Each week a professional investor tells MoneyWeek where they’d put their money now. This week: Andrea Williams, manager af the Royal London European Income Trust.
Warren Buffett’s comment that “you only find out who is swimming naked when the tide goes out” is apt for the current market. As economic growth suffers a savage and rapid collapse, many firms will struggle as their top line comes under pressure. Their inability to cut costs quickly will put stress on balance sheets, forcing them to raise capital. Many are likely to go bust. The key to beating the market will be avoiding the failures and having minimal exposure to financial institutions that need large capital injections, as this will significantly dilute the value of existing shareholders’ stocks.
The current lack of bank lending will have severe consequences for economic growth and the financial position of firms, with growth in corporate defaults just beginning. Fund managers need to find firms whose business models can survive the slump and who will benefit from the demise of their rivals. So it is critical to focus on cash generation, debt positions and bank covenants (the Altman Z score can be a useful screen for companies at risk).
I believe Novo Nordisk (Copenhagen: NONB), the Danish pharmaceuticals group, can deliver consistent earnings and cash flow over the medium term. Its market-leading position in diabetes treatment and the predictable revenue streams this generates leave it well placed to weather the current storm and emerge in an even more dominant position. Similarly, Thales (Paris: HO), Finmeccanica (Milan: FNC) and Indra (Madrid: IDR) all benefit from exposure to long-term defence contracts and security spending and will continue to prosper. Their strong business models, well-defined revenue streams and low indebtedness will help them come through the recovery as winners.
Another challenge will be to avoid banks and insurers running low on capital due to the need to write-down financial instruments or the growing burden of non-performing loans depleting their profit base. But with financials still comprising 20% of the Europe ex-UK index, sensible risk-management measures dictate that funds hold some of these stocks. Of the spectrum of banks across Europe, the Irish, Spanish and Danish institutions are most at risk, with the Scandinavians and French less so. So far, inadequate country responses to the banking crisis have proved insufficient to restore confidence to the sector; further pain should be anticipated. Careful stock selection will be the key. For me, BNP Paribas (Paris: BNP), and Credit Suisse (Zurich: CSGN) offer the best prospects.
But it’s important not to be too gloomy; at some point rational behaviour will return. The oil price and other input costs have fallen steeply, fiscal measures will eventually boost the economy and falling interest rates will help consumer and corporate debts. These factors, along with eventual stability and confidence in the banking sector, will allow risk appetite to return. Perhaps the biggest challenge in this environment will be to identify firms whose valuations already discount the worst-case scenario and so offer value. The retail sector looks attractive. Hennes & Mauritz (Sweden: HMB) and Royal Ahold (Amsterdam: AH) offer opportunities over the medium term.
The stocks Andrea Williams likes
| 12-month high | 12-month low | Now | |
|---|---|---|---|
| Novo Nordisk | DKK352.50 | DKK246 | DKK315 |
| Thales | €43.62 | €27.52 | €33.76 |
| Finmeccanica | €20.34 | €8.51 | €12.00 |
| Indra | €18.92 | €12.90 | €15.59 |
| BNP Paribas | €73.00 | €20.66 | €26.42 |
| Credit Suisse | CHF63.15 | CHF21.56 | CHF29.06 |
| Royal Ahold | €10.02 | €6.58 | €9.17 |
| Hennes & Mauritz | SEK378.00 | SEK239.50 | SEK324.50 |