Best Value Stocks to Buy Now Are in Europe, Says Causeway Capital CEO

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Sarah Ketterer has the value of investing in her blood. His father, John Hotchkis, founded the home value manager Hotchkis & Wiley, where Ketterer got his start in asset management and met his future business partner, Harry Hartford. In 2001, they formed Causeway Capital Management, a value-oriented global investment manager.

“It was an opportunity for us to think about how we could take a traditional value investing approach – a true echo of the teachings of Benjamin Graham – and then apply it to international markets that were quite nascent at the time. ‘era,’ says Ketterer, who oversees $45 billion as the firm’s chief executive.

Its flagship Causeway International Value fund (ticker: CIVVX) has outperformed its benchmark since its launch in 2001.

As she notes, the winter has been “deep and cold” for the value. Until recently, value stocks followed growth stocks. Today, in the face of pernicious inflation and rising interest rates, investors are shifting from growth stocks to value, and the permafrost is melting.

Ketterer was recently appointed Barrons 2022 list of the 100 most influential women in American finance. From her Dallas office, she spoke to us about the current market environment, attractive investment areas and the outlook for value investing. An edited version of the conversation follows.

Barrons: It’s an extraordinary time to be an investor: two years of pandemic and now war in Ukraine. How do you view the markets?

Sarah Keterer: It is unusual to have two seizures in a row. Usually there is some kind of discrepancy. I see investors are uneasy and nervous. But what drives the markets are earnings and liquidity. We knew before Russia invaded Ukraine that we had come out of the cycle of monetary expansion almost everywhere except in China, and that we had moved into a cycle of monetary tightening. This is sobering for the markets. This means there is less money looking for a home and asset price inflation is likely to turn its head and become asset price deflation. It’s just a matter of speed and scale.

Large market dislocations often lead to periods of significant outperformance. How are you taking advantage of the current situation?

I cut my teeth in the Asian financial crisis of 1997. I was covering Asia then and was baffled to see stocks trading down to the cash level of their balance sheets. This has got to be the biggest purchase I’ve ever seen. And the crises that followed brought those same opportunities. Today is no different.

When pessimism rises and other investors suffer losses, a value investor can do well. And a value investor with quantitative risk controls does even better.

So what are you buying while others are selling?

We are trying to figure out the best entry points because you don’t want to be too early. Adding specific exposure at the right time is what separates good portfolio managers from mediocre portfolio managers.

Bank stocks, particularly in Europe, fell on their proximity to war and suspicions that they have exposure to Russia, Ukraine and Belarus on their balance sheets. Many have plunged in price and valuations are hovering around March 2020 levels, which was no different from their valuations during the European financial crisis of 2012. Yet their balance sheets are demonstrably better than then, from multiple multiples of equity to assets.

They have weathered the regulatory boom and are poised to return significantly more excess capital and future earnings to investors in the form of redemptions and dividends. And yet, investors abandoned them after Russia invaded Ukraine on February 24 and in the days that followed. It was one of those amazing opportunities.

In a crisis, markets often price stocks based on the current environment as if it would last forever. We make an assumption about the cycle, and that’s a big difference.

Which European banking stocks are you buying?

We bought


ING Group

(ING) and


UniCredit

(UCG.Italy), the two hardest hit after the invasion. They trade at massive discounts to tangible book value.

Where else do you see opportunities?

We bought stocks that were Covid disasters because we expected that management could improve the companies so much that when the pandemic subsided, the stocks would see a huge rally and the underlying companies would be more profitable than before the pandemic.

We bought


Rolls Royce Holdings

(RYCEY), the British aircraft engine manufacturer, during the pandemic, and also recently. We like too


Ryanair Holdings

(RYAY). It is the cheapest carrier in Europe and has the newest fleet. The pent-up demand for travel is gigantic. Ryanair operates a new fleet of highly efficient aircraft, so they have the best fuel efficiency.

We also picked up


Alstom

(ALO. France), the French rolling stock manufacturer. It is mainly a railway and equipment activity. We started buying this last year, and the invasion of Ukraine made it more interesting.

The market views any exposure to Russia as toxic. But being in that part of the transportation business, especially a company that offers that kind of equipment and service, we think it’s a pretty good deal, ultimately.

Alstom made a difficult acquisition last year and struggled to integrate it. We got it even cheaper because of its association with Russia. Alstom holds a 20% stake in Russia’s largest rolling stock and rail services company, last valued at 480 million euros [$532 million]. Even if the participation of the Russian company drops to zero, we do not foresee any impact on Alstom’s results. My colleagues and I believe that this Russian risk has been completely ignored by the market, probably on several occasions.

At present, we are looking for companies that can pass on the increased costs. We think Alstom and Ryanair can do it.

What do you see beyond transport?

One area that has been fantastic in times of crisis has been healthcare stocks, particularly pharmaceuticals. You would think they would be great in Covid and some were, some weren’t. But in an invasion, that’s where the ballast is in a wallet. They have huge cash flow and need to be innovative. And, typically, these companies don’t have supply chain issues and inflationary pressures to the degree that plague other industries.

European pharmaceuticals dominated our list because they were trading at a discount to their US counterparts, so we bought shares of


Novartis

(SNV),


Astra Zeneca

(AZN), and


Roche Holdings

(RHHBY).

Do you own Russian stocks?

We don’t. Our emerging markets portfolio, managed largely quantitatively with fundamental risk control, was slightly overweight relative to the benchmark, meaning we had less than 2% in Russia. We sold.

What is your outlook for emerging markets?

China is the largest of the emerging markets. The country is slowing and experiencing a small headwind of growth, but stocks have sold off so much that the opportunities are fantastic. If you start from scratch, China could end up dominating the emerging market basket with attractive returns relative to the developed world.

Earnings and liquidity are the two most important components of market movements. And right now, China is in the mode of adding liquidity.

With China, what are you watching more closely?

Geopolitics is #1 because everything we do on a stock level could be turned upside down if we get the wrong relationship between China and its trading partners. We don’t want to be overexposed to a market and find that there is a major trade dispute.

There are far more risks. The regulatory environment seems harsh, but as long as regulations are well-signalled, reasonably streamlined, and consistent, they set parameters and companies circumvent them. This is a sign of a developing market rather than an emerging market.

In China, internet giants that do not have obvious regulatory headwinds have the largest weights in our China fund.


JD.com

is the leading one-stop multi-product e-commerce platform in China. JD also holds a majority stake in


JD Logistics
,

a fast growing supply chain and logistics services company in China. It is trading near its historically low valuation, but has very promising long-term growth potential.

What other emerging markets are you interested in?

Our process in our emerging markets portfolios is a combination of top down and bottom up. The bottom up is more meaningful. Asia continues to be an important place for us to make money for our customers, not only in China, but also in South Korea and Taiwan.

What is your vision of the American market?

There have been so many other good deals overseas. Our Global Value fund remains underweight the US relative to the benchmark. The most undervalued stocks are currently in Europe.

Any advice for investors who might be feeling anxious, given the market turmoil?

Heading down the cycle is always horrible. Now is the time to use dollar cost averaging – investing smaller amounts over a longer period – to buy the stocks you’ve always wanted and take advantage of other people’s panic, because on the other side, there is the rise. Markets tend to reflect GDP; we may be in a downturn, but if the past is any guide to the future, we will recover and grow again.

Thank you Sarah.

Write to Lauren Foster at [email protected]

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