Nine For 2009 & Beyond

Author: Eric Uhlfelder

5 October 2009, Financial Advisor

Some of the strongest industry leaders are based outside our shores, and these foreign shares may offer among the most compelling long-term investments, writes Eric Uhlfelder.

Since the very dark days of early March, investors have started to believe again, sending major indices around the world soaring. According to MSCI, US shares have made up their disastrous first quarter start, when they had lost nearly one-quarter of their value, and are now ahead for the year by more than 19 percent through September 24.

But even more impressive performance has been found abroad over the same period. MSCI’s developed market index, EAFE, was up nearly 26 percent for the year in US dollar terms. Emerging markets soared by 63.8 percent. We think some of the best opportunities will be found abroad.

After surveying successful fund managers complemented with our own research, we have compiled a list of nine foreign well-run, industry leaders whose stocks should prove profitable over the long term.

HSBC is Gary Anderson’s favorite foreign bank. Anderson, who manages the Scout International Fund with $4.4 billion in assets and who has been outperforming EAFE by 3.34 percentage points annually over the past five years, has 1.66 percent in this London-based bank.
He likes the bank because of its superb management. Its loan-deposit ratio is a conservative 85 percent, and it was among the first bank to aggressively respond to the subprime crisis.

Anderson is keen on HSBC’s global diversity. In 2008, $21 billion in sales was generated in North America, $34 billion across Europe, $12 billion from Latin America, $11.6 billion from Asian emerging markets, and $12 billion from Hong Kong. This helps insulate the shares from variations in regional growth. But if the global economy freezes up again, Anderson admits will again be exposed, as virtually all other companies.

After losing nearly two-thirds from its 2007 peak of 93, HSBC was trading around $55 at the beginning of October, paying a 4 percent dividend.
Hennes & Mauritz, a.k.a. H&M, is best known for bringing cat-walk-like fashion to consumers at affordable prices. It is one of a handful of retailers who have successfully branched out of its home market, and is now in 37 countries across the globe. It has done so with efficient execution, according to Anderson, who explains the speed in which the company can execute the latest fashion trends.

This well-managed company maintains an outstanding balance sheet with no long-term debt, as well as attractively designed stores. Its revenue has grown at a 12-15 percent annual rate with a stable Return on Equity of 40 percent.

Anderson has 1.53 percent of his assets in the retailer, considering it one of his core holdings. His largest concern is if the world falls back into recession. But the company’s focus on affordable, fashionable designs for the younger consumers, focused on spending, may shield it during difficult times.

The ADR sold off from its December 2007 high of $12.29 to a low of $5.80 in November 2008. At the start of October, shares were trading around 11.
Staying in the realm of clothing, Li & Chung is a Hong Kong-based manufacturer for major retailers across the US and Europe, including JC Penny, Macy’s, Nordstrom, Saks, The Gap, Ann Taylor, and Abercrombie & Fitch. It’s one of Simon Hallet’s–the lead manager of Harding Loevner’s $287 million International Equity Fund–favorite plays.

Hallet, who has outperformed EAFE at annual pace of 3.22 percent over the past three years [and is also the firm’s CIO], says investing in such a successful outsourcing play is the safest way to maintain consumer discretionary exposure. “We see high quality management sustaining the firm’s global competitive advantage with industry leading growth and a strong balance sheet.” He adds that Li & Fung, whose market cap is $14 billion, is in fact growing and increasing its market share and profitability through what the company describes as the worst industry downturn it has experienced. First-half 2009 gross and net margins were right were they were before the recession started, exceeding 11 and 3 percent, respectively.

Its OTC-traded shares had peaked over just $4 in mid-2007. It then lost half its value over the following year. But by the end of September 2009, its stock was again brushing up against its previous high.

Hallet also likes the Brazilian energy concern Petroleo Brasileiro, which makes up 1.5 percent of the fund. Petrobras, as the firm is known, has a market cap of $166 billion, making it the fifth largest integrated oil and gas producer in the world.

Starting this year, the company is embarking on a $174 billion 5-year exploration and production that’s focused on the Pre-Salt Basins off the Atlantic coast. Discoveries promise to expand the firm’s proven reserves by at least 50 percent. And according to Craig Shaw, an analyst at Harding Loevner who tracks the company, subsequent finds will likely boast reserves by a lot more given that only one-third of the targeted off-shore region has actually been explored. “Current and future discoveries in the region,” says Shaw, “should ensure that this already well-run, solidly growing, and profitable energy concern, with historical return on investments running consistently above 20 percent, will remain a top industry performer.”

Since peaking in spring of 2008 at nearly $75, the company’s ADRs collapsed to under $15 by year’s end. They have since rallied three-fold, starting October at $45. And Simon believes that over the next year, the stock could rise an additional 30 percent.

In the aftermath of the worst credit crisis since the Depression, the most unexpected stock we came across is Experian, a UK-based credit information and analytical firm founded in 1980. With a market cap of $8.5 billion, the firm’s prime customers are banks, credit companies, and governments the world over. And Daniel OKeefe, coportfolio manager of the Artisan International Value Fund, makes Experian his top position, representing 5.0 percent of his $1.74 billion portfolio. With the fund having outperformed EAFE by an average of 5.56 percent per annum since its inception in September 2002, his commitment is a compelling statement.

He thinks the company’s focus and business model offers unique access to a key market that is shared globally by only one other meaningful competitor–Equifax. “But Experian is the clear leader,” says O’Keefe, “run by solid management that was able to grow the business during the recession.” Currently trading at roughly 11 times 2009 earnings, which is below projected growth rates, he thinks it’s a solid way to play economic and credit recovery.

The key risk is if the world slides back into a credit crisis. But O’Keefe believes the company’s essential data and services provide investors a buffer against a faltering recovery. However, that’s not certain.

After peaking at just over $13 in the summer of 2007, the ADR fell to $4.26 in October 2008. It has since doubled in value as of the end of September.
South Korean-basedLG Electronics is fast becoming a household name. It wasn’t always so. In having rebranded itself from a low-end to high-end manufacturer of electronics and home appliances, executing extremely well across multiple product lines, the stock, with a $14.4 billion market cap, has become one of David Gerstenhaber’s favorites.

Gerstenhaber manages a total of $550 million. His $65 million Argonaut Global Equities Partnership is one of the most consistently performing hedge funds around, generating annualized returns of 18.8 percent over the past five years versus MSCI’s World Index, which was up 0.49% per annum.

Gerstenhaber likes the stable, innovative, highly regarded management that has expanded sales beyond Asia with 31 percent of revenue coming from North America and 12 percent from Europe. He’s also attracted by a 2009 earnings multiple of 8.1 times current stock price–less than half the global consumer technology average while enjoying a projected return on equity of 21 percent that’s on the high end of the industry average. This has encouraged Gerstenhaber to invest 3.1 percent of his fund in LG shares.

“LG has been helped by the relative weakness of the South Korean won versus the startling strength of the yen, which has hurt Japanese exports,” says Gerstenhaber. A risk is if these currency trends reverse.

After reaching a high of nearly 160,000 Korean won [KrW] in spring 2008, the stock plummeted below 70,000 KrW in November 2008. It was trading at 110,000 KrW at the beginning of October 2009.

Madelynn Matlock, manager of the Huntington International Equity Fund, which has outperformed EAFE by 1.5 percent annually over the past five years, has 3 percent of her $313 million fund in Standard Charter. This UK-based bank may be one of the most direct and effective ways of gaining emerging market exposure, with 86 percent of revenues coming from Asia, the Middle East, and Africa.

It is widely regarded as one of the world’s best-run banks with 7 percent annualized profit growth over the past five years through 2008. Non-performing assets as of mid-year were less than 1 percent. In 2008, net profit margin was 23.79 percent and return on equity was 15.56 percent.

Over the past ten years through mid-September, the stock’s total annualized returns were 9.28 percent versus the FTSE All-Share Index of 1.86 percent.

“Standard Charter is a core position,” says Matlock, “with the only caveat being a return of the banking crisis that hit all banks hard, regardless of underlying performance.”
The stock hit a high in December 2007 of 1,728 pence, then collapsed to 554p in March 2009. It has since soared with emerging markets, starting October at 1,478 p.
Scout International Fund manager Gary Anderson has a core holding in the volatile airline industry. Held since 2003, Dublin-based Ryanair, with a market cap of $8.8 billion, is not your typical airline stock. Modeled precisely after Southwest Airline’s highly efficient model, Ryanair has become the European benchmark for low-cost air transport.

2008 was the first time the airline lost money due to soaring fuel prices. However, its aggressive expansionary strategy has propelled annual sales up 22 percent over the last five years with a return on equity of 17 percent. And Anderson believes Ryanair is very well positioned to significantly profit when economic stability returns to the continent.

Anderson’s biggest fear is a return to higher of higher oil prices. But this risk should be managed through the airline’s normally deft use of futures contracts, locking in today’s lower costs.

The airline’s ADRs peaked in November 2007 at $49. They steadily declined to a low of $17 in October 2008. A year later, they were trading above $29.
We conclude with a stock that, according to Morningstar, is scarcely owned by US mutual fund managers. However, it is a constituent of Morgan Stanley’s 20 for 2012–the best European franchises that appear to be dislocated from their fundamental valuations, with business models and market positions that will likely reward investors going forward.

Paris-based Veolia Environnementis one of the 20. Its roots date back 155 years. With 2008 revenue of $52 billion, it is a superb way to play the pent-up demand for water across the globe–among the most pressing issue facing governments in both developed and emerging markets for decades to come. It also provides waste management, energy, and transport-related services.

VE’s business model is based on long-term service contracts to improve infrastructure, ensuring transparency and assured returns on investment. This is in contrast to the huge expenses and uncertain politics associated with ownership of local resources.

Veolia’s ADRs collapsed by nearly 80 percent after peaking in late 2007 above $96 as profits more than halved to $592 million. After breaking below $21 in mid-March 2009, shares have started to recover, starting October at nearly $36. Net income is not likely to recover significantly this year.

Veolia has $8.7 billion in cash, and its market position is protected by limited competition and high barriers into this industry. But its fortunes are geared to the recovery of both the global economy and government budgets to finance expansion of essential services.


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