Dudding: Europe's multi-nationals have 'golden opportunity' to dominate

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Top European equity manager David Dudding of Threadneedle thinks Europe's multi-national blue chips have a golden opportunity to dominate the business landscape despite the poor macro environment.

Dudding also believes investors were far too pessimistic on the short term prospects for European equities this year and that companies focused on emerging markets will continue to lead the market.

The FTSE World Europe ex UK benchmark was up almost 11.5% in the year to the end of October, despite its well documented problems.

The Citywire AAA-rated manager believes investors overlooked equity prices that were 'too low' relative to other areas of the world and the fundamental strength of European multi-nationals such as core holdings Nestle and Unilever.

Dudding, who runs the Threadneedle European Select and Threadneedle European Smaller Companies funds, said Europe’s poor macro backdrop masked a number of positive factors for equities on the continent.

He said: ‘People have to recognise that there is no correlation between short term growth rates and stock market performance.’

He cited China as a good example of where superior growth rates did not necessarily translate into strong equity performance.

‘No one would dispute China’s economy has done much better than European economies over the past three years and yet the stock market has gone nowhere. That is in part because it started off at very high valuations.

He contrasted that with Europe, where equities had performed well over the same period but economies had gone ‘absolutely nowhere.’

‘In the long run that divergence of performance between the macro and share prices is not sustainable but it had become very consensual to be underweight Europe so the market became very cheap.’

Dudding does not expect Europe’s economies to perform well for up to a decade, but sees a raft of potential positives for globally focused firms in the region. 

‘Realistically we don’t expect Europe to be a high growth part of the world economy for at least the next five to 10 years. They are relatively mature economies and governments are following austerity policies, banks are deleveraging and the demographics are not great.’

Despite this, he says many European companies have performed well because money is very cheap to borrow and bond markets have had a significant and sustained rally.

‘Good quality European corporates are finding it easier than ever before to raise money at very low rates, and with government bond yields at historically low levels, savers are being forced to look at alternative asset classes whether that is corporate debt or equities, as it is impossible to make a meaningful return from government debt.’

Dudding also tips equities to shine relative to corporate debt, which in turn he thinks is preferable to government debt.

‘We are a big believer in the equity story above corporate debt. There are numerous examples of great global companies with very strong franchises. These are growing businesses where the dividend yield is higher than the interest rate they are paying on the debt.’

Dudding said that with it being up to a decade before Europe restored its competitiveness European equity investors needed to focus on those companies growing their exposure to emerging markets.

‘This crisis has really been a crisis for the US and Western economies. For the rest of the world, growth rates are as good as they have ever been [and] there are loads of world class European companies which have huge exposure to parts of the world growing very significantly.

Dudding believes that Threadneedle European Select top 10 holding Nestle is ideally placed to keep boosting its returns and cites its market leading positioning in China as well as in Brazil.

‘Nestle has 65% market share of the Chinese coffee market. The average consumption per person per year is three cups of coffee. In Shanghai it is in the 20s, in Hong Kong it is 160 and in Taiwan it is 99.’

‘Nestle has been growing this business at 15%-20%  a year so it doubles every five years but it is still only around 6% of Nestle’s operations. It is a tremendous way to get exposure to Chinese consumption [and] is ideally placed as it has been in China for many years and has a very strong brand name.

Dudding also expects Nestle to remain in a dominant position in the country.

‘We believe they spend enough money on advertising and promotion to get behind those brands and that they recruit and retain top performing talent in emerging markets and all around the world.’

With Dudding’s focus on stocks with strong cash flow and balance sheets,  he dismisses the idea that any of the stocks in his portfolio are expensively valued.

While he expects many weaker firms will go to the wall, he expects Europe’s multi-nationals to continue to face a benign backdrop.

‘This is a golden opportunity for the well capitalised blue chip multi-nationals because if you are a small start-up it will be very hard to raise the money to innovate or get financial backing.

‘It is bad for economies because rates of innovation will probably go down but it is a nice environment for those companies that can raise money very cheaply because they can buy up the competition or keep reinvesting  on advertising and promotion to increase their share of the market.’

Over five years to the end of October the European Smaller Companies fund has returned 35.4% compared to the benchmark’s -11.8% loss and is a Citywire Selection pick.

Since he took over the Threadneedle European Select fund in July 2008, it has posted a return of 53% compared to a 6.4% rise in the FTSE World Europe ex UK index.