While the recent melodramatic clashes between eurozone members have been horribly painful for its citizens, the economic churn has lifted quality companies to the top.
“Good businesses get stronger when there’s a problem. They do the right things to make the business grow and that gets rewarded in the share price,” says Dean Tenerelli, the pragmatic straight-talking European equity manager at T Rowe Price.
Whether he’s talking about Spanish media companies or UK burger chains, Mr Tenerelli refuses to allow his investment thesis to become mired in the macroeconomic maelstrom. Instead, he doggedly pursues bottom-up, value-based stock picking, guided by a stringent discounted free cashflow overlay.
“What most people do is take the free cashflow and forecast it out many years and then at the end of that period come up with a magical terminal growth number, usually 2-3 per cent,” he explains. “I put zero. I’m very strict on not paying for growth after a certain period.”
By taking such a conservative approach to stock valuations – only accounting for what he calls “visible growth” of the next couple of years – Mr Tenerelli says he has managed to override emotion-led rationales for avoiding certain stocks, instead allowing the quantitative analysis to lead him to stocks that he would otherwise be “scared to death to buy”.
Putting his two decades of investment experience to use, Mr Tenerelli has been vocally bullish on European banks, stating that within three years European banking stocks won’t be available below book value. While today sees depressed bank earnings, weak profit outlooks, regulatory upheaval and bad legacy assets, Mr Tenerelli says there are sound reasons for the tough times faced by banks. However, from rock bottom, with regulatory calm and strengthening global growth, the only way is up.
“Six months ago if you talked about recovery, people would have laughed at you,” he says. “It’s a stockpicker’s paradise when the market has sold them off and [banks] are just really, really cheap.”
The illiquidity that froze banks – the ‘credit crunch’ precursor to what became a full-blown global financial crisis – made a lasting impression on Mr Tenerelli. “This theme of absolute risk aversion and [subsequent] illiquidity repeats itself throughout time, in different instruments and in different situations in the world economy, but one thing is always the same: it’s a big problem,” he says somberly.
“Watching that unfold… I had never seen anything in my life that was [like that]… I found it really intellectually fascinating, and, very dangerous.”
Mr Tenerelli explains that a cashflow-focus is a useful “reality check” when markets display bubble characteristics, overheating and generating sky-high valuations on companies with little or no free cashflow. Moreover, it helps identify ‘cream of the crop’ companies with decent free cashflow and resilient business models but which are trading at low share prices.
He says: “Last year, my valuation measures showed so much upside that I was buying media companies in Spain and France during the third and fourth quarter when we expected the recession to be even worse the following year… Well all that stuff is up roughly 80 per cent this year. I was able to buy it because my focus was on valuation. They came out so ridiculously cheap that I had no choice but to buy it if I’m following my investment style.”
Mr Tenerelli is referring to Atresmedia Corp (formerly Antena 3, a 0.67 per cent holding), and Mediaset España, which is in the top-10 holdings for T Rowe Price European Equity (a Sicav) at 1.79 per cent of the portfolio. A media company reliant on advertising revenue that’s depleted 50 per cent and based in a country gripped by 55 per cent youth unemployment – Spain represents a third of the eurozone’s unemployed – may seem like a contrarian play, but these stocks benefit from the third plank of Mr Tenerelli’s investment approach: competitive advantage.
A consequence of the fall out from Spain’s struggling economy has been the closure of several media companies, as well as public/private rule changes that have effectively whittled the country’s key commercial broadcasters from approximately 10 companies to, well, just these two. As Mr Tenerelli says: “No matter how bad [macroeconomic] Spain is, if you’re L’Oréal and you want to advertise on Spanish TV, you’ve got two stations to go to” – both of which have decent balance sheets.
“If I hadn’t done my work with both the quality and the valuation, I wouldn’t have bought those stocks,” Mr Tenerelli says, “and that’s how you generate performance – and you do it when everyone else is panicking about dumping Spain because [they think] it’s going to leave the euro.”
Spain has featured so prominently in Mr Tenerelli’s media interviews about European stocks that he’s been noted to be ‘running with the Spanish bulls’ in market terms. He is clearly impressed by the Spanish authorities.
“I think Spain deserves all the credit in the world for doing a lot of things during this crisis: restructuring their banking system and doing reforms, although of course they can do more,” he says. “The structural measures that Spain has put in place are starting to manifest in increased exports and gains of competitiveness in the country, so I wasn’t investing in a country that was doing the wrong things; I was investing in a macro situation where the country was doing the right things.
“This led me to believe that at some point in the future it would get better, normalise, and in fact that’s what has happened: Spanish exports have gone up, they’ve gone into a current account surplus, which is a macro figure that shows you that they’re competitive, and now you’re starting to see better PMIs [purchasing managers’ indices].”
Be that as it may, no one – Mr Tenerelli included – thinks European countries, particularly those among the hardest hit, like Spain, will simply bounce back and revert to some pre-crisis ‘norm’ any time soon, if ever. There is still much work to be done and while Mr Tenerelli heaps praise on Angela Merkel – “I think she deserves a Nobel Prize for holding this thing together” – the pragmatist continues to see weak spots in Europe.
Greece, for example, is likely to require further EU funding and continues to have a “precarious regulatory framework in many industries”, he says. Noting, with a rueful chuckle, that he has lost money on Greek stocks, Mr Tenerelli says he continues to be “very sceptical” about the investment case for Greek equities. He has also been tentative about Italian stocks because, as he sees it, while “the Spanish were pushing through a lot of reforms, the Italians were dragging their feet and there’s a lot of political uncertainty”. That said, from a bottom-up perspective, there are some “very decent” Italian companies, which have continued to thrive during 50 years of chaotic government rule, he says.
It is perhaps through the lens of such tenacious companies that Mr Tenerelli rejects the notion that Europe is halfway through a so-called lost decade of economic growth. He points to Scandinavia, the Netherlands and Germany as being “tremendously competitive in the past decade” and suggests the reforms undertaken by countries such as Spain, France and Italy are at least tackling the structural economic problems they face, unlike the US.
Paraphrasing his hero, Angela Merkel, Mr Tenerelli says Europe accounts for a quarter of global GDP but has to finance 50 per cent of global social spending. “If we want to maintain that spend and our social system and be competitive in world markets, we have got to work like hell,” he says, “and that’s the reality, right?”