Fidelity European Trust PLC (LON:FEV) Marcel Stötzel, Co-Portfolio Manager, appraises Europe’s Granola stocks, the alternatives to Granolas and the outlook for European markets. Marcel highlights the importance of finding strong resilient European businesses in the investment trust’s portfolio.
Like the US’s ‘Magnificent Seven’ or the FAANGs before them, Europe has its very own collection of super stocks: the Granolas. These are a handful of companies that have led European markets in 2023. The worry is that the market has become excessively reliant on their success or failure, but we believe many of these titans have longevity.
The Granolas comprise 11 index heavyweights – GSK, Roche, ASML, Nestlé, Novartis, Novo Nordisk, L’Oréal, LVMH, AstraZeneca, SAP, and Sanofi[1]. Unlike their US equivalents, which are focused on technology (and specifically AI), they are diversified across multiple sectors, providing exposure to the health care, technology, consumer staples and consumer discretionary sectors, across several countries. They draw their revenues from across the world, including Europe, the US and elsewhere.
The concern with the US ‘Magnificent Seven’ is that their share price growth has, in some cases, outstripped their earnings growth, leaving them looking expensive. By contrast, the Granolas[BN1] are significantly cheaper, with European markets generally out of favour compared to their US peers.
These stocks are popular for a reason. They have many compelling characteristics, such as consistent dividend growth, a strong competitive position, pricing power, earnings stability, cash generation and strong balance sheets. These characteristics are particularly valuable in periods of uncertainty: economic and market volatility has helped draw investors to these companies.
However, it is vital to keep an eye on valuations. Passive flows can distort prices for large index stocks and these companies now form 25% of the Stoxx Europe 600[2], almost as high as the Magnificent Seven in the S&P 500. For the time being, however, valuations do not look stretched, and a number of the Granolas feature in our portfolios.
Granolas alternatives
That said, there are opportunities outside the Granolas that have similar attributes but are trading on lower valuation multiples. For example, we are finding a number of consumer discretionary companies we like, even though it was one of the best-performing sectors in 2023. We own luxury goods names LVMH and Hermès.
The management team at Hermès has created some of the most coveted products in the world through a combination of scarcity and quality excellence. This has afforded Hermès considerable pricing power even as household incomes have been squeezed. In turn, LVMH owns a fantastic portfolio of brands and operates across a wide range of end markets including fashion, alcoholic beverages, perfume, retail, as well as luxury hotels.
It is also worth noting that Europe has its own AI story. Much of the hype in 2023 was around US companies developing large language models such as OpenAI with ChatGPT, or providing the chips needed to run them. Europe has a group of companies that have been quietly using these emerging technologies to develop new products that are already benefitting their customers. In our view, they haven’t been getting the investor attention they deserve, which has resulted in the European-listed beneficiaries trading at more attractive valuations.
In particular, there are several companies that have evolved from offline data vendors to online data and analytics providers. These companies possess vast amounts of data, which can be used to generate real insights for businesses and is ultimately, the strongest use case for AI. This process is still in its infancy. Companies such as Dassault Systèmes and SAP should be able to bring new capabilities to the analysis and insight parts of their product offering through AI.
European markets
European markets have been remarkably resilient over the past 12 months, in spite of a looming threat of recession. The market continues to be minutely focused on central bank policy and the timing of an interest rate cut, both by the ECB and the Federal Reserve. That cut appears to be coming closer, particularly in Europe, with recent inflation data showing pricing pressures falling. Members of the ECB’s monetary policy committee have started to make more encouraging noises about rate cuts.
The ECB is treading a fine line. Cut too soon, and it risks inflationary pressures rising again. However, households are feeling the sting of higher rates. Consumers have largely exhausted their pandemic savings and the lagged impact of higher interest rates may start to bite as re-financing comes through for both households and businesses. If unemployment starts to pick up, then consumers could rein in their expenditure quickly.
In this environment, finding strong resilient businesses will be important. Avoiding risks such as companies with high debt, or weak pricing power, will also be important in delivering returns. In this respect, the Granolas have their place in a portfolio, as do some equally resilient, but less high-profile companies within the European investment universe.
Important information
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[1] https://www.euronews.com/business/2024/02/13/who-are-the-granolas-a-look-at-europes-magnificent-eleven-stocks
[2] https://www.ft.com/content/b87e7bd6-b2be-43ca-bf03-a221383a8a92
