We look at some of the best buys among the growing list of industry-leading foreign companies.
Finding the best industry players often can mean
looking outside the United States. For example, consider the water
industry, which has just recently emerged as a growth business in
America. Abroad, the ability to access clean, purified water has been a
challenge for centuries.
With current global municipal business amounting to nearly $500 billion a year, which JP Morgan estimates will reach $1.2 trillion by 2015, the water industry offers a remarkable opportunity in an essential service. But if you're looking for a U.S. company to play this explosive growth worldwide, forget it.
In the states, the business of water is still largely a government function. There are some listed companies whose stocks have done quite well. But they are domestically focused.
Paris-based Veolia Environnement is a unique global play that offers substantial exposure to the water industry. More than one-third of the company's $37.8 billion annual revenue is derived from this business, making it the worldwide leader in water and wastewater management.
Veolia typically arranges long-term contracts to manage water networks. This way it avoids the political and investment risks associated with owning foreign infrastructure, keeping its balance sheet assets light. Instead, it helps government revamp dilapidated systems by directing investments and improving management. Because water prices are largely regulated, Veolia is pretty much assured of securing an adequate return for its services. Accordingly, London-based Morgan Stanley industry analyst Emmanuel Turpin believes Veolia is one of the best ways to invest in global water infrastructure.
Between 2001 and 2006, the company enjoyed annualized revenue growth of more than 8% and earnings growth of 9% per annum. Through June 25, its New York Stock Exchange-listed American Depository Receipts (ADRs) had soared by nearly 21% annually in dollar terms over the past five years, doubling the rate of return of the S&P 500.
There is no question that investors can find many great stocks in the U.S. But Derek Izuel, manager of the $590 million AIM Global Equity Fund, whose five-year annualized total return exceeds 16%, believes it's essential for advisors to look beyond our shores. "This is not just because global diversity can enhance returns and reduce risk," explains Izuel, "but because historical, regulatory, cultural, geological and managerial realities have produced some of the best opportunities in certain industries abroad."
"Moreover," adds George Evans, who oversees $61 billion in foreign investments as director of International Equities at Oppenheimer Funds in New York, "there are certain industries that are dominated by overseas players, such as luxury goods and consumer electronics makers." And Evans has found superior operations and investments among some foreign companies that have gone head to head with U.S. firms in a number of industries, such as auto and truck manufacturing.
The emergence of foreign industry leaders is a testament to the long-term outperformance of international markets versus Wall Street. Over the past five years through June 22, in local currency terms, the MSCI developed foreign market index, EAFE, generated annualized total returns of 13.65%. That was 272 basis points better than the MSCI U.S. Factor in the weakening greenback, and dollar-based EAFE returns jumped to 18.91%, nearly 8 full percentage points better the U.S.
Given that the EAFE is a market-cap-weighted index, this outperformance is being driven by large, dominant industry players.
A New Way Of Doing Business
Two such names in Evans' portfolio are fashion retailers: Sweden's Hennes & Mauritz (H&M) and Spain's Inditex, the parent company of Zara. Both of these large-cap companies are pioneers in developing mass-market, catwalk-chic clothing lines that are designed and brought to market in a matter of weeks rather than rolled out each fashion season. This gives both companies a substantial leg up on traditional retailers, by offering customers quicker access to the latest trends and giving management the ability to quickly respond to shifts in consumer taste, all at competitive prices.
This strategy reduces inventory liability and the risk of missing the mercurial hot points in fashion demand. And success has spurred on what few retailers have ever succeeded in pulling off-aggressive cross-border expansion. H&M's store count is rising by more than 11% a year, and Inditex's by more than 16% a year.
Without cannibalizing same-store sales, this expansion rate has fueled remarkable top- and bottom-line growth. Over the past five years, H&M's revenue has increased by 11.5% per year and net profits by more than 23%. Inditex has been bounding ahead at an even faster clip with sales up by more than 20% a year and annualized profit growth climbing by more than 24%.
These numbers have translated into remarkable equity performance for both companies' dollar-denominated, OTC-traded shares. Over the past five years through June 22, H&M has soared by nearly 25% a year. Since it went public in mid-2003, Inditex has risen comparably, gaining nearly 23% a year.
Europe started to deregulate its airline industry nearly two decades after the U.S. This has created unique opportunities (already come and gone here), as travel and free enterprise spread across much of central and eastern Europe. Among the best ways to play this regulatory and political change has been via Dublin-based Ryanair.
The airline remade itself after Southwest Airlines in the mid-1990s as deregulation started opening up continental markets, countering pricing schemes that made local travel far more expensive than crossing the ocean. And therein lay the opportunity.
The company relies on a single airplane type, and it flies to cheaper secondary airports. It also enjoys fast turnarounds that allow it to increase the number of daily flights, and relies nearly exclusively on Internet sales, which allows it to eliminate revenue leakage to travel agency commissions. But besides these advantages, Ryanair makes money on every other aspect of travel. Offering seats at extraordinarily cheap rates enables Ryanair to pick up revenue ranging from baggage and beverage charges to the myriad commissions generated from bus tickets that get passengers into town, as well as from hotel reservations and tour packages. This has produced after-tax net margins of 19.5%, more than double that of Southwest Airlines.
Rapid fleet and hub expansion has fueled annualized revenue growth of more than 40% and after-tax profit expansion of nearly 35% between fiscal years 2002 and 2007. The stock has responded in kind, with its NYSE-listed ADR shares having appreciated by more than 17% in dollar terms over the past five years through June 26, despite a recent selloff that has shaved 20% off its recent record highs. With the stock trading at the bottom of its historical multiple range, Citigroup airline analyst Andrew Light expects shares to rebound when the market refocuses its attention away from intense seasonal pricing pressures on the company and turns to the larger core story: Ryanair's unique long-term growth prospects.
Smarter Management And Better Execution
The rise of foreign industry champions can also result when domestic leaders forfeit their position by failing to read market trends and support distinct product lines while falling short on quality and innovation. This past spring, Toyota surpassed General Motors as the world's largest automaker, generating record profits of $15 billion as Detroit continues to bleed red ink. Between 2002 and 2006, Toyota's revenues increased at an annual pace of 12.58% while profits soared by twice that rate. This has sent the NYSE-listed ADR rising at an annualized clip of nearly 20% over the past five years through June 26, and that's without any support from a strengthening yen, whose exchange rate against the dollar is the same as it was back in June 2002.
A key to the company's sales strength comes from a broad range of well-made products and a commitment to regularly introducing new lines across all segments of the market, says Nikko Citigroup analyst Andrew Phillips. The benefit of this more balanced strategy was evident several years ago as Detroit was betting heavily on continued strong demand for high-margin, gas-guzzling SUVs. At the same time, Toyota's hybrid initiatives have given the company an early lead in the next generation of fuel-efficient vehicles, with worldwide vehicle sales having surpassed 1 million in May.
Europe has been faster to embrace alternative energies than the states, since energy costs are higher there, and there is greater government backing. Denmark-based Vestas Wind Systems has become the world's largest pure wind turbine play, generating 25% top-line growth over the past five years, with more than $6 billion in sales projected for 2007.
However, this mid-cap manufacturer has been handicapped by substantial production costs. Gross profit margins are in the very low double digits, and EBIT margins were negative two out of the last three years.
But Jeff Saul, an industry analyst at ABN AMRO, expects last year's EBIT margin of 4.8% to nearly double to 8.3% this year, and then to rise and stabilize at around 11% in 2008 as economies of scale kick in.
At the same time, Vestas' sales and profits are expected to rise substantially because, as Saul explains, "The wind turbine industry is going to be a substantial global market that should enjoy high growth rates over the next 10 to 15 years." This assessment is backed by a recent report by the brokerage CLSA Research, which projects spending on wind projects in the U.S. and across Europe and China to approach $150 billion over the next five years.
With this trend supported by government mandates for nonpolluting energy production, concerns about global warming and the rising price of fossil fuels, investors, fearful of being left behind, have poured into Vestas. And over the past two years, the price of common shares trading in Copenhagen has more than tripled.
As the U.S. economy becomes increasingly more service oriented, Harold Sharon, director of international equities and a partner at the New Jersey-based asset manager Lord Abbett & Co., emphasizes the need for advisors to sustain foreign exposure between 25% and 50% of assets to have a well-balanced portfolio. "The U.S. can't be leaders in every industry," says Sharon, "and finding foreign companies that have achieved such status will improve the risk-return performance of one's investments."