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Fund manager tips: European stocks for income

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Written by: Thomas Buckingham
03/12/2015
Selective stock picking is more critical than ever for income investors in European equities, because the most attractive stocks can be found outside of the traditional equity income sectors.

In our view, investors should avoid the traditional ‘bond proxy’ sectors such as beverage companies and pharmaceuticals, which look overbought and hence have less attractive dividend levels at this point in time.

However, in other defensive sectors such as telecommunications and utilities, there are still attractive opportunities to be found in sustainably high yielding stocks. Cyclical sectors such as financials (insurance, real estate, banks) and media also contain some of the most interesting investment ideas.

European automotive companies Daimler and Michelin are stocks that tick multiple boxes. Both are significant beneficiaries of weaker oil prices, which help to bring down the running costs on cars, making them more attractive to prospective buyers.  Both also have dollar linked revenues but a euro cost basis, helping them benefit from lower currency.  They should also be beneficiaries of rebounding European consumer confidence helping auto sales.

Whilst concerns over Chinese demand caused some weakness in the shares, this has largely abated, and the European car market remains robust and continues to offer support. Additionally, Daimler’s product cycle and Michelin’s market leading position in the manufacture of energy efficient tyres leave them well positioned to continue taking market share on a global basis.

Another attractive income pick is Orange, the French telecoms company. The potential for further consolidation in the French market has been seen as a positive for incumbents given the potential favourable impact on pricing. Additionally, the monetisation of data services, which for some time has been seen as a weakness in European telcos, is starting to come through as a positive, as evidenced by Orange’s better than expected third quarter results, and the subsequent increase in full year profit guidance.

An example of another interesting telecommunications company holding is Proximus (formerly Belgacom), Belgium’s largest telecommunications company.  The 4.7% dividend yield looks fundamentally sound and there is strong upside potential for the company based on the limited smartphone penetration in Belgium relative to other European countries.

Financial services are another fertile income hunting ground. The prospects for Intesa Sanpaolo, KBC, BNP Paribas and ING have looked strong for some time now. These companies have undergone major restructuring and now offer attractive dividend policies.

Equally, a large number of insurance companies continue to offer attractive dividend yields (as well as buybacks and special dividends in many cases), with underwriting returns having improved owing to efficiency drives, and the potential for increased investment returns becoming more apparent given the increasing market expectation of a December rate rise in the US. It is also interesting to note that attractive cashflow profiles in the insurance space has attracted material M&A activity, particularly in the UK, with Amlin, Catlin and Brit all being acquired in the last 12 months (all were held in the fund). Insurance companies that continue to look attractive to European income investors include NN Group, Lancashire Holdings and Munich Re.

For investors who are concentrating on the highest yielding portion of the European equities market, it is important to avoid yield traps. Fundamental analysis using criteria such as balance sheet strength and earnings momentum can help to determine whether optically high yielding stocks can realistically continue to pay attractive yields on an ongoing basis. Stocks which are expected to reduce their dividends should be avoided, as these companies tend to underperform the wider market.

Thomas Buckingham is European equities fund manager at JP Morgan Asset Management

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