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Globally Focused Firms Best European Bets

Jeremy Glaser

Jeremy Glaser: For Morningstar, I am Jeremy Glaser. What impact is the European sovereign debt crisis having on both European economies and individual firms? I'm here today with Gary Motyl. He's the chief investment officer of Templeton Global Equity Group. We're going to talk a little bit about some of these issues. Gary, thank you so much for joining me today.

Gary Motyl: Good morning, Jeremy. Thanks for having me.

Glaser: So, my first question is really about the sovereign debt crisis which seems to keep cropping up, and we keep hearing more bad news. We keep hearing more plans. What do European leaders really need to do to solve this crisis and to really start focusing on growth again?

Motyl: The European leaders probably need to do what the U.S. leaders need to do, and that is, start getting serious about fiscal discipline.

Glaser: What kind of steps do you think they need to take? Does it involve kicking out some of the peripheral members from the eurozone? Does it involve defaults? What are some of the strategies they could use?

Motyl: To a certain extent, I think some of the concerns are a bit overblown because when you look at the statistics, whether it's the debt/gross domestic product ratio staying or the tangible book value of the banks involved, again, there is a significant amount of strength there. But the markets are worried that you're going to see some type of repeat of 2007 and 2008. We think that Europe does have the financial wherewithal to make it through this period, but again, it is going to take some pretty serious steps to get their individual countries' fiscal houses in order.

Glaser: So, would you expect to see the kind of trauma in terms of bank closures or huge recapitalizations that are needed in the financial sector from the sovereign debt crisis, or do you think that they're kind of appropriately capitalized and will be able to move on from here?

Motyl: I think given the current situation, it's probably as much a question of liquidity, providing the liquidity on a short-term basis to make sure that a particular bank or a particular country can avoid missing payments or defaulting. I mean, it's a very serious problem, but again, I think when you look at the underlying assets, whether it's individual countries or individual companies, there's still a lot there to be reasonably comfortable with.

The question is, can they do something in the short to intermediate term to make sure that the payments are made, that loans are able to be redone. So, it's a matter of can you keep the liquidity situation such that it does not lead to a real problem with the real economy.

Glaser: So, when we talk about the real economy, what impact is the sovereign debt crisis having on corporations? Are they investing less? Do you see retrenchments or building up of cash on balance sheets? What has been the corporate response to the crisis in Europe?

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Motyl: Putting aside some of the domestically oriented financial institutions in Europe, by and large, the more globally oriented companies really have not announced any major cutbacks in their capital expenditure programs or in their global expansion plans. They have been pretty adamant that they're going to at least maintain their dividend payouts.

So, I think to a certain extent, there has been a little overreaction on the part of some investors, because the vast bulk of those companies there really aren't terribly dependent upon certainly the markets of Italy or Spain. They really are globally oriented companies that have very solid global market position. They have very strong balance sheets. Their cash flows have held up beautifully in the last few years, and their profit outlook is still reasonably good.

Now again, we wouldn't expect that the profit performance of 2010 and 2011 is going to be repeated in 2012. But then again, the valuations are such that the markets are really not discounting that at this point either.

Glaser: So even if there is a slowdown in the European consumer, either because of austerity measures or for whatever reason they decide to retrench a little bit, those globally oriented companies, you think, are still going to be able to survive or to thrive?

Motyl: Actually, I think thrive. Again, if you look at the revenue and earnings composition of most of the big European global firms, whether it's a Siemens, whether it's an Ericsson, or whether it's a Roche, these companies are really pretty well-insulated from certainly what's happening on the periphery in Europe.

Glaser: So, now many of the companies you just mentioned, like Siemens are big exporters, and Germany as a whole is a big exporter. With, the markets that they are sending those goods to, such as emerging Asia and North America, as well, do you see those also holding up pretty well? Or do you think that there could be more of a global slowdown, and this could be a true global issue?

Motyl: Well, we think, at this point, the Asian markets, such as China and pretty much Asia, ex-Japan, still look in pretty good condition here. We're not expecting a dramatic falloff in GDP growth rates in those areas, again, over the next one or two years. Obviously, a slowdown in Europe and the United States concurrently would exert some pressure. We saw that in 2008.

So, from the standpoint of the individual companies, they are really concerned with their global market position and they are probably going to be pretty adamant of maintaining their focus, especially in some of the emerging markets countries. They really want to make sure they're positioned to gain market share in the future and stay at the forefront of technology while at the same time maintain their balance sheet strength. Again, I don't know that you're going to see them do anything too aggressive here in the next few months.

Glaser: Then looking at opportunities, are you seeing a lot of value in any European equities right now?

Motyl: I think the markets have really not differentiated between the quality stocks and those that are positioned globally, and some of the ones that may have more of an issue specific to the weakness within the European community. I mentioned a few of those names--Siemens, Ericsson, and Roche--and I could name a dozen, two dozen other companies, whose stocks have really come under serious pressure here. Again, on a long-term basis, they are starting to look extremely good value, a very good value on a total-return basis, I might add. You take a pretty good dividend yield with these firms and then pencil in some even modest earnings growth during the next few years. These are very well-run, very well-capitalized, and very well-positioned companies.

Glaser: So, it sounds like the global names with good competitive advantages are the places to look in Europe right now?

Motyl: We would certainly think so.

Glaser: All right, Gary, thank you so much for your thoughts today. We really appreciate it.

Motyl: Jeremy, my pleasure.

Glaser: For Morningstar, I'm Jeremy Glaser.