Tags: gil | shidlo | Europe | invest | crisis

A Touch of Europe Isn't the Kiss of Death

Tuesday, 26 Jul 2011 07:38 AM

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The spiraling debt crisis in Europe is hardly aided by the loud criticism over the recent banking stress tests.

Spain and Italy topping the list of countries passing Europe’s bank-stress test didn’t prevent criticism that the tests weren’t tough enough and failed to consider sovereign failure in the face of Greece being on the brink of it.

The crisis in the euro zone hasn’t only put European integration in jeopardy but seems to have posed a serious threat to global recovery.

So while the ECB and European leaders quarrel over Greece and how to save the euro zone, it would be wise to look at why Europe is still a good place to invest.

A nervous reaction by investors resulted in considerable market volatility. Though the tendency is to focus on debt-ridden countries and their difficulties, a wise investor won’t be blinded by it or shy away from opportunities wherever they present themselves.

To take advantage of investment opportunities in Europe, one shouldn’t confuse the situation of individual companies and their potential for growth, with the underlining macro-economic conditions of the countries in which they are listed. It would be wise to consider European-based companies performing well in some of the markets that were initially overly feared to decline in demand.

As an investor, one should remember that European exporters actually benefited from the sizable decline of the euro.

The “smart” investment then would be achieved by looking at the performance as well as the potential of individual companies and careful stock picking, irrelevant of country risk valuation.

Although the sector which has suffered the sharpest decline – European financials and especially banks – should be the first to consider for opportunities, it is highly risky and possibly too early for the individual investor to consider.

Hence, the sector which is ranked as the second worst performer – cyclical – is a safer bet.

There are quite a few large European companies that focus on exporting to Asia and other emerging markets, as well as to traditional Western economies, and are poised for a recovery in the next 12 months. One such example listed on the NYSE is Arcelor Mittal (MT).

Arcelor Mittal is the largest steel producing company in the world and its products are used for these industries – auto, construction, household appliances and packaging. The company was formed in 2006 when Mittal Steel merged with Arcelor and its headquarters are in Luxembourg.

According to the company website, in 2010 Arcelor Mittal had revenues of $78 billion and crude steel production of over 90 million tons, which is about 8 percent of world steel output.

Although most people would consider it a European company, it is really a global player with operations in over 20 countries in both emerging and mature economies. The stock has underperformed the broader market in 2011 with a fall of about 17 percent versus the S&P 500’s 5 percent year to date.

But if one compares its performance to other competitors, it is more or less average – Nucor Corp. has fallen about 10 percent and US Steel about 26 percent year to date.

US Steel produces mostly in North America and Central Europe, unlike Arcelor Mittal, which has global production.

Still, a large part of the underperformance of the steel sector can be attributed to its leverage to the economy. There is still a perception that global GDP growth is slow, the automobile industry is sluggish and there are high input costs to this industry (iron-ore and energy).

But in reality, there is limited downside risk due to the construction industry picking up in emerging markets and the auto industry poised to recover.

With a 2012 forward P-E ratio of 7.47 and price to book of 0.81, Arcelor Mittal is cheaper than many of its competitors and being a large player has its advantages. A recent report by the World Steel Association forecasts that steel use will increase by 5.9 percent in 2011 and a further 6 percent in 2012. What is most interesting in this report is that in 2012, emerging and developing economies will account for 72 percent of world steel demand in contrast to 61 percent in 2007.

In addition, Arcelor Mittal will benefit from an increased demand in the U.S. due to an extension of tax cuts and an improving automobile industry as well as other stimuli. The slower pace in Europe is mainly in Southern Europe with Germany and its surrounding neighbors in the North of Europe having impressive growth (Poland, Czechoslovakia, Austria and the Netherlands)

In 2011, benchmark steel prices have risen in Europe and North America, which demonstrates not only an improved demand but also an ability to pass on costs to consumers.

Arcelor Mittal’s group strategy of producing most of its own raw material will put it an enviable position in the long term — with a target of iron-ore self sufficiency to 75 percent. Indeed, already the group has mining activities in Algeria, Bosnia, Canada, Kazakhstan, Mexico, Ukraine and the United States.

According to Arcelor Mittal’s report in 2007, approximately 46 percent of the group’s iron-ore requirements and 13 percent of its coal requirements were supplied by its own mines or via long-term contracts.

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