Source: ODDO BHF AM

In this new monthly METROPOLE Gestion Fund Insight, we will address the new investment opportunities that have emerged following the sharp falls experienced by a number of so-called Growth stocks. This allows us to illustrate our approach to identifying discounted stocks froman Industrial Value perspective.

SOME UNDERVALUED OPPORTUNITIES AFTER THE SHARP FALL IN “GROWTH” STOCKS

The sharp decline in long-term interest rates from 2014 onwards triggered an unprecedented inflation of valuation multiples on some segments of European equity markets. The less cyclical sectors or those offering promising growth prospects, i.e. those lending themselves well to discounted cash flow (DCF) valuation, did particularly well during this move. Over recent years, a number of stocks saw their valuation multiples rocket simply on the impact of the falling discount rates used. These multiples hit their dizziest heights, often unsupported by the fundamentals of the companies concerned, just as the Covid crisis broke out.

Like so many long duration assets, however, this segment of the market, heavily represented in the “Growth” indices, has suffered disproportionately since the beginning of the year, against a background of returning inflation and a sharp rise in long-term interest rates. The P/E ratio for the MSCI Europe Growth index, for example, has dropped from 26x at the beginning of the year to 20x at end May. This is a noteworthy downturn, but only to a certain level as this still represents 125% of the long-term average for this index. Though the vast majority of companies in the segment have not yet pared back their inflated valuation, some are beginning to display attractive discounts.

ADOPTING AN INDUSTRIAL VALUATION APPROACH OPENS UP AN UNTAPPED POOL OF INVESTMENT OPPORTUNITIES

It would be a mistake to evaluate the investment opportunities for a “Value” style manager solely on the basis of the valuation criteria used in constructing “Value” indices. Our approach, based on an industrial valuation of companies, opens up a much wider spectrum that sometimes leads us to invest inwhat are traditionally seen as “Growth” stocks. Our view is that no company is structurally definable as either a “Growth” or a “Value” stock. Any company, throughout its market history, can find itself falling into one or the other of these categories.

LUXURY SECTOR STOCKS OFFER A GOOD CASE IN POINT

The Luxury sector is considered, by its very nature, as strongly associated with Growth, and luxury goods firms tend not to be seen as potential investment opportunities for Value managers.

While it has to be said that such opportunities have been few and far between in recent decades, they have not been completely absent: in 2008, for example, at the time of the financial crisis, or in 2014 when China introduced anti-corruption measures. Such blips in no way call into question the structural profitability of the luxury groups but, by raising fears of a slowdown in business, they did help to wipe out the growth premiums such groups had previously enjoyed. The lock-downs imposed in China in recent months in response to new waves of Covid and, more recently, fears of a global recession, have had similar effects on valuations in the sector and are opening up a new window of investment opportunities.

On this basis, we added Kering to our portfolios: in the space of just a few months, its 12-month P/E ratio has dropped from 25x to 14x(1).

Its EV/Sales ratio has fallen sharply from 5.5x to 3x(2). Even allowing for a scenario of recession, this multiple remains well below the industrial valuation of a luxury group, which would be over 4x earnings(3).

Adopting an industrial valuation approach led us to invest in several luxury goods groups in 2009 and 2014 investments which turned out to be very positive.

Circumventing short terms hazards and market volatility by maintaining a rigorous management process opens up an untapped source of investment opportunities on which to build long term performance.

MSCI EUROPE GROWTH P/E: Source Bloomberg 31/05/2022
(1) Source: Bloomberg
(2) Source: Bloomberg
(3) Source: METROPOLE Gestion - Internal M&A database