Equities Blog

Europe’s Ugly Duckling Stocks Deserve More Love

14 February 2018

4 min read

Andrew Birse | Chief Investment Officer—European Value Equities and International Small Cap Equities

European stock markets are looking prettier in 2018 amid improving macroeconomic growth and easing political risk. Yet the continent’s equity ponds are still full of ugly ducklings—stocks that may not look attractive on the surface but have the potential to turn into swans.

Market conditions in Europe are encouraging as the year begins. The euro-area economy is expected to expand by more than 2% this year, according to consensus estimates, with recent data suggesting that growth could well be better. Companies in the MSCI Europe Index are poised to deliver double-digit earnings growth. Following the recent sell-off, European stocks trade at a price/forward earnings valuation of 14x—a discount of more than 15% to their US peers.

A Cautious Awakening

Even within European markets, stocks appear to be mispriced. There’s still a preference for low-beta stocks, which move less than the market over time and are considered less risky, over high-beta stocks, which move more than the market and are generally perceived as riskier. This can be seen in the very wide gap between the price/book ratios, a common measure of stock valuations, of these two groups of shares in Europe (Display), dwarfing the comparable spreads in other regions.

European Stock-Market Dislocations Look Extreme

Relative Price/Book Valuations of High- and Low-Beta Stocks (Percent)

Through December 31, 2017
Historical analysis does not guarantee future results. Historical information is provided for illustrative purposes only and subject to change.
US: price/book ratios of the highest and lowest quintiles of monthly beta within the AB US large-cap universe of stocks versus the universe average Developed Europe: price/book ratios of the highest and lowest quintiles of monthly beta within the AB European universe of stocks versus the universe average Emerging markets: price/book ratios of the highest and lowest quintiles of monthly beta within the AB emerging-market universe of stocks versus the universe average Japan: price/book ratios of the highest and lowest quintiles of monthly beta within the AB Japan universe of stocks versus the universe average
Source: Center for Research in Security Prices, MSCI, S&P Compustat, Thomson Reuters Datastream, Worldscope and AB

This feature of European markets may be a hangover from the euro-area debt crisis of 2010–2012. But in our view, it doesn’t reflect current reality, with the most potentially disruptive political risks coming from other parts of the world today. We believe that stock pickers can exploit the continued widespread mispricing of many European equities—by applying careful industry and company-level research to find candidates that are much healthier than widely believed. Our research aims to identify misunderstood or underappreciated companies, which we call ugly ducklings, across industries and countries with underestimated high-return potential.

Amer Sports: Identifying a Healthy Business

Amer Sports is a good example of how unappealing data can make a company look worse than it deserves. Shares of the Finnish sportswear company underperformed in 2017 as investors worried that weak inventory figures in the US might signal a deterioration in the popularity of its brands such as Wilson and Arc’teryx, which are stronger in North America than in Europe. We think investors are looking at Amer Sports through the wrong lens, lumping them together with US sports retailers who have been stuck with too much stock amid an onslaught from online rivals.

In fact, our research suggests that the data are misleading. Weak inventories don’t signal that Amer is losing market share, but rather are a symptom of the market’s transition toward more online sales, which has caused distortions in inventory. Our research indicates that the company has healthy cash flows, and we believe market inventories will ultimately stabilize to new normals that reflect the new online market reality.

CaixaBank: Tarnished by Location

Sometimes, stocks may look ugly simply because of the neighborhood they’re in. CaixaBank of Spain, for example, was tarnished last year because it’s based in Barcelona and was considered vulnerable to local turmoil related to Catalonia’s independence bid. Yet we think CaixaBank’s business is actually quite resilient—and it has little to do with local politics.

With the largest retail network in Spain, CaixaBank commands 18% of the country’s retail banking market. As Spain’s economy continues to recover from a prolonged economic slump, CaixaBank is seeing improvements in loan quality, funding costs and stabilizing margins. And, with a very strong position in the retail market, the bank benefits disproportionately from cross-selling financial services products such as insurance and investment funds to its customer network.

Airbus: Perpetually Misunderstood

The corporate transformation of Airbus is long behind it, yet the company still struggles to rebuild its reputation. Many investors still think Airbus suffers from weak corporate governance because it was run by four European governments before its ownership structure was changed in 2012. Shares of Airbus seem to be perpetually depressed, trading at a 20–30% discount to its main rival Boeing on simple earnings metrics, even though the two companies sell similar products to similar customers, with similar cash margins and are subject to similar market forces.

Why the extreme negativity? We think it has more to do with the product cycles than a fundamental weakness of Airbus. Airbus manufactures the A350 long-haul commercial aircraft, which competes with Boeing’s 787 Dreamliner product. Boeing is several years ahead of Airbus in its product cycle. That means Airbus is still spending heavily to build the jets, while pricing has yet to stabilize. These factors have suppressed Airbus’s cash flows dramatically when compared with Boeing’s. This could change as Airbus’s product cycle starts to catch up.

Finding Potential Swans

Companies that look superficially unattractive to investors aren’t always easy to identify. But appearances can be deceptive. Just as in the fairy tale, some unappealing stocks will eventually turn into swans, and investors who recognize them before they mature are likely to be rewarded over time.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams and are subject to revision over time. AllianceBernstein Limited is authorised and regulated by the Financial Conduct Authority in the United Kingdom.

About the Author

Andrew Birse

Andrew Birse was appointed Chief Investment Officer of European Value Equities in November 2022 after serving as portfolio manager of European Value Equities since March 2016. He has also served as Chief Investment Officer of International Small Cap Equities since 2021 and has managed the International Small Cap and European Small Cap Equities services since inception in 2014 and 2017, respectively. Prior to joining the firm as a research analyst in 2010, Birse spent seven years in the Corporate Finance Group at McKinsey & Company, working in the firm's London, Sydney and Auckland offices. He holds a BCom (honors) in finance and a BA in history and economics from the University of Auckland, and an MSc in economics and philosophy from the London School of Economics. Location: New Zealand

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