As the euro era beckons, the landscape of corporate Europe is changing. Cozy cross-shareholdings are being untangled and patriarchal governments are loosening their grips. With the corporate focus changing, Europe’s analyst community is having to respond. And fast.
The trouble is that clients – institutional investors – are no longer happy with just a bird’s-eye view of a company and its home position. Rather they want a broader picture painted across both Europe and the globe. As they scan global markets, they want to read more than just the traditional country-by-country profiles traditionally favored by many European analysts. After all, it makes little sense to evaluate companies like Hoescht in Germany or Axa-UAP in France in splendid isolation. That’s been true for the giants for a number of years, but it’s also becoming applicable to smaller and medium-sized firms too.
Sector focus
Charles Scott, director of European research at Morgan Stanley, believes ‘the only way to understand companies on a regional basis is to look at their sectors. If you look at the top players in Europe, their managements are not just thinking about market share in their home market but about global opportunities. The research structure should reflect this.’
For many, the impending European monetary union is only part of the equation. The euro may have put pressure on European companies to tidy their balance sheets but it is industry-wide forces and growing competition in such sectors as oil, pharmaceuticals, telecommunications, utilities and financial services that have really propelled companies into action. That competition, of course, has been mirrored in the world’s leading securities houses and they’ve been forced to rethink their research approach just as quickly.
As Arjen Los, deputy director of research in Europe for Merrill Lynch, puts it, ‘I think there’s a growing demand from institutions for knowledge about stocks in other countries. The euro has only accelerated this trend toward peer group comparisons and in-depth sector research. But industries such as telecommunications, oil, chemicals and engineering are increasingly becoming global and it is difficult to take purely a local or regional view and analyze stocks in isolation.’
Divisions ahead
A single currency may create a wider pool of euro-denominated investments for institutions to tap into but it will also create divisions. European monetary union will take its toll on companies that have trouble coming to grips with operating in a single currency with similar fiscal policies, converging inflation rates and common interest rates.
Scott believes new benchmarks will be developed, splitting the continent between the large, premier level European companies which will be included in a Euro-100 and the remaining smaller to medium-sized companies which will comprise national indices. ‘This could significantly affect liquidity as pension fund money flows into the larger rather than smaller companies,’ he says.
The euro coupled with sweeping changes in demographics and pension needs will eventually mean European fund managers having to rebalance their portfolios. For now, though, there have not been any significant shifts, with mot funds preferring the relative comfort and safety of home ground.
But that could alter dramatically if, for example, the UK joined the euro. Currently, a typical UK pension fund holds 52 percent of its assets in domestic equities and a rather paltry 9 percent in other European equities. Within a single currency, though, continental European companies may well look more attractive as the currency risk is erased.
At the moment, research teams on both the buy and sell-side seem to favor a top-down approach – whereby general trends in each economy are evaluated to see which companies might benefit. For example, if interest rates are low then perhaps companies in the retail or property sectors might be favored. Looking ahead, many believe that the euro and global industry trends will prompt a shift toward bottom-up analysis, focusing on companies that outperform rivals – even in adverse market conditions.
Henderson Investors, for example, is a ‘top-down’ research house although it believes that it will gradually be forced to change over time. The fund manager bundles France, Germany and Benelux together as one core entity, but has separate asset allocation strategies for the UK, Spain and Italy – due to their individual stock market performances.
‘Over time, I expect that our core group of countries will expand to include the rest of the European market,’ says Robert Charnegie, research and strategy director at Henderson. ‘In the next two years I see Italy and Spain joining that core and then the rest of Europe will eventually fall into the euro-block.’
Going global
On the sell-side, giants such as Merrill Lynch, Morgan Stanley, Goldman Sachs as well as the newly-merged SBC and UBS, are among the few leading the global sector pack. Although they all have the same objectives, their strategies and structures differ.
Goldman Sachs, for example, embarked on a new research strategy less than two years ago, creating 21 new global industry groups. So far, about 25 weighty reports comparing companies around the world by pricing, valuation and supply and demand have been produced. More are expected to roll off the presses in the near future.
Morgan Stanley also opts for the worldwide view, covering 21 sectors with five to 15 people dedicated to each. It first produced a comprehensive report entitled The Competitive Edge in 1996 and the latest version carefully scrutinizes companies across the globe in order to identify the leaders in various industries.
‘What we are looking at,’ says Scott, ‘is what gives a company a competitive edge in its industry, who those companies are and whether it is reflected in their share prices.’ Out of the 250 companies that were selected, 133 hailed from the US followed by 77 from Europe, 21 from Japan, 13 from Asia ex-Japan, and six from emerging markets. The research reveals that there are three key factors which put a company in Morgan Stanley’s top league:
- management team;
- scale such as full product line, broad geographic exposure and economies of scale; and
- low cost base including price competitiveness in manufacturing.
Merrill Lynch, on the other hand, has around 465 fundamental equity analysts in 26 countries and built up its European presence in 1995 with the acquisition of Smith New Court. Initially the two houses had to work out some teething problems – Smith New Court covered the UK on a sectoral basis and Europe by country, whereas Merrill Lynch took a pan-European approach in its research. Today, the group covers ten industries on a global basis and other sectors are expected to be added this year.
‘Our global expertise is the backbone of everything we do,’ claims Los of Merrill Lynch. ‘We feel that pan-European research is not relevant because so many companies are global players. You need a combination of skills to provide the right kind of analysis for a company and we have analysts on the ground everywhere who can provide a combination of global expertise and local know-how of companies and their industries.’ SBC Warburg Dillon Read has also been praised by institutional investors for its global research efforts. Although it is too early to tell the effects of the recent merger with Union Bank of Switzerland, the company boasts a wide network of both sector analysts – there are 400 people in over 40 countries – as well as country analysts.
Tripping up
Whichever route these investment houses pursue, the one stumbling block they all encounter is the lack of common accounting and disclosure standards which make it difficult to apply the same valuation techniques to all regions. Buy and sell-siders have been busy trying to develop tools that can put companies on a level playing field, such as cash flow measures or economic value added analysis. Still, it’s not always an ideal approach. While waiting for international action on the issue, some companies are taking matters into their own hands. Several continental European companies are moving toward US and UK accounting practices in the run-up to 1999 and the euro. Others have elected to follow the unified set of accounting standards proposed by the International Accounting Standards Committee in London. The IASC remains locked in talks with the US Financial Accounting Standards Board on how to smooth over the differences between the two approaches. Most of the analysts questioned above welcomed any moves by companies to help make their accounting more international in stature.
What every analyst would really like to see, of course, is every company in every country using the same accounting practices. That remains a long, long way off.
