European Equities: Finding Value in the New Year

Philippe Brugere-Trelat
Executive Vice President and Portfolio Manager
Mutual Series

Last year's rebound in European equities was not driven by a single event but rather by a sequence of factors. Early in 2009, evidence of the banking system's mere survival was enough to halt market declines and reverse their course. Capital raisings by many large financial institutions enabled them to absorb legacy losses, avoid distressed asset sales and generate new business at attractive spreads.

We also noticed in late 2008 and early 2009 that many European companies were aggressive in taking cost-cutting measures as the crisis intensified—such as reducing staff, managing the supply chain and trimming inventory—instead of passively waiting for better times. As a result, they protected their operating margins and may be well-positioned, in our view, when the recovery strengthens. That being said, we think that it will take a few more quarters for the top line, or sales, to grow substantially because end demand has not yet fully materialized.

We believe that to be a successful value investor, one must be contrarian to some degree and diligent in doing homework looking at sectors and industries that many investors avoid because they are not considered fashionable. Our investment criteria also include seeking companies in economically defensive industries with strong market positions, high barriers to entry and reasonably predictable earnings and cash flow.

So far in 2010, we are finding value in companies such as A.P. Moller—Maersk, a Danish company engaged in marine transportation, oil production and shipbuilding. Maersk was probably one of the most unpopular European stocks in 2009 due to concerns about global trade and the impact on container shipping, which is a significant portion of its revenues. We still think there is considerable upside appreciation potential for Maersk's share price, even after a sharp rise in January.

A primary driver for my thesis is that shipping rates have risen significantly since the beginning of 2009 and that Maersk is one of the lowest cost operators. So, when other firms are still losing money and may need to be careful about overcapacity, Maersk appears to us to be already at breakeven. It seems highly likely, in our opinion, that Maersk may record a small operating profit in their container shipping division in the near future even though analyst expectations have been quite to the contrary.

We are also finding value in the shares of German automaker Daimler. We think that people are focusing too much on its Mercedes division. Management has already disclosed that fourth quarter sales are expected to come in at 8% higher than the third quarter. However, I think many people have overlooked management's restructuring of the truck division, which is the world's largest truck manufacturer. Management has decided to improve the division's profitability, which declined after the company failed to properly integrate acquisitions of other truck companies. I think if Daimler's management can return the truck division to operating margins in the low teens, perhaps 10% to 12%, the company may see a meaningful amount of incremental earnings flowing down to its bottom line.

As investors, we will wait patiently to see if the Daimler restructuring is successful. Usually our investment time horizon is 18 to 24 months, but we like to see management meet milestones along the way. And we normally like to keep in touch with management to monitor the steps they are taking. Mutual Series celebrated its 60th anniversary in 2009—a milestone we could not have achieved without being patient investors.

Please click for more information on the following funds:
FTIF - Franklin Mutual Euroland Fund
FTIF - Franklin Mutual Beacon Fund
FTIF - Franklin Mutual Global Discovery Fund