| BUSINESSWEEK ONLINE : JUNE 26, 2000 ISSUE | ||||||||
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| COVER STORY
The Continent Regains Its Allure Mergers are up, so is productivity, and inflation is tamed The Old World is back in favor with investors, and with good reason. Euro zone growth could reach 4% this year, inflation is under control, productivity is rising, and the sickly euro is on the mend. What's more, Europe Inc. is being transformed by an unprecedented wave of restructuring that will boost corporate profits and enhance shareholder value. Analysts expect European companies to earn an average pretax return on capital of 22.4% next year, up from an estimated 19.4% this year. ''It makes us very bullish on European equities,'' says Richard Reid, who is chief European economist at Donaldson, Lufkin & Jenrette Securities Corp. in London. For all that, investors still have to grapple with a complicated global economic environment. Growth in Europe may now be robust enough to survive the European Central Bank's June 8 interest rate hike of 50 basis points. But the world economy is starting to slow: Economists predict that global growth will peak at 4.5% this year and slip to 3.9% in 2001. And that could eventually hit the sales and earnings of international companies. Meanwhile, some sectors, such as retail, are being ravaged by deflation; others, such as financial services, are being transformed by the Internet. That's why many investment gurus are looking for companies that are likely to grow even as the global economy cools. ''I'm suspicious of cyclical investments,'' says Pascal Constantini, global equity strategist at Germany's Deutsche Bank. ''This is a time to go for growth.'' DEFENSE. European telecom, media, and technology stocks still have a lot of mileage left, say analysts. ''We'll continue to see a huge increase in mobile [phone] penetration,'' says Dhaval Joshi, global strategist at French bank Societe Generale. ''That's particularly good news for equipment suppliers because they aren't affected by the price deflation that is hitting operating companies.'' Swedish phone manufacturer Ericsson (ERICY) is a favorite for this reason. What's more, Ericsson's stock was trading at $22.65 a share on June 9, well below its $26.45 peak in early March. Other good bets include Finland's cell-phone maker Nokia Group (NOK), trading at $58.12 a share on June 9 compared with its April peak of $62.31, and Germany's Siemens (SMAWY), currently down 11% from its late February high of $185.58 a share. Nokia will benefit from its concentration on the mobile-phone business, while Siemens will reap the rewards of recent extensive restructuring. Other, more traditional havens in a slowing global economy are pharmaceuticals, food products, and utilities. Pharmaceuticals are attractive because they are not as exposed to regulation as utilities. Besides, unlike food and drink manufacturers, drug companies still have pricing power. At the top of many analysts' lists are Britain's Glaxo Welcome PLC (GLX) and Switzerland's Novartis (NVTSY), which are benefiting from strong global demand. Yet both are reasonably valued, with price-earnings ratios of 35.2 and 24.6, respectively. That's way below the 67.4 p-e of rival Aventis (AVE), a Franco-German life sciences group. Of course, there are some bright spots even in sectors where ferocious competition is eroding earnings or where the Net has turned the traditional way of doing business on its head. The secret, says DLJ's Reid, is to look for companies that can cut costs through good management, by harnessing new technology, or by merging. That's particularly true in retailing, where pressure on prices is rising and profit margins are falling. French retailer Carrefour, for example, is using its massive buying clout to force suppliers to lower prices--by about 5% over the past year, say analysts. With a p-e of 67.5, Carrefour may look expensive, but strategists reckon its shares still could rise. Old Economy stalwarts that are embracing New Economy techniques have their fans, too. David Thwaites, a strategist with French bank BNP Paribas, likes Britain's Barclays Bank and Spain's Banco Bilbao Vizcaya Argentaria. Barclays is well ahead of its competitors in shifting customers to the Web, which reduces costs. And it looks undervalued, with a p-e of just 13.8. BBVA is building up an online banking and e-commerce powerhouse through a joint venture with Terra Networks (TRRA), the Internet subsidiary of telecom giant Telefonica. Yet BBVA's p-e of 32.2 looks cheap compared with Banco Santander Central Hispano, which has a p-e of 41.5. Food giants Nestle of Switzerland and France's Groupe Danone are also cutting costs and boosting profits by buying more of their raw materials over the Net. Plus, their shares are undervalued, with p-e ratios of 26.7 and 28.9 respectively. JUNK FINANCING. It may be tempting to try to ride Europe's mergers-and-acquisitions wave. Many companies are flush with cash and need to merge or restructure to gain economies of scale to compete in a newly unified Europe. But it's not easy to spot the deals that are likely to work. ''Companies that want to merge are often like two drunks trying to keep each other standing,'' says Savvas Savouri, head of quantitative economics at Germany's Commerzbank. ''They often don't benefit all that much from getting together.'' There are exceptions, of course. The Anglo-Dutch Unilever Group's $20.3 billion acquisition of U.S. foodmaker Bestfoods on June 6 is one. Unilever paid for Bestfoods with cash, which would otherwise have weighed heavily on its balance sheet, since cash generates very little return. The merger should help Unilever boost pretax profits from its current target of 15% to 17%. Analysts also think the merger may lead to wholesale restructuring at Unilever. That, in turn, should boost the company's share price from $6.54 on June 9 to as much as $8 by the end of the year. An effective way to play Europe's M&A binge, says SG's Joshi, may be to buy shares of banks that do a lot of M&A deals. U.S. investment houses, such as Goldman, Sachs & Co. (GS) and Morgan Stanley Dean Witter (MWD), still dominate European dealmaking. But Deutsche Bank (DBK), for example, is finally making inroads into the M&A area and is underwriting high-yield debt, an increasingly popular way to finance acquisitions. Its p-e ratio, now 17.2, should increase by as much as 25% in a year's time. Of course, the biggest wave in Europe now is the merging of the Old and New Economies. Companies with a solid footing in both may do best in this fast-changing environment. And that will be true even if the global economy slows. By DAVID FAIRLAMB _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP |
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