Written by Clime & StocksInValue Investment Team, International Research
In recent months macro indicators have weakened in Europe and European stocks have corrected by ~13% since April highs. Within certain sectors including automotives, industrials and luxury goods the pullbacks have been more severe.
But investors outside Europe should distinguish between broader economic and company-specific fundamentals. For example, the world’s largest brewery, Anheuser-Busch InBev, is listed in Belgium but its European income accounts for less than 30% of turnover.
The secret to investment success in Europe is identifying companies where investors have unduly punished companies for being based in a country where macro drivers are weak but the companies’ own positions are quite strong. Below we suggest some companies which could defy generally weak European economic conditions.

Aena SA, AENA.MC (View valuation)

Aena SA commands a national monopoly over air transport in Spain with its ownership of 46 airports and two heliports, assets which control virtually air traffic in the country. As owners of Sydney Airport can attest, airports are fantastic businesses due to their bargaining power with airline customers. In most cities airlines compete for landing slots at a single airport. In our view Aena is akin to a recoiled spring for three reasons.
First, Spain recently shifted to a dual-till regulation system, essentially deregulating the commercial activities. This is important as Aena’s commercial revenue is among the lowest in the world; just consider parking your car overnight in Madrid costs 20% of what it does in Sydney. Aena can now reprice its commercial contracts towards market rates, a theme driving recent results but one which has a long way to go.
Second is the economic recovery. While Spain has endured deep recession since the global financial crisis, green shoots are emerging which augurs well for increased discretionary spending on travel as employment recovers.
The third aspect is valuation. Relative to peers such as Sydney Airports, Aena is trading at a significant discount on a price to free cash flow basis.
To summarise, Aena has the potential to earn substantially higher profits over the medium term, a powerful driver of the share price if achieved.

Diageo PLC, DGE.L (View valuation)

Diageo is the British spirits juggernaut with market leading labels such as Johnnie Walker, Smirnoff, Tanqueray and Captain Morgan. In recent years, the conglomerate has established itself in emerging markets in Africa, India and Asia. One of its more notable developments was taking a controlling stake in the Indian based United Spirits, the second largest spirits company in the world by volume.
Europe has previously been one of the most consistent drivers of growth for Diageo throughout its rich history, and until recently its most profitable geographical segment. Since the economic slowdown of the GFC, Diageo Europe has been experiencing volume declines and margin compression, notably in its Smirnoff brand. However, the company still remains the largest premium spirits business in Western Europe by both volumes and profits. A return to growth for the European region, involving growing wages and falling unemployment, would allow for additional discretionary spending from consumers and provide Diageo a platform for a significant turnaround in the area.
Diageo’s most important geographies are Europe and the U.S., accounting for a combined 70% of profits yet only 37% of volumes.

Henderson Group PLC, HGGH.L (View valuation)

Henderson Group PLC (HGG) is a UK based global asset manager with a proven track record that spans decades. HGG has a substantial product suite that encompasses an array of global equities, fixed income, multi-asset and alternative products. In many ways the stars have swiftly aligned for HGG over the last year. Sound investment performance, accommodative monetary policy settings, substantial inflows of higher margin retail funds under management and thus the potential for operational leverage have all positively contributed to the investment case for HGG.
HGG’s recent results were impressive, with growth across all key metrics. First half pretax profit was up 29% to £117.4m, net inflows totalled £5.6bn and assets under management increased 10% to £82.1bn.

Roche AG, ROG.VX (View valuation)

Roche is the global leader in oncology therapies, driven by its hugely successful and clinically effective blockbuster drugs Avastin, MabThera/Rituxan and Herceptin. Roche’s strong drug portfolio, with 75% from biologics, is a buffer against generic competition.
Moreover the leading position in diagnostics enables the company to benefit from competitive advantages and synergies. The launch of new drugs to market, namely Perjeta and Kadcyla, will drive the expansion in Roche’s existing strong position in breast cancer beyond Herceptin.
The company has been developing a large number of biologics through phase III trials during the past few years in areas such as oncology, immunology, haematology and cancer immunotherapy. Roche’s immuno-oncology pipeline looks exciting to us with impressive data at ASCO 2015 and has the potential to catch the leader, Bristol-Myers Squibb. We see Roche as having a wide economic moat driven by its impressive portfolio of biologics, leading position in diagnostics and relatively inelastic demand for its leading oncology drugs. Moreover, we view Roche as one of the scientific leaders enabling it to develop and become a leader in many new and exciting therapies

Volkswagen AG, VOWG_p.DE (View valuation)

At the time of writing the German carmaker’s shares had fallen over 35% since the emissions test cheating scandal went into the public realm on 18 September. The US Environmental Protection Authority (EPA) alleges VW ‘cheated’ in emissions tests in the US by installing ‘defeat devices’ into diesel cars made during 2009-15. This is serious and VW’s premeditation suggests it will be treated more harshly than others who broke the EPA’s rules.
However it is unlikely VW will face the maximum theoretical fine of US$18bn. We have seen estimates of just US$2-3bn. VW shapes up as a deep value opportunity for investors with an appetite for risk, as the current share price assumes profit margins half the lowest recorded in the global financial crisis, no long-term growth and an impossibly high cost of capital. The price-earnings ratio has fallen to just over four, making VW cheap.
Clime Asset Management (Clime) owns DGE.L, HGGH.L, and ROG.VX on behalf of various mandates where it acts as an investment manager.

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