European cyclicals are expensive when compared to the wider European market, according to a recent research report from Morgan Stanley.
However, Morgan Stanley analysts believe the valuation of European cyclicals appear more reasonable when compared to their global peers.
Macros support investors’ interest in cyclicals
Graham Secker and team at Morgan Stanley prefer financials over cyclicals, as they believe financials offer more attractive valuations with better EPS leverage into an economic recovery.
However, the analysts point out that a macro backdrop of improving growth data and rising bond yields is generally a positive one for cyclicals and investor interest in the area is likely to remain high.
But when the analysts consider the relative valuation of European cyclicals to the wider European market across a number of different metrics, they conclude that cyclicals are expensive relative to the European market.
For instance, as can be evidenced from the following graph, industrials’ relative 12 month PE is at the lower end of its 4-year range. However, it still trades at a premium to the market of 13% when compared to its long-run average premium of 3%.
Similarly, materials trade at a moderate premium to their long-run average.
The following table considers how a sector’s relative valuation today compares to history back to 1973. Morgan Stanley analysts conclude cyclicals look expensive, with every cyclical sector above its 50th percentile. However, the only other sectors trading above the 50th percentile that are not classified as a cyclical are food, beverage & tobacco and diversified financials:
Global vs. European cyclicals
Morgan Stanley analysts also take a look at the valuations of European cyclicals relative to their US and global peers.
The analysts observe that the 12 month PE premium/discount that the major European cyclical groupings trade on relative to their global sector peers in the US and ACWI (MSCI World All Countries).
For instance, the analysts point out that European Industrial stocks trade modestly above their long-run average compared to US and global peers, although valuations are more attractive on a shorter time comparison. The following graph highlights this aspect:
Morgan Stanley analysts conclude that European cyclical sectors where valuations look most attractive relative to US / global peers are Autos, Consumer Durables and Transport. However, Capital Goods, Materials and Retailing are the European cyclical sectors where valuations look the least attractive relative to US / global peers.
Cyclicals with lowest normalized PE
The analysts believe the cyclical stocks depicted in the following table all offer a normalized PE below 15, with the market’s normalized PE at 15.1.
The five overweight-rated companies on the list are Boliden, Hays, Prysmian, Atlantia and TF1.
The following 20 cyclical stocks are considered to offer the best value in their respective sectors based on Morgan Stanley analysts’ pool: EADS, Meggitt, Safran, Renault, Volkswagen, ABB, Rexel, Philips, BASF, Clariant, Hays, Wolseley, Accor, Thomas Cook, TF1, Boliden, Rio Tinto, SSAB, Debenhams and Panalpina.
