Europe: Making Sense of the New Euro World
If you liked the uncertainty of European investing in 2001, you'll love 2002. The rally that pushed up Europe's stocks recently could peter out early in 2002 when dismal fourth-quarter earnings are released. An anemic recovery is expected to lag behind any U.S. rebound. And there's a wild card: On Jan. 1, 2002, euro notes and coins will replace those of the 12 euro-zone countries.
A scary picture, yes--but the euro conversion also offers opportunities in Europe for careful investors. Company strategies, buying patterns, and profits will all be affected by the new transparency in European prices. Nobody knows which companies will be winners or losers, but analysts are trying hard to handicap the outcome for major sectors. Many are pushing euro plays as the region's next big investment story. "The euro means we are now able to build competitive global companies," says Jean-Philippe Billot, fund manager at AXA Investment Managers in Paris. "In the long run, the euro will benefit the whole euro-zone economy."
One thing most agree on is that the biggest impact will be on consumer behavior. Since the euro came into being on Jan. 1, 1999, it has been only a bookkeeping unit. Once Europeans have euros in their wallets, they'll suddenly see how wildly prices vary in the so-called single market--and they'll shop with their feet.
At least in the short term, companies that make big-ticket items such as cars and appliances are vulnerable to margin squeezes, says Brian Hilliard, director of economic research at Société Générale. According to British research firm Taylor Nelson Sofres, nearly half of Europe's largest companies believe the euro will hurt profits. Richard Needham, deputy chairman of Britain's Dyson Appliances, expects, for instance, to bring vacuum cleaner prices in expensive Germany into line with those in cheaper Italy. "That is bound to eat into our earnings," he says.
Despite fears that shops are using the euro conversion to raise prices, most will face intense pressure to cut them, especially in border areas. Fund managers also say profits of retailers such as Germany's Kaufhof and France's Pinault Printemps-Redoute could be choked by costs associated with the euro introduction--such as temporary help, training, and security.
But consumers are only part of the euro story. Richard Reid, who heads European equity economics at Schroder Salomon Smith Barney in London, thinks the euro could inspire a revival of mergers and acquisitions, helping not only investment banks but the shares of takeover targets. That's why SSSB analyst Alberto Ponti thinks Italian utility Italgas' shares, which trade at a discount to other European utilities, will rise strongly. The company is bait for a raider or a cash-rich energy distributor, he says.
The financial sector also could finally see cross-border mergers: Euro notes and coins may help managers and regulators transcend the tendency to protect national champions. At the very least, with only one currency to handle, large financial firms are likely to cut back-office operations. Such expansion-minded banks as UniCredito Italiano (UNCFF ) and Spain's Banco Bilbao Vizcaya Argentaria (BBV ) have long seen the euro introduction as an opportunity to slash expenses and grow.
The euro won't be the only factor moving European stocks. By the third quarter, the economy should gain some steam and investors will be able to look for recovery plays. Banks, which lost ground for much of 2001, may outperform their home markets, as demand for loans and investment-banking services increases. Martin Gilles, an equity strategist at Germany's WestLB Panmure, expects the profits of asset managers such as insurance giant Allianz and Swiss financial conglomerate Credit Suisse Group (CSGKF ) to surge in 2002 because demand for mutual funds, private pensions, and private banking is still growing. Carmen Weber, a fund manager at Metzler Investment in Frankfurt, also likes insurance and reinsurance companies such as Munich Re. In the wake of September 11, she says, "they should recover quickly."
Companies that should do well in the second half of 2002 include industrial equipment suppliers, because their customers buy after a recovery is under way. Especially attractive will be market leaders such as Heidelberger Druckmaschinen, which has 40% of the printing-machinery market, and Italian oil-services group Saipem. Analysts foresee an increase of as much as 30% in Saipem's share price as oil companies, anticipating rising energy use, boost production.
One sector that's expected to rise from the ashes is telecommunications. People are traveling less and using the phone more since September 11, so demand has spiked. Europeans have fallen in love with instant-message services on mobile phones. WestLB Panmure's Gilles says Vodafone Group PLC (VOD ) is well-placed to benefit because of its size and international reach. He predicts a 30% rise in Vodafone's share prices.
Investors should be wary. Europe's tendency to lag behind the U.S. means economic trends that start on the other side of the Atlantic often wane before they gain much momentum on the Continent, trapping investors. Europe's New Economy boom, for example, had a much shorter run than the one in the U.S. Yet the euro is forever. A few good picks early on could offer a long ride.
By David Fairlamb
With bureau reports