Market comment by Frederic Jeanmaire, European Equities Fund Manager at Threadneedle Investments.
France, like many developed countries, is facing the prospect of a stagnant economy in 2013 and low growth for many years unless it is able to reform its labour market in a way that boosts the competitiveness of its companies and reverses its debt and unemployment trends.
Hollande has been facing the dilemma of sticking to the socialist pleas of raising taxes and protecting workers whilst encouraging investment in structurally challenged industries. An attempt to reform labour market is under way which shows that his government may be taking a pragmatic approach to improve France’s economic outlook. Like the periphery in 2011-2012, France is now faced with a budget imperative limiting politicians’ room for manoeuvre. As such we believe François Hollande will continue his predecessor’s policy of more austerity (although less aggressive than Spain or Italy). This will weigh on domestic consumption and construction.
The French stock market is much polarised. On the one hand you have former State-owned companies and some large “old economy” companies, companies in which we don’t invest. On the other hand you have global champions where we see at Threadneedle a large upside potential and have been key investors for years.
We are avoiding domestic champions. For instance, Bouygues, a construction to telecoms conglomerate makes up 72% of its sales in France, EDF the utility company 61% and France Telecom half. On top of being exposed to structurally challenged industries (Telecoms, nuclear power generation) these companies are highly exposed to a sluggish domestic market and are seeing regular dividend cut.
But the analysis shouldn’t stop there. Like Germany, France similarly has some dynamic companies operating abroad successfully. L’Oreal the cosmetics companies derives only 12% of its sales in France, Pernod Ricard 10%. These companies are exposed to secular trends (emerging market move from investment to consumption for instance) which limits the downside from France. So the consumer segment is clearly an area of opportunities for investors.
But there are also some industrial companies. Legrand (electrical products) is one of our favourite stocks with just 27% of its sales in France. Legrand ticks nearly every box of what we like about a company: pricing power, high barriers to entry, well invested (R&D c.5% of sales), attractive growth (organic and inorganic) even in a stale environment, capital light - strong cash generation (13% of sales this year), value adding acquisitions, a good balance sheet (1.1x net debt to ebitda), a strong focus on costs (each country having a monthly budget meeting) and a very good management team. It is difficult to fault.
Generally speaking we see lots of such companies in France, so our message is clear: avoid the domestic French market but there are some very attractive French companies!
Regarding the health of the financial sector we view it as satisfactory, with the largest banks BNP Paribas and Société Générale expected to reach more than a 9% CT1 ratio (full Basel 3) by the end of this year, and therefore meeting regulatory requirements. However, unlike Sweden or Switzerland, France hasn’t imposed harsh additional capital buffers so the sector remains vulnerable to a worsening of the Euro-crisis.
French Banks’ exposure to the periphery remains significant. For instance BNP Paribas holds €13bn of sovereign periphery bonds (mostly in Italy), representing more than 20% of its market capitalisation. The French banks are also exposed via their subsidiaries, the biggest exposure here again being BNP Paribas which derives 8% of its revenues from Italy.
That said, exposure to the periphery ex-Italy (Ireland, Spain, Portugal) is limited and all the French banks have exited Greece.