Swiss Stocks Overcome Record Franc Gains With Valuations Lowest Since 2007
Stocks in Switzerland, up the most in 15 months last week, may extend gains as investors speculate the country’s drug- and foodmakers will boost earnings even after the franc reached a record high.
The Swiss Market Index (SMI) rose 15 percent since slipping to a two-year low on Aug. 10, more than double the 7.1 percent rally in the Euro Stoxx 50 Index of the biggest euro-region companies through yesterday. The increase narrowed the gauge’s loss to 4.4 percent in August, the smallest decline among 18 western European markets infected by the crisis that drove the Euro Stoxx 50 down 14 percent, according to data compiled by Bloomberg.
Swiss shares are climbing even as companies from Swatch Group AG (UHR) to Lonza Group AG (LONN) say gains in the franc are crimping profits. Andrea Williams at Royal London Asset Management and David Herro of Harris Associates LP are betting valuations compensate for the risk that the Swiss National Bank succeeds in weakening the franc and erases stock returns, or that it fails and an appreciating currency shrinks the economy.
“The Swiss stock market still has a safe-haven status as it is seen to have no exposure to the European debt crisis,” Williams, a fund manager who helps oversee about $1 billion including Swiss stocks, said in a phone interview last week. “Swiss companies will be hit by the strong franc but, because of the degree of unrest in Europe, the positive will outweigh the negative for investors.”
The debt crisis that began in Greece in 2009 has triggered 365 billion euros ($520 billion) in emergency bailout loans, exposed cracks in the euro’s architecture and rattled markets around the world. The franc strengthened to a record on Aug. 9 after yields on government bonds in Italy and Spain surged to the highest ever amid speculation the nations will default.
Swiss stocks attract investors in times of increased uncertainty because earnings at the country’s biggest companies aren’t tied to economic growth, according to Jon Cox, head of Swiss research at Kepler Capital Markets in Zurich. Nestle SA (NESN), the world’s largest foodmaker, accounts for 26 percent of the SMI’s weighting, while drugmakers Roche Holding AG (ROG) and Novartis AG (NOVN) make up another 32 percent.
From its all-time high of 4,557.57 on July 16, 2007, the Euro Stoxx 50 fell 60 percent through March 2009, compared with a retreat of 55 percent in the SMI. Nestle, Roche, Novartis and four other companies in the 20-member SMI have risen since the Euro Stoxx 50 reached its 2011 peak on Feb. 18, compared with six equities in the gauge of euro-area shares, data compiled by Bloomberg show.
The SMI dropped 2.7 percent to 5,383.79 at 10:53 a.m. in Zurich today.
“In the current environment, defensive stocks such as Nestle are the better performers as they aren’t so exposed to the macroeconomic situation,” Cox said in a phone interview.
Profits at SMI companies are forecast to increase 15 percent in 2012 compared with 9.6 percent for the Euro Stoxx 50, according to data compiled by Bloomberg. The KOF Swiss Economic Institute estimates Swiss gross domestic product will grow 2.8 this year and 1.9 percent in 2012, while the European Central Bank expects the euro-region economy to expand about 1.9 percent in 2011 and 1.7 percent the following period.
Swiss stocks are cheap, according to Harris Associates’ Herro. The SMI’s valuation fell to 12.9 times its companies’ reported earnings on Aug. 8, the lowest in four years, according to data compiled by Bloomberg.
“We choose stocks based on value,” said Herro, whose fund owns Zurich-based Credit Suisse Group AG (CSGN) and Glattbrugg, Switzerland-based Adecco SA, the world’s largest provider of temporary staffing. “We are overweight in Swiss stocks. The strong currency has hurt earnings, but it’s not permanent.”
Royal London’s Williams said she has shares of Nestle, Roche, Novartis and Swatch, as well as the largest banks, UBS AG (UBSN) and Credit Suisse. They have low debt and “reasonable” dividend yields, she said.
The ratio of net debt to earnings before interest, taxation, depreciation and amortization for companies in the SMI is 2.85, compared with 8.46 for the Euro Stoxx 50, according to data compiled by Bloomberg. The Swiss index’s dividend yield is 2.7 percent, compared with 4.9 percent for the Euro Stoxx 50.
UBS and Credit Suisse’s net holdings of Portuguese, Italian, Irish, Greek and Spanish sovereign debt amounted to about 1.69 billion francs ($2.1 billion) and 400 million euros, respectively, at the end of June, according to their second- quarter reports. That compares with 31 billion euros for Paris- based BNP Paribas SA and 5.9 billion pounds ($9.5 billion) for Lloyds Banking Group Plc in London.
The franc strengthened 28 percent against the euro from April 6 to Aug. 9, almost reaching parity with the single European currency. It has since depreciated 11 percent after the Swiss National Bank stepped up its fight to counter what it called a “massive overvaluation” by boosting liquidity for the first time since 2008.
The currency’s decline from the peak nearly wiped out the SMI’s 11 percent gain when converted in euros, and overseas investors may suffer more if the central bank succeeds in weakening the franc further.
With exports contributing about half of Switzerland’s gross domestic product, the currency appreciation is hurting earnings. Analysts have reduced their forecasts for earnings growth at SMI companies this year to 12 percent from 18 percent at the start of July, according to estimates compiled by Bloomberg.
Erode Market Share
Swatch must accept declining profitability because boosting prices would erode market share, Chief Executive Officer Nick Hayek said in an interview with Swiss newspaper SonntagsZeitung on July 31. Basel, Switzerland-based Lonza, the world’s biggest maker of drug ingredients, reported a drop in first-half profit on July 27, saying earnings are “under substantial pressure” from the franc.
Holcim Ltd. (HOLN), the world’s second-largest cement maker, fell the most in more than two years in Zurich trading on Aug. 18 after profit declined more than analysts estimated due to the strong franc. Second-quarter net income dropped 13 percent to 347 million francs from a year earlier as currency effects shaved 916 million francs off sales.
For John Plassard, director at Louis Capital Markets in Geneva, concern about European debt trumps other considerations.
“As long as there is a crisis in the euro zone and Switzerland manages to keep the unemployment level low and sustain growth, the country, along with its currency, will remain a safe investment haven,” Plassard said. “And I believe that the crisis in the euro area will worsen.”
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