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GAM's A-rated Gallagher: my top five European stock picks

Niall Gallagher, the A-rated manager of the GAM Star Continental European Equity fund, says European equities are 'very attractively' priced and names five of his top stock picks.

Gallagher: ‘European equities are very attractively valued’

Superficially, European equity markets appear calm, with volatility at low levels, but this masks what has been a ‘highly significant and quite violent rotation underneath the surface’, said Niall Gallagher, A-rated manager of the GAM Star Continental European Equity fund.

He said this rotation has seen a strange dispersion in share price performance that is hard to explain on the basis of bottom-up company fundamentals.

‘Throughout this year we have seen a move from the stocks of very profitable businesses that earn high returns on capital employed into the stocks of companies that typically make a low return on capital employed.’

This ‘trash rally’ has seen ‘structurally challenged, low growth and highly indebted businesses’ rise. Meanwhile, some stocks where Gallagher anticipated a jump in profitability have fallen 15-20% in value year to date. But these strange market movements are throwing up opportunities and Gallagher believes European equities are ‘very attractively’ valued.

The GAM Star Continental European Equity fund has returned 29.13% over three years compared to a sector average gain of 25.02%.

Here are five of his favourite picks, which he believes offer significant upside.

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‘Kingspan, a global leader in high performance insulation and building fabric, has experienced a strong start to the year. The general pick-up in UK activity seen in the final quarter of 2013 continued into the early part of 2014, and Kingspan’s sales for the first four months were 8% ahead of the same period last year at €561 million.

‘In North America, Kingspan’s insulated panel business continues to advance, driven by market penetration gains despite limited evidence of a wider market recovery in the region.

‘Kingspan is thriving in the Middle East and Australia as its penetration continues. It has excellent structural growth prospects as the need to reduce carbon emissions prioritises the improvement in thermal efficiency in new building stock.’

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‘Unicredit is one of the few banks in Europe we like. The bank achieved excellent first quarter results to put it on track to reach its 2014 net profit target of €2 billion.

‘Unicredit’s Italian operation posted the first signs of a growth in revenues and with a structural decline in its cost base and improving loan quality, the prospects of a strong bounce in profitability are excellent. The bank now has a sound capital position and a strong coverage of impaired loans, which is the highest among Italian banks and in line with its best European peers.

‘For the first time since 2008 and the acquisition of rival Italian bank, Capitalia, Unicredit’s stock of gross impaired loans is decreasing, while new loan origination is experiencing a revival.

‘Unicredit is well positioned to support the economic recovery that is starting to materialise in Italy and we believe the bank will experience several years of strong earnings growth.’

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‘Richemont, the Swiss-based luxury goods company, whose brands include Cartier, operates in a sector where we hold very different views to the consensus.

‘Most investors remain wary over the luxury industry’s prospects following a continued slowdown in China, which accounts for a significant portion of demand. However, Richemont’s four-year average sales growth at 10.9% is a significant premium to global GDP growth and there is little evidence of a material slowdown in organic growth.

‘The firm has invested heavily in retail store expansion over the last decade and we expect this to slow over the next few years, allowing profits and cash flow to grow ahead of revenues.

‘Richemont has a fortress-like balance sheet and operates in a segment with high barriers to entry and strong pricing power. Yet, on a price to earnings ex-cash valuation basis it trades at only a slight premium to the market.

‘While it is not as heavily exposed to a recovery in Continental Europe as the other stocks, given its superior growth, return on capital employed and balance sheet strength, we believe the company has been undervalued.’

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Grafton Group

‘Trading in the first four months of the year has been positive for Grafton Group, the UK and Ireland-based building materials firm.

‘Demand in the group’s markets has greatly improved, but is still far below levels experienced in 2006, suggesting the recovery has a long way to go. Grafton’s revenue for the first four months increased by 13.5% to £654 million, and this growth looks set to continue as house building and investment in residential property is boosted by strong domestic economic recoveries in both markets.

‘The share price has declined 15% year to date despite rapidly improving prospects and we believe the shares offer excellent value.’

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‘Shares in Publicis, the French multinational advertising and public relations company, have underperformed in recent weeks following the failed merger with Omnicom.

‘While the merger would have provided Publicis with greater scale, we still believe the company has excellent long-term prospects based on its positioning in new areas of digital media and a growing share in emerging markets.

‘The shares are good value at the current price with strong profit growth and high cash generation.’

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