer 2012 and stock markets embarked upon a strong run when Mario Draghi promised to do “whatever it takes” to save the euro. Timing investments to coincide with such turning points is notoriously difficult, if not impossible. Many investors will have missed the bottom and after a strong 18-month period might be concerned the best gains have passed.

It is true the valuation argument is no longer as compelling and shares are not as cheap as they were but nor are valuations excessive. Europe offers a gateway to opportunities in both developed and emerging markets. Businesses with strong brands or a leading position in a niche market have the potential for sustained earnings growth throughout 2014 and beyond.

Amid the political and economic turmoil of recent years it has been easy to forget Europe houses many globally successful companies with strong cash flow, recurring revenues, and the ability to increases prices without affecting demand for their products and services. Such companies, despite not appearing particularly exciting at first glance, often have more secure profit margins and are well-positioned for long-term growth.

It might be difficult to find absolute bargains in Europe but this doesn’t worry Richard Pease, manager of Henderson European Special Situations, to a great degree. For him it is business as usual; investing in well-managed companies dominating their niche area and selling high-quality products into overseas markets.

Richard Pease looks for companies whose growth is driven by long-term trends and where a high proportion of revenues are recurring. Elevator and escalator manufacturers, such as Kone and Schindler, of Finland and Switzerland respectively, are examples. They can benefit from urbanisation and construction booms in emerging markets and a high proportion of revenue comes from the provision of maintenance services for previously installed lifts and escalators.

Companies supplying products which are highly important to the customer but where the cost forms a small part of the overall price of goods are also favoured. A good example is the flavours and fragrances industry, where products made by Germany’s Symrise and Givaudan in Switzerland, for example, are positively perceived by their customers, yet cost a fraction of their sale price to manufacture. Companies like Symrise and Givaudan, as well as Irish food ingredients manufacturer Kerry Group, are ultimately able to pass on cost increases as companies are reluctant to use alternatives for fear of altering the flavour or smell of their products.

Richard Pease aims to avoid companies overly reliant on the vagaries of the economic cycle or which are burdened by too much debt. He also sees little opportunity in highly regulated consumer utilities (e.g. telecommunications, waste and energy utilities). This is an area where government involvement is particularly important, given their ability to control returns through regulation and taxation, and where management team remuneration is often not sufficiently tied to share price performance.

The portfolio generally contains in the region of 60 stocks, including some higher risk smaller and medium-sized businesses. Presently, just over half the fund is invested in businesses with a market capitalisation less than €5bn.

The fund was launched in October 2009 and so far performance has been impressive with the fund growing by 65 per cent compared with 39 per cent for the average fund in the sector.

Over the past year performance has been slightly weaker than Richard Pease hoped. Less exposure to banks and more economically sensitive companies, as well as those listed in Southern Europe didn’t help as these areas performed strongly.  However, he prefers to focus on more resilient businesses and does not believe the potential rewards are significant enough to justify investing in poor businesses.

Following the strong run of the past 18 months the easy stock market gains have arguably been made. Looking ahead I believe a more discerning approach could be necessary and Richard Pease’s focus on high quality businesses at reasonable valuations could serve investors well over the long term.

Richard Troue is an Investment Analyst at Hargreaves Lansdown

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