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Mega-caps: can Europe's giants justify their valuations?

Overpriced safe havens, or undervalued cash flow monsters? We compare and contrast fund manager views on six of Europe's biggest companies.

Is bigger better?

Uncertainty in the markets has led many investors to seek refuge in Europe's biggest and strongest companies, and the premium attached to these giants compared with their smaller rivals has steadily risen.

But as confidence returns to the markets, can the defensive giants retain their appeal?

In the following slides we take a look at six of the region's biggest firms, and what some top investors on both sides of the argument think the future holds for these corporate titans.

Share-price graphs in the following slides cover 10/01/2008 to 01/01/2013. The above chart shows the percentage change in the share prices of all six companies, rebased to 100 at the start of the period.

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The Swiss consumer goods giant

Consumer goods giant Nestlé is the world's largest food company in revenue terms. Euro Stars AAA-rated David Dudding believes mega-caps will continue to move further ahead of their smaller rivals by moving into new markets and taking advantage of more favourable levels of debt.

Nestlé is one of the three biggest holdings in his Threadneedle European Select fund, and its exposure to emerging markets is a big draw for him. 'Over the last 20 years Nestlé's annual compound return in sterling is 15% with very low volatility and it has around 40% of its revenues coming from emerging markets,' he told Citywire earlier this month.

JO Hambro's Robrecht Wouters, meanwhile, dropped Nestlé from his JOHCM European Select Values fund in the summer, believing there are better opportunities elsewhere.

‘Nestlé only realised a +6.5% compound annual growth rate in its earnings per share over the last decade if one excludes the now disposed of Alcon, a modest growth rate which would have been exposed had it not been for expensive growth replacement acquisitions like Pfizer,’ he said.

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A picture of health?

Another Swiss company, this time operating in the pharmaceuticals space, is our second European giant.

Citywire Euro Stars AA-rated Andy Headley is among the managers backing Roche, and it's currently the second-biggest holding in his Veritas Global Focus fund. His high-conviction style, with only 30 to 35 positions in the $1.4 billion fund at any one time, means his fund tends towards the mega-caps.

Euro Stars A-rated Thomas Michel, meanwhile, said in November that he would not want to be overexposed to names such as Nestle, Roche and Novartis – his three largest holdings – despite their huge combined presence in the Swiss market.

‘You need to be diversified when investing in Switzerland and you do not need more than four, five or six per cent in these names and spread investments over more quality companies in other market segments,’ he said.

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Disconnect between share price and performance?

Investec global equity manager Clyde Rossouw is among the managers backing Unilever. His $400 million Investec GSF Global Franchise fund is nearly 50% overweight consumer stocks, with 4.4% of the portfolio in Unilever, even though the sector as a whole is trading at historical highs.

‘We are very mindful of the expense. We still see a lot of tail winds for stocks in consumer staples although they have probably not performed as well as some people expect,’ Rossouw told Citywire Global in October.

On the other side of the fence is Citywire Euro Stars AAA-rated Torsten Graf of MainFirst, who believes there is a disconnect between the share price and the performance of some of the big consumer staple names, including Unilever.

‘I am surprised by the performance of staples,' he told Citywire Global in the summer. 'Unilever’s stock price increased despite constant earnings estimate downgrades since the beginning of 2011.

‘And in my opinion, a valuation of more than 15 times earnings is rather rich compared to the entire market. I fear for staples that more and more investors will figure out the expensiveness during the months to come. They will become aware of other sectors’ relative cheapness.’

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Value stock or growth chances ahead?

European equity veteran John Bennett, who manages the €849 million Henderson Gartmore Continental European fund, has gradually increased his exposure to the pharmaceuticals sector, and Swiss group Novartis is among his favoured names.

‘The pharmaceutical sector is treated as a value sector but factors such as an ageing population and new drugs are creating secular growth opportunities,’ he told Citywire in August.

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Cheap(er) at twice the price

Jupiter JGF European Growth manager Alexander Darwall believes some of Europe's largest quality companies can continue to more than justify historically high valuations. Denmark-headquartered pharma business Novo Nordisk is his biggest holding, and he argues it's effectively cheaper now than it was two years ago despite a trail-blazing stockmarket run.

'Novo Nordisk has always looked expensive but we see it as a cheaper stock now than a couple of years ago, even if the stock price has more than doubled since 2009,' he told Citywire in January. 'The stock is now trading at 25x earnings but it was already trading at more than 30x when I bought it 12 years ago and has been above 15x for most of the past decade. In the meantime the share price has risen by approximately 600%.'

Schroders' head of European equities, Rory Bateman, however, believes French rival Sanofi is better value. 'Sanofi has now put its patent cliff issues behind it and we think we are paying a low multiple for a company that has a number of drugs in its pipeline. It is a key value trade in the pharma space,' he said in December.

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Sowing the seeds of success

Specialised chemicals business Syngenta is another mega-cap that Threadneadle's David Dudding David Dudding believes can continue to outperform over the long term. The company's currently his seventh biggest holding in the Threadneedle European Select fund, making up 4.2% of the portfolio.

Jupiter's Alexander Darwall is another backer. 'Syngenta has very good fundamentals. Technology pays and the company is able to help farmers improve their yields. There are very few who can provide this ability so farmers are very happy to pay for it.'

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