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GAM’s Gallagher looks to next leg of Europe's rally

Citywire A-rated manager of £1.8 billion GAM Star Continental European Equity fund believes Spanish and Italian stocks will pick up the baton.

 
GAM’s Gallagher looks to next leg of Europe's rally
 

Niall Gallagher, manager of the £1.8 billion GAM Star Continental European Equity fund, believes that Europe’s recovery will gather strength, with Spanish and Italian stocks picking up the baton.

Last year marked a watershed for European compnay earnings, with stocks either matching or beating expectations after six years of disappointment.

That was reflected in a strong showing from European markets, which beat the returns of the US and UK, and the rallying euro.

‘We’ve been optimistic for a while, we picked up cyclical names early 2014 when European economies started doing better and have progressively become more optimistic,' said Gallacher.

‘To take advantage for the recovery, we are currently very cyclically positioned in our fund and overweight domestic European earnings,’ said the Citywire A-rated manager.

The recovery in Europe has helped the fund enjoy its longest period of outperformance since 2007, with the fund returning 40% over three years to the end of February, compared to 32% from the MSCI Europe ex-UK benchmark.

Holding on

Despite the move into cyclicals, turnover in the portfolio remains low.

‘We have a low name turnover, with only a handful of companies coming into the portfolio and a handful coming out. A lot of the holdings in the portfolio I have held for a very long time,’ explained Gallagher (pictured).

Inditex (ITX.MC), Ryanair (RYA.I), Hexagon (HEXAb.ST), LVMH (LVMH.PA), Grafton Group (GFTU_u), Kingspan (KSP) and Paddy Power Betfair (PPB), I have held for something like 15 years.’

These core holdings, which Gallagher likes for their above-average returns on capital employed, make up the majority of the fund, which has a total of 35 stocks.

The portfolio’s current active share is 87% compared to its benchmark, and Gallagher is happy to stick to his guns.

‘I’m not looking to rotate the portfolio too much, rather shift it through time; for example, right now, that’s why I’m a little bit more cyclical and a bit less international,’ he said.

‘The fund is currently made up of cyclical growth from its European earnings and fast growing structural growth outside of Europe in luxury and tech sectors.’

The cyclical names are mainly in the construction and building materials, automotive and banking sectors. These sectors will stand to benefit from a strong growth in earnings should Europe’s recovery pick up pace, he said.

‘We have two house builders, Aedas (AEDAS.MC) in Spain and Cairn Homes (CRN) in Ireland. Both are new companies founded in the last few years that have similar business models. They bought non-performing loans from banks, structured these loans so that they took over the collateral, which was typically a land bank of a bust real estate developer that was seized by a bank or a national “bad bank”.

‘The reason why we think that is a good business model is because both Spain and Ireland are in the midst of a housing crisis, because house building slowed to a crawl after the financial crisis and there is a lot of demand for a new land bank with a pristine balance sheet and lots of cash.’

Recovery spreads

The geographic allocation of the fund also reflects the fund manager’s view on the European recovery.

‘We have a fair exposure to Spanish and Italian names, reflecting our view that the recovery has only just got underway there. In Spain this comes from names like Aedas and media company Mediaset España (TL5.MC) as well as core holdings like Caixabank (CABK.MC) and clothing retailer Inditex,' said Gallagher.

‘Conversely, we are very underweight Switzerland and have only one investment in power company Schindler (SCHP.S). The reason is simply that we believe the Swiss companies are seriously expensive.’

The fund’s earnings split is also tilted towards Europe, with 55% in domestic earnings.

‘Typically our exposure to overseas earnings is 50-50, but as we have taken a positive view on earnings growth potential in Europe we have increased our exposure,’ explained Gallagher.

Despite this bias towards European earnings, the fund’s two most recent purchases are both value plays targeting international earnings.

‘We have been adding Bayer (BAYGn.DE) over the past year or so. The new chief executive announced that he was buying Monsanto, which was a change in the company’s policy,’ said Gallagher.

‘Up until that point they had been selling off their chemical businesses and focusing on pharma. The announcement caught a lot of shareholders by surprise and the share price took quite a big hit off the back of that.

‘We are positive on the Monsanto acquisition and believe that the agricultural economics sector is an interesting one. If you combine Monsanto’s seed developments with Bayer’s chemical intellectual property then you get a firm that controls more than a quarter of the world’s seed and pesticides market.’

Another name that has made it into the fund is luxury jewellery maker, Pandora 

‘Controversially, we’ve also started buying Pandora (PNDORA.CO) in recent months,’ said Gallagher.

‘The stock was out of favour because it is seen as quite faddy and the company had been a little slow in renewing its rolling stock.

‘We’ve gained a lot of comfort from speaking to the company that it is speeding up its innovation to improve replenishment and the brand’s strong presence in its established markets dispel the idea that it’s faddy. Last year, sales slowed down but they were still pretty decent, they are still growing revenue and growing profits.’ 

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