Brexit or Not, Adidas and Roche Offer Solid Returns
If investors aren’t willing to bet on how the British vote will go, Adidas and Roche are all-weather businesses with strong balance sheets that generate plenty of cash.
European markets were sent into a tailspin last week by rising uncertainty over the outcome of Britain’s referendum on its membership in the European Union.
Having been remarkably sanguine about the June 23 vote since the campaign began in April, investors were unsettled by a flurry of opinion polls suggesting the so-called Brexit was now too close to call, with the leave campaign nosing ahead for the first time in some cases. An Ipsos Mori survey actually gave the leave campaign a six-point lead.
Then on Thursday, Britons were left reeling from news that Labour Party lawmaker Jo Cox had died after being attacked by a man armed with a gun and a knife. Her death prompted a temporary halt of the referendum campaign.
Speaking in the days before Thursday’s news, Tim Gregory, a fund manager with London-based Vermeer Asset Management, said: “To be honest, I was amazed that markets had been so complacent until now. It took a shift in the polls and betting odds to change that.”
By Friday, the FTSE 100 had recovered some of its losses to end the week down 1.5%, while the pound dropped to $1.41, its lowest level in over three months. European stocks also came under pressure, with the Stoxx Europe 600 index down over 2% despite making gains toward the end of the week.
Britain accounts for almost 18% of the EU economy and some observers believe its departure could prompt other countries in the 28-member bloc to consider an exit.
Gregory says investors were troubled by expectations that a British vote to leave the EU would possibly lead to years of political uncertainty. “Aside from not knowing which way the vote will go, it could take years to unpick the legal ties between Britain and Europe, and investors are never happy with that sort of uncertainty,” he says.
He points out too that Thursday’s vote is just one of several unknowns. “Once this is out of the way, markets will still be pressured by other concerns, such as future [Federal Reserve] policy and the prospects for China,” he says.
On Wednesday, the Fed kept short-term rates unchanged and scaled down its forecast for possible rate increases through 2018. European investors sold equities in favor of traditional safe havens such as German and Swiss sovereign bonds. On Tuesday, Germany’s 10-year Bund yield dipped into negative territory for the first time.
Gregory says if investors aren’t willing to bet on how the British vote will go, there are European companies he believes will offer solid returns regardless of the outcome. His picks include German sportswear maker Adidas (ticker: ADS.Germany) and Swiss pharmaceutical firm Roche Holding (ROG.Switzerland). Both are well managed, all-weather businesses with strong balance sheets that generate lots of cash. “These are stocks I would want regardless of whether Britain remains in the EU. You’re buying into their potential rather than their high [price/earnings ratios],” he says.
He says Adidas stock has been heading in the right direction after suffering a series of setbacks from 2014 that saw it struggling to find its previous form in the U.S. “I’ve been keeping an eye on it for some time, certain it would eventually show signs of turning around,” he says.
That moment came when the company named Kasper Rorsted as its chief executive. Rorsted is a Dane who earned a reputation as a turnaround specialist while running German consumer-products company Henkel (HEN.Germany). The company’s stock value more than tripled during his eight years at the helm. He’s due to take over Adidas in October, but news of his appointment in January helped drive the company’s shares up 15%.
Gregory says the sportswear business should benefit from growth prospects in emerging markets. Adidas brands are attractive to increasingly affluent consumers there who regard it as “affordable luxury.” In the U.S., the company is closing the gap with leading player Nike (NKE) and No. 2 Under Armour (UA). It plays to the health and fitness trend while also including a fashion element, Gregory says.
Bryan, Garnier analyst Cedric Rossi has Adidas as a Buy with a fair value estimate of 124 euros ($138.11). He expects a P/E ratio of 27.1 times estimated 2016 earnings. The shares closed at €117.2 on Friday.
GREGORY SAYS ROCHE FACES head winds, but its upside outweighs them. “Health care in general offers long-term structural growth, though it’s hampered slightly by the issue of health-care costs,” he says. Roche’s focus on oncology treatments could benefit from the U.S. Food and Drug Administration’s intent to fast-track approval of some treatments. There are concerns about the rise of biosimilar alternatives, but with a P/E of 17 times 2016 estimated earnings and a yield of over 3%, those risks are already factored into the price, Gregory says.
Morgan Stanley analyst Vincent Meunier has Roche at Overweight, with a 308 Swiss franc ($318.88) price target. He credits Roche's burgeoning pipeline and operation improvements. Roche shares closed at 243.8francs on Friday.