You know you're in trouble when you get dissed by spectacularly ineffective U.S Treasury Secretary John Snow. But that's exactly what happened to the 25-country European Union last week. Sounds like a buy signal to me. The news has been so bad for Europe in the last two weeks that I think this is a good time for contrarian U.S. investors to pick up a European equity or two. Snow's lecture added insult to what has been, by anybody's count, an extremely tough three weeks for Europe. On May 29, the French soundly rejected a new constitution for the European Union. Days later, Dutch voters followed suit. The euro, which has been weak against the dollar, kept on falling on that news, hitting a nine-month low at $1.2018 on June 15. Governments in France, Italy and Germany teetered, and pundits now expect Germany's Gerhard Schroeder to go down to defeat this fall. On June 17, the European Central Bank added fuel to the euro fire when Vice President Lucas Papademos worried that diverging economic performance inside the eurozone was a threat to the monetary union. And the sight of Europe's leaders squabbling amongst themselves at the European Union's budget summit in Brussels, with no budget agreement emerging from the meeting, has rattled nerves further. (For more detail on turmoil in the eurozone, see my recent column "
Thank Europe for a Stronger Dollar .") But all this hasn't kept Europe's stock markets from hitting new highs. In fact, all this seeming chaos may actually be fueling the advance. A weaker euro, for a start, means that the products of eurozone companies sell for less in dollars. That's a big boost to exports for export-driven economies, such as Germany's.
Rate Cuts and Election HopesThe political dissension has led the European Central Bank to finally admit that it is at least willing to consider the possibility of an interest-rate cut. European economic growth is just barely positive; the European Central Bank forecasts just 1.4% growth for 2005. Unemployment is at an official 10.2% in the key French economy, and stands at nearly 25% among workers under 25. That makes the bank's insistence on keeping rates at 2% to fight inflation less and less tenable -- especially since even the bank admits that inflation is running below its target rate. And even the political turmoil has an upside. German investors, for example, believe that a switch from Schroeder to Angela Merkel, the likely winner in a late-September contest for chancellor, would produce a more conservative government willing to push reforms in the labor market, reduce regulation and overhaul the tax system. Even if those hopes are dashed once an actual government is in place, right now they're enough to fuel the markets. Germany's Xetra DAX Index is up 7.6% this year, as of the close on June 16. France's CAC 40 Index is up 9.53%. The Dow Jones Euro Stoxx 600 Index is up 9.76%. Even the United Kingdom's FTSE 100 Index, while lagging its eurozone counterparts, is up 4.79% for the year to date. Not at all shabby when you remember that the Dow Jones Industrial Average is down 1.9% for the same period.
Three Themes to WatchTechnically, all these markets look set to run higher, with charts that look much stronger than their U.S. counterparts, concludes Prudential Equity Group. The German market looks especially attractive, because the economy is especially sensitive to exports -- exports accounted for about 21% of Germany's gross domestic product in 2002 -- and corporate profits in Germany stand to get a big boost from the weak euro.
That said, there are sectors in the European markets and some European stocks that look fully valued after their rally this year. Roche Holdings (RHHBY), for example, is up 9.84% in 2005 and 17.2% in the last three months. The Swiss drugmaker certainly looks fully priced now in comparison with a U.S. drug stock such as Pfizer ( PFE). If you want to find European stocks that aren't fully valued and that still have good runs ahead of them, I suggest following these three names and themes.
Weak Euro Boosts German ExportsHeidelberger Druckmaschinen (HBGRF) is the world's No. 1 maker of printing machines, with a market share about three times that of its nearest competitor. In fiscal 2003 and 2004, the company fell into the red as demand for printing machines experienced a cyclical low that drove down prices. But in fiscal 2005, which ended in March 2005, Heidelberger Druckmaschinen showed an operating profit of 167 million euros and a net profit of 61 million euros, thanks to cost-cutting and divestiture of struggling web-press and digital units. (The fiscal 2004 loss had come to 695 million euros.) The stock retreated in the beginning of June as German investors decided that the company's forecast that it would top fiscal 2005 profit in fiscal 2006 was disappointing, since the consensus estimate already called for earnings before interest and taxes of 290 million euros. I think that has created a good entry point in the shares. Net margin on sales, before interest and taxes, will climb to 10% in fiscal 2007 from 5% in fiscal 2005, thanks to another 50 million euros in cost-cutting this year. With a weak euro boosting sales, I think there's a good chance for an upside surprise on both revenue and earnings. The company also will take a big step to reducing future costs this year when it opens its first plant in China. The Shanghai plant, which should start production next year, also moves the company closer to customers in its fastest-growing market. Sales in Asia made up 25% of the company's business in fiscal 2005.
Weak Euro Boosts Plans to Go GlobalRenault's (RNSDF) goal is no longer simply beating rival Peugeot Citroen for the top spot among French carmakers. Renault is now among the top-six global car companies, thanks to its alliance/cross-ownership/joint top management with Japan's Nissan Motor ( NSANY) and moves into Latin America, South Korea and Eastern Europe. Renault owns 44% of Nissan, 20% of Volvo and 70% of Korea's Samsung Motors. In April 2005, Renault named Carlos Ghosn, the Renault veteran who led the turnaround at Nissan, as CEO of Renault. (Ghosn will continue his position at Nissan.) All this gives Renault a strong base in Asia, where Korea is the second-biggest car market. Add in an acquisition of Romanian car company Dacia that gave Renault a platform for sales in Eastern Europe, and manufacturing plants in Brazil, Argentina and Turkey, and you can see the outlines of the company's global strategy to tap high-growth markets. But like U.S. car companies, Renault faces two major challenges: rising costs at home and a global flood of cheaper cars. Globalization has been Renault's answer to both these challenges. Remarkably, Renault has been relatively successful in cutting costs in France, partly as a result of the increased freedom of operation that resulted when the French government reduced its ownership in the company. But even that cost-cutting hasn't been enough to keep margins from slipping in France. The fall of the euro against the dollar will help with the cost problem in the short run and is likely to increase margins, but the long-run solution requires expanding production overseas. Renault's strategy there is to develop low-cost cars for overseas markets and manufacture them in those markets. Renault launched the first vehicle in this effort, the Logan, this year. The car, to be manufactured in Romania by Dacia, is intended for sale in Russia, Eastern Europe and Latin America. The car shares some parts of older Renault models, so the weaker euro will help even this part of Renault's strategy.
Tide Shifts to Less RegulationThe utilities sector is one of the most potentially profitable ways to play the shift in Europe's politics that is likely to follow from the rejection of the European Union's proposed constitution. RWE (RWEOY) is one of Germany's top two suppliers of electricity, but the company's reach no longer stops at that country's borders. RWE owns utilities in the U.K., including RWE Thames Water, the third-largest water provider in the world. The company also acquired American Water Works in the U.S. It also sells electricity, water and gas in Eastern Europe. All in all, the company provides electricity to 21 million customers, water to 70 million customers and gas to 11 million customers, and it disposes of waste for 20 million customers. (It also owns a 50% stake in Heidelberger Druckmaschinen, which it plans to sell.) Utility deregulation forced this reinvention of what was a rather traditional utility, and the company hasn't done badly under the new regime: The consensus analyst forecast calls for earnings to climb almost 9% in the fiscal year that ends in March 2006. The ADR, or American Depositary Receipt, now trades near its 52-week high, but I think it could go higher as Germany moves closer to a September election. The thinking is that a new government led by the Christian Democratic Union -- which now has a 20-point lead in the polls over the Social Democratic Party (which now holds power in Berlin in coalition with the Green Party) -- would be more receptive to utility arguments for a change in government regulations to extend the life of nuclear power plants to 40 years from the current 32 years. That would push off costly decommissioning charges and could add almost 10% to the price of the shares. Even at a 52-week high, RWE trades at a relatively modest 13.5 times earnings for the fiscal year that ended in March 2005. The company recently increased its dividend by 20%; the yield is now 3.5%. And the company has stated that its goal is to raise the dividend another 15% next year. With this column, I'm adding the shares to Jubak's Picks.
I know it can be daunting to invest in overseas equities -- it's tough to find information, for one thing. But don't let that stop you from giving your portfolio a dash of Europe. You can use an ETF, or exchange-traded fund, to buy a basket of European stocks, and these baskets have done well this year: BLDRS Europe 100 ADR ( ADRU), for example, is up 14.9% in the last 52 weeks.