With newspapers full of Trump, Brexit and speculation about European politics – especially the upcoming French elections – it would be understandable if European investors opted to head for the hills. But US equity indices have continued to hit new highs and the party mood seems to have spilt over into Europe, even though no European politician is offering anything like the Trump agenda of tax cuts, deregulation and protectionism. Why the upbeat mood?
On the face of it, it is not clear why European markets are advancing ahead of elections that could, at best, confirm the shaky status quo and, at worst, threaten the future of the euro. A victory for Marine Le Pen would make Brexit look like a storm in a tea cup, given her stated desire to lead France out of the single currency. With instability in Italy and elections in the Netherlands and Germany, there is more political uncertainty in Europe than at any time since the Greek crisis.
Market pragmatism prevails
But markets are gently optimistic for a number of reasons. At the simplest level, people do not believe the French will vote Marine Le Pen into power in the second round of the French elections. Perhaps that is complacent; there are certainly deep-seated problems in France that politicians have failed to address, but the French appear to be tempted by Macron’s more positive agenda. On a more general note, investors remember that the Eurozone has shown remarkable resilience in previous crises. It has been better to buy than sell during these periods.
Another factor is economics. Slightly more optimistic signals have been coming out of the European economy since the middle of 2016. Construction activity, confidence indicators and unemployment are all heading in the right direction, even if the picture is patchy and some of the moves are tentative. The recovery in the price of oil has also given headline inflation a short-term boost, although underlying inflation remains steady. This boost has removed some of the jitters about the potential risk of deflation as well as encouraged talk of when the European Central Bank (ECB) will start to temper its bond buying scheme. This has provided a more positive backdrop for the banking sector, which has continued to rally since Trump’s arrival, although the progress of European banks has not been as dramatic as those in the US.
Undervalued… and underfoot
So perhaps, rather counter-intuitively, we have been looking at companies in France that might be undervalued because of the general anti-French, anti-euro mood. We have recently talked about French-based flooring group Tarkett, which is controlled by the Deconinck family. Flooring is much loved by Warren Buffet and private equity because a high proportion of the business operates around the replacement market – and it is much less cyclical than other areas of construction. In the case of Tarkett, the company is using part of its cash flows to consolidate the sector, using ideas from the car industry to squeeze out productivity gains year after year. In the three-month period between the end of November 2016 and 28 February 2017, a combination of strong results and improved prospects in Russia saw the stock rise by over 20 per cent.
How many Frenchmen does it take to change a lightbulb?
Changing French lightbulbs might be even less glamorous than flooring, but Spie is another French company that has built financial success from managing boring tasks, usually slightly more complicated than changing light bulbs. Spie also maintains information technology (IT) systems, air conditioning, security systems, electrical circuits, power stations and much more. It makes money by making sure its staff are busy and by getting its bills paid promptly. In the past, Spie’s cash flows were used to prop up a number of dreadful contracting companies, but after passing through the hands of a series of private equity owners, it is now listed separately and is developing a solid record of consistent delivery. Again, cash flow is partly used to consolidate what is a fragmented sector. The company’s attractive valuation was ignored until recently because of its exposure to … France. But a sizeable acquisition in Germany at the end of 2016 put a spotlight on Spie and its shares have risen 30 per cent over the same three-month period as Tarkett.
Allure of the big screen
Finally, we step over the border to French-speaking Belgium to view cinema operator Kinepolis. Cinemas, you might imagine, are on the way out, because of an ageing population and the temptations of Netflix. But over the past few years Kinepolis (again family controlled) has developed a reputation as one of Europe’s best cinema operators: best in the sense of combining a good viewing experience with solid financial returns to the owners. In a sector where many European cinemas are tatty and run by enthusiasts (or tatty and run by private equity), Kinepolis offers the rare combination of a skilled property developer and cinema operator, with a growing portfolio of some of the largest, most advanced multiplex cinemas.
The company delivers a high return on capital because of its ability to develop new projects to budget, while controlling day-to-day operating costs. It is famous for not wasting popcorn. It counters changing demographics by using social media and emails to drum up customers. More recently, Kinepolis has expanded beyond Belgium, buying up existing, undermanaged cinemas for relatively modest prices in France, the Netherlands and Spain, often doubling profits within 18 months. There are still plenty of family-owned cinemas in Europe that are struggling to keep up with internet booking software, promotions on social media and higher expectations of comfort and cinema quality and who may be happy to sell to our Belgian friends rather than private equity.
Business models that can survive and thrive
Like flooring and property services, cinemas are a business that is pretty resilient whatever is going on in politics and the rest of the world. These are the kinds of businesses you expect to be around for many years to come, so we are focussed on similar types of companies in these uncertain times. The cinema business has been unusually exciting in recent months because Chinese investment company Dalian Wanda has started to assemble a global portfolio of cinemas, paying high prices for cinema chains in the US (AMC), Europe (Odeon) and most recently the Nordics. No one really knows what Dalian is up to or who it might buy next.
The stock examples here are intended for illustrative purposes only and are not indicative of the historical or future performance, or the chances of success, of any particular strategy. Henderson Global Investors, one of its affiliated advisors, or its employees, may have a position in the securities mentioned in this article. References made to these securities should not constitute or form part of any offer of solicitation to issue, sell, subscribe or purchase the security.