European investors like to invest in the U.S. for the diversification and higher growth rates. Unfortunately, it can't be said that U.S. investors like to return the favor. Still, as U.S. equity markets become increasingly overvalued, European equities are looking increasingly attractive as they still trade at a relatively attractive valuation.
Indeed, according to a recent research report from Barclays, European banks, in particular, are near the cheapest they have ever been relative to U.S. banks since 1980. What's more, as inflation picks up across the continent, unemployment falls and economic growth starts to pick up, Barclays' analysts are forecasting 20% earnings per share growth this year, which isn't factored into the market's value implying euro area equities are trading at an estimated 20% discount to the U.S., which is "just above the relative valuation lows over the last two years."
Still, despite the low valuation, it's fair to say that most investors are not going to be jumping into European banks just yet. There may be a price for everything but considering that these banks have shown over the past few years that they cannot consistently earn a stable return, and are chronically underearning, even going out of business, giving the stocks away might be a hard sell.
Nonetheless, there are some bargains to be found in Europe, especially holdings companies.
The holding company bargain
Some sizable holding companies in Europe have been family owned and run for many years. These companies own significant interests in leading companies such as Peugeot (XPAR:UG, Financial) (PUGOY, Financial) and Fiat (FCAU, Financial). FFP is one of the three top shareholders of PSA Peugeot Citroën Group, and Exor (MIL:EXO, Financial) is one of the main shareholders of Fiat as well as Ferrari (RACE, Financial). Other such examples include Bolloré (XPAR:BOL, Financial) and Tetragon Financial (XPAR:TFG). The one common factor among these businesses is that they all trade at a discount to net assets value, offering value.
Exor is probably the most valuable of these four. The company is 53% owned by its founding family and is a mishmash of businesses. Of the $20 billion market value, 25% is Fiat, 17% is CNH Industrial (CNHI), 15% is Ferrari and 34% is PartnerRe (PRE), which was acquired last year. At the end of 2016, the net asset value of this portfolio was 14.6 billion euros ($16.339 billion). Today, the market value of Exor is 12.2 billion euros, and year to date all of these shareholdings have gained in value.
The real value of Exor is to be found in its portfolio. Fiat Chrysler has the potential to quadruple in price over the next four years as its recovery continues. Ferrari is lifting production at 55% incremental profit margins versus the 16% the company reported last year. And CNH Industrial will see healthy gains if the agricultural cycle returns to normal levels.
The discount issue
With all value investments, the one problem investors face is the issue of the value gap closing. Just because an investment offers value does not mean that the value will ever be realized. Exor is not immune, but the company does have some protection. Even if the discount to net asset value persists, the company will see an uplift in value thanks to rising underlying holding values; if these holdings gain in value, the overall value of the business will increase. Shareholders should be well rewarded.
There's also a strong amount of downside protection here. The shareholdings in publicly traded businesses, all of which have strong brands, are liquid and the company will be able to sell them off if it faces a cash crunch.
All in all, Exor is an undervalued holding company that owns a collection of strong businesses all of which have a substantial runway for growth. Management interests are aligned with those of shareholders as management still owns the majority of the outstanding shares. This is one company that's certainly worthy of further investigation.
Disclosure: The author owns shares in Exor and Tetragon Financial.
