3 Ways to Euro-proof Your Portfolio
Justin is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
There is little debate to the notion that Europe is in a recession, especially if one tiptoes outside Germany. The Markit Eurozone PMI Flash Index was 46.0 in June and has remained below the contraction/expansion line of 50 in nine of the last ten months. That is persistent weakness. Other emerging markets are also suffering as well. Take China for instance, its PMI has been below 50 for eight straight months according to the HSBC China PMI Index. When China rebounds and starts growing again is debatable, but it most likely will be before Europe. Europe continues to suffer under the heavy strains of austerity and lack of a cohesive fiscal union. Value investors often seek out the beaten areas, but the best opportunities in Europe still lie ahead and will present themselves after the full collapse of the European Union or selective breakoffs. Until then, the region should be avoided. Will Europe bring the U.S. into a recessionary state? Maybe or maybe not, but selective equities with heavy European exposure will certainly feel the strain. Below I highlight selective equities that should be relative winners while European strains persist.
Phillip Morris International (NYSE: PM) is the latest casualty of the downward spiral in Europe. The company reduced full-year EPS guidance as a result of two key themes. First, volume trends in Europe continue to deteriorate. Second, and a theme that will play out for many large-caps, is that currency headwinds will shave about 25c off reported earnings-per-share. This is because of weakness in the Euro, although it has staged a small comeback in recent weeks. Still, the near-term rebound will only be temporary if the region continues to suffer or realize a cataclysmic breakup scenario. In such a situation, companies with heavy European exposure that aren’t fully hedged, and many aren’t, will see their European profits translated into less dollars and lower than expected earnings-per-share.
Investors should instead look to Altria Group (NYSE: MO), the original holding company of Philip Morris International prior to its 2008 spin off. The stock has been a strong performer recently, but upside remains if U.S. relative strength persists. The company derives all of its income from North America. They are the leading tobacco company in the U.S. and have grown recently via the purchase of smokeless tobacco company UST and cigar manufacturer John Middleton. The company’s only European exposure comes via their 27% ownership interest in SAB Miller. The net result is that 5% of total company earnings have exposure to the European region. Altria isn’t the cheapest stock with valuation levels above historical averages and a maxed payout ratio. Still, the 4.8% dividend yield, defensive attributes, and minimal European exposure should continue to be the critical factors for the stock in the event that Europe remains in its zombie-like state.
The Hershey Company (NYSE: HSY) is another equity that fits the bill. The stock has recently popped in part to steady results and upward movements in consensus expectations for FY2013 earnings-per-share. Analysts now expect the company to earn $3.53 per share in fiscal 2013, which is up 20c from the start of the year. Hershey is the largest confectionary manufacturer in North America and has more than a 40% share of the chocolate market. The $6 billion in annual sales are mostly derived in North America with little exposure to Europe. The stock isn’t at a bargain price now, but like Altria, investors can have strong faith in the modest earnings growth regardless of what happens in Europe. Valuation isn’t crazy either with the EV/EBITDA multiple at 12x, which is below the 2004-2006 highs that reached 15x, and lower than peer Nestle. Peers Heinz, Kraft Foods, Conagra, and Sara Lee all have their stocks trading above 11x EV/EBITDA, but all have more European and emerging market exposure than Hershey.
The fact is that many stocks that fit this theme have moved pretty significantly of late. While I believe there is plenty of room for them to move further, some investors may balk at the notion of adding notable exposure to a name that has already moved a good deal. All is not lost. There are a couple index ETFs that can work and should Euro-proof a portfolio with minimal transaction costs. The first is the Utilities Spider ETF (NYSEMKT:XLU). Obviously utilities have minimal foreign exposure, but they also pay consistent dividends. This particular ETF currently yields 3.8% and looks poised to outperform the S&P 500 should things across the pond get ugly.
Anything that isn’t super defensive? If you want the upside potential in a bull market without European austerity affecting earnings, then think smaller companies. They generally have less foreign exposure than large-caps. The S&P 500 constituents derive nearly 40% of profits from overseas with Europe making up between 15-20% on average. The iShares Russell 2000 Index ETF (NYSEMKT:IWM) is a logical choice as it provides access to growth companies with reduced European exposure, but this is offset by heavy financial exposure that could suffer if a Europlosion shuts off liquidity in the system.
Some blue-chip companies are going to be reducing earnings forecast for the second half and may have to for several quarters if the Euro starts descending again. It is not too late to Europroof your portfolio with dividend paying stocks that have minimal earnings exposed to the tanking European region. This dynamic will surely continue to play out for several quarters and possibly for several years. Position accordingly now and when the storm finally passes you can buy all the beaten up Euro-exposed stocks making sell lists following the final capitulation.
market8 has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Philip Morris International. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.