European value stocks are priced for a deflationary scenario and Citywire AA-rated Hans Ulrich Jost believes this is largely due to investors wrongly believing disruption is harming future potential.
In a market commentary, Jost, who runs the GAM Euroland Value Focus and GAM Multistock – Euroland Value Equity funds, said the role of shale, Amazon, Tesla and financial technology had huge implications for traditional and established companies.
However, Jost said the picture is not as clear-cut as people envision. Here he outlines what the real drivers for change will be and how value-focused stocks can thrive.
#1 – Shale takes lion’s share
‘In June 2016, the price of crude oil slipped back to around $46 as US production numbers started coming in ahead of expectations and the spectre of shale disrupting the market reared its head once more.
‘However, the most efficient acreages, employing the most efficient rigs and the most efficient teams have now been harvested, the major shale players will have to accept much lower efficiency and, therefore, higher break-even levels.
‘With OPEC’s decision to extend output cuts, we expect OECD inventories to fall and oil prices to spike, as the oil market is pushed firmly into deficit by the end of the year,’ he added.
#2 – Amazon eats it all
Focusing on Amazon’s mid-2017 purchase of food retailer Whole Foods, which coincided with huge price cuts, Jost said the market responded as if all traditional food companies would be priced out of the industry.
‘Amazon specialises in procuring, storing and disseminating hard goods with no expiry date in huge quantities at massive discounts; the fresh foods business is a totally different ball game.
‘The belief in the market is obviously that Amazon can fix it. But after 18 years of trying, they seem to get further and further behind the leading incumbents rather than catching up,’ Jost said.
#3 – Tesla takes it all
With the focus falling more than ever on Elon Musk’s company at present, Jost said the long-held belief is that the entrepreneur will demolish the existing automotive industry with his electric vehicles. However, this is yet to be realised.
‘The likes of Daimler and VW have made significant progress since the carbon dioxide emissions scandal of 2015, developing very credible EV strategies with detailed product roll-out schedules across the whole product range. These firms are experts in design and are making much bigger commitments to R&D than Tesla, which is massively leveraged and burning cash.’
#4 – Fintech eats the banks
Jost said there is a growing belief that the existing business model for banks is ‘structurally challenged’, but he said this is becoming a cliché that blinds investors.
‘The major reason that returns on equity (ROEs) halved over this period is that, by 2017, banks were required by regulators to hold more than twice as much CET1 capital as they had to back in 2007. This is a simple mathematical function of numerator and denominator and has little to do with the banks’ earnings power.
‘We consider continental European banks, which are trading below book value and on single-digit forward earnings – despite offering growing dividend yields of some 4% on modest pay-out ratios of 45-50%, with the added potential for share buy-backs – to be among the most attractive investment opportunities currently available in the value universe.’