European stocks are cheap, according to a value investor Oliver Kelton. He told the Morningstar Investment Conference this week that European stocks are trading at a 30% discount to previous market peaks, but warned that not all sectors offer compelling value opportunities.
Telecoms stocks are where Kelton sees the real value opportunity in Europe, as changes are taking place within the sector.
“The European telecoms sector trading at a 45% discount when compared to the US. I also believe we are now at a junction of change, because of the regulation change. That is a re-pricing opportunity,” said Kelton, partner and portfolio manager at Odey Investment Management.
As a result, 5% of Kelton’s fund is invested in the telecoms sector. French telecoms stock Orange (ORA) is the biggest position in his portfolio. Kelton manages the Odey European Focus fund, which has a Bronze Rating from Morningstar analysts.
“Orange’s earnings per share are about 60% below their previous peaks, as the company suffered from a decade of deflation across the sector. There are signs that we are at the end of this now. As a result, we have started to see a stabilisation in Orange’s earnings. From my perspective, there is a huge re-pricing taking place in this company under a rising interest rate environment,” said Kelton.
Allan Nichols, Morningstar senior equity analyst says that Orange is one of the leading beneficiaries of some of the biggest macroeconomic movements in European communications: convergence, 4G, and fibre deployment. This is because the convergence can lead to lower churn and more-valuable customers.
“Orange is also pushing its converged service into the rest of its European footprint and is enhancing its wireless footprint in Africa. Orange has operations in 20 African countries, positioning it well to participate in one of the fastest-growing regions in the world,” said Nichols.
Vincent Durel, portfolio manager of European equities at Fidelity commented previously on Emmanuel Macron’s win in France’s presidential election that French company earnings could receive a 10% boost from it, of which the telecom sector could also see renewed consolidation.
Music Industry Back from the Grave
Another sector that Kelton sees value opportunities in music streaming companies. The music industry lost 50% of revenues from 1999 to 2014, thanks to the rise of social media channels such as Youtube, leading to a dramatic fall of values in the sector.
“The good news is finally something starting to change. A new model has emerged in the music industry – streaming, and it has brought this industry back from the grave over the last two years. Interestingly it seems to be accelerating. Music streaming growth was 58% in 2016,” said Kelton.
Neil Macker, Morningstar equity analyst says the company’s revenues benefit from the growth in streaming music, offsetting the ongoing decline in physical media sales. However, Macker notes a sustainable model for streaming music has yet to be discovered.
“While Spotify has 30 million paying users, the company continues to rely on debt to fund growth. Consumers are still consuming music at high rates but seem unwilling to pay more than a minimal fee for unlimited streaming. Apple may be able to sustain losses on its streaming platform but the standalone players will likely need lower royalty rates to survive,” said Macker.
Tesco Put its Problems in the Past
“New management came in in 2014 to turn the company around. We finally decided to take position back in 2015 – really based on the fact that this company’s profitability is back to in line with its peers, and you can see a huge opportunity in valuation,” said Kelton.
Underweight Financial Stocks in Europe
Not all stocks in Europe look attractive to Kelton; particularly not the financial sector.
“We have not been investing in financials for many years. We believe that the zero interest rate policy in Europe is disrupting revenues and building unprecedented credit risk, which people have not been thinking about,” said Kelton.
The Dangers of Quantitative Easing
Kelton also believes there is a massive bubble in ‘safe equities’, which he considers to be growth stocks and mid-cap stocks.
“Money has to be allocated into Europe despite the fact that we have been through Eurozone crisis. There is a tendency for investors to go into the same fund and the same equity with similar performance. That’s a big issue,” he warned.
“Particularly in Europe, but also globally, quantitative easing has massively misallocated capital. As a result, many industries are growing extremely fast at the moment of time. But that growth is becoming increasingly sensitive to rates, in areas like construction, autos and aeroplanes. These industries, from my perspective, have a massive fall of demands taken place.”
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