Gloom has descended on Europe. The United Kingdom’s inflation rate has hit double digits, and Germany’s is getting close. The euro is flagging, recently dipping below parity with the U.S. dollar. With Russia squeezing the supplies of natural gas to the region, the winter heating season is apt to be a brutal one. It is all raising concerns that Europe may be headed for a deep recession.
But Matt Burdett, who helps run international equity and global income strategies at Thornburg Investment Management, sees big opportunities in Europe. He says it’s important to look beyond the headlines, to dig deeper to understand what is really going on. “Knowledge is comfort,” he says.
Burdett joined Thornburg in 2010 after an earlier career as a medicinal chemist at
Sunesis Pharmaceuticals
and a stint as an investment banker, focused mainly on biotech. He worked at Pimco as a senior vice president and portfolio manager from 2011 to 2015, and then rejoined Thornburg.
He is a co-portfolio manager on three Thornburg funds, including the firm’s $11 billion flagship strategy,
Thornburg Investment Income Builder
fund (ticker: TIBIX), which he has co-managed since 2018.
Investment Income Builder, which invests internationally in both stocks and bonds, has consistently beaten its peers. So far this year, it’s down 8.6%, versus a 10.7% loss for Morningstar’s Global Allocation category. Though it is less exposed to stocks than many funds in that group, it has handily topped the category average over stretches of one, three, and five years. Over the past 10 years, it has returned an average of 6.5% a year, outpacing 92% of its peers.
Burdett says the fund is designed to solve a problem: “The problem is income and growing income over time.” The portfolio is 80% global dividend-paying stocks; 13% bonds, mostly BBB-rated or below-investment-grade corporate credit alongside securitized debt; with the balance in cash. Domestic equities are 30% of the portfolio, versus 54% for international equities.
Barron’s recently spoke with Burdett about why he believes now is the right time to invest in Europe and where he is finding value. An edited version of the conversation follows.
Barron’s: So, what do you like about Europe, given all of the troubles?
Matt Burdett: We are income-focused, and dividend yields are much more attractive outside the U.S. Europe, specifically, is a very attractive yield market. I don’t think of Europe as all the same, or all of the companies in Europe as the same. It’s really more about finding value. In some cases, a company just happens to be domiciled there, but their business is global. So, there are many examples in the portfolio of companies that are domiciled in Europe but have very global businesses.
What’s a good example?
Roche Holding
[RHHBY] is a company we’ve owned for more than 10 years. It’s based in Switzerland, but more than half of its sales comes from the U.S. So, it’s not as simple as just looking at the domicile of a company and then computing it as a European company. It’s more complicated than that. Roche’s dividend yield is about 3% in Swiss francs.
The negative backdrop today creates opportunity. Our view is that we can buy companies that we think are going to be long-term winners at more attractive relative values. Everything’s about relative value. We still think there’s great value in Europe.
Where are some of the best values right now?
TotalEnergies
[TTE] is a French-listed oil major that is benefiting from the energy crisis, as it has the second-largest LNG [liquefied natural gas] business in the world, second only to
Shell
[SHEL]. Even if the Russia-Ukraine situation were to resolve tomorrow, and I’m not saying that it will, but if it did, things would not go back to the way they were. We think TotalEnergies is excellent value—it’s half the valuation of Exxon Mobil [XOM].
That does sound cheap.
If you look at consensus estimates, the price/earnings multiple is roughly four times forward earnings. So, a low multiple. What we tend to look at is enterprise value to Ebitda [earnings before interest, taxes, depreciation, and amortization], which is going to factor in the market capitalization and the net debt that the company would have. Ebitda is a better proxy for cash flow. And so that valuation is 2.4 times, which is very low. Exxon Mobil is 4.2 times, so TotalEnergies is more than 40% cheaper.
You’ve held it since 2017, and it’s your biggest position today. How bright is its future?
We’ve intentionally made it our largest position and think there’s great value there. The capital allocation is reasonable and disciplined, and so we feel good about it. TotalEnergies’ dividend yield is 5.6%, based on Bloomberg consensus estimates for calendar-year 2023.
“We are income-focused, and dividend yields are much more attractive outside the U.S.”
But we’re also well aware of the fact that if there is a meaningful recession in Europe, that’s usually not good for oil prices and gas prices. But right now, we feel that given the supply-demand balance and the geopolitical tension, there’s probably some support for these commodities, at least in the near to medium term.
You just mentioned the elephant in the room. Do you expect a recession in Europe?
I think the consensus is that there will be a recession. The question is, how severe will it be? I think the main lever is how high energy prices will go, in particular gas. We don’t really come up with recession scenarios. What we try to do is look at the individual companies and the sensitivity of their earnings to different environments. A lot of people have concluded that you can’t own Europe, given the negative outlook, but investing in companies really depends on the key drivers of the businesses you own. Mass fear is an opportunity. You have to dig around to find where that true value lies.
Where else do you see value?
Orange [ORAN] is the fund’s No. 2 holding. We’ve owned it since 2016 and think it’s an undervalued telecommunications company. It’s what we would call a consistent earner. This is a business where the earnings stream doesn’t vary very much throughout an economic cycle. People don’t usually cancel their phone and internet service, even in hard times.
Orange is present in a lot of countries. France is the home country, where they have the leading market share in both mobile services and fixed broadband—internet service and TV service. What we like about Orange is that they’ve been investing heavily in fiber deployment in all of their geographies, but mainly in France. They’re coming off of the heavy investment this year. So, starting next year, you’ll see a material inflection in the free cash flow they can generate, and usually when that happens, it tends to be a good time for a digital infrastructure company, which is really what this company is.
Another reason that we like Orange, and why we bought more during the pandemic, is because the pandemic showed us how important digital connectivity is. You saw all kinds of stocks like
Zoom Video Communications
[ZM], and all of these other highflying names, move materially higher. But the core digital infrastructure that a company like Orange owns is really the critical backbone. If that’s not there, nothing works.
What do the numbers look like?
If you look at the forward P/E, it’s roughly nine times earnings. The enterprise value to Ebitda is about 5.2, which is probably a more relevant metric to look at. When the free cash flow inflects higher next year, which we expect will happen, that’s an attractive point for other investors to get more involved in the stock. It’s a well-run business and has controllable levers to create value. Orange’s dividend yield is 7.1% in euros, based on consensus 2023 estimates.
Let’s pivot to U.S. stocks.
Pfizer
[PFE] is in your top 10. Why do you like the stock?
We first bought Pfizer in 2010 and have increased our position meaningfully over the past couple of quarters on the grounds that it’s a consistent earner and very attractively valued. We could not have asked for a better delivery from the company than what we saw during Covid with the vaccine and now with the antiviral Paxlovid.
The stock is trading at 9.5 times next year’s earnings, and 7.5 times this year’s earnings, and the earnings estimates are going down simply because the Covid vaccine sales are expected to go down.
Our view is that the Covid business is probably more durable than people expect. We think Covid probably ends up being like the flu. Is there going to be the same amount of demand for the vaccines as there was early on? No. But there are other levers to pull. When Pfizer first started selling the vaccine, they were not selling it at what would be a typical commercial vaccine price. So, even though volumes might fall, price can make up for some of that, and that would be true for Paxlovid, as well.
And, more importantly, they have a lot of stuff going on in the pipeline. They have built up, and are continuing to build, large amounts of cash, which allows them to acquire other assets and help them grow. This stock is helping us meet our income needs, with a dividend yield of nearly 4% and growing.
Which sectors do you like the most and the least?
Our largest overweight is financials because that’s the sector where we think the best value is going to be. A lot of people think that if a recession is coming, you can’t possibly own financials. We think the conditions are somewhat different than, say, before the [2008-09] financial crisis, when capital ratios were much lower. Our financials holdings are fairly diverse. We have some U.S. financials, such as
CME Group
[CME]. We also own some European insurance companies and banks. We think
BNP Paribas
[BNPQY] is still very good value and probably a winner in the European banking sector.
Our biggest underweight is information technology. The primary reason is simply because a lot of that sector doesn’t pay income.
Alphabet
[GOOGL] doesn’t pay a dividend.
Meta Platforms
[META] doesn’t, either.
Thanks, Matt.
Write to Lauren Foster at [email protected]
