UK stocks Lloyds Bank and International Consolidated Airlines and European firms Amadeus and STM are among are among the most attractive stocks in the region, according to SW Mitchell’s Stuart Mitchell. 
FE Alpha Manager Mitchell, who manages the offshore, four FE Crown-rated SWMC European fund and was recently awarded a mandate by Witan Investment Trust, said the recovery in the European economy is “undeniably real” with economic data improving on a monthly basis.
Although the fund manager is bullish on Europe and believes its robust reversal of fortunes in recent months can continue, it remains maligned by other investors.
But with stocks trading at an unusually large cyclically‐adjusted price-to-earnings discount to US counterparts, investors should be taking more note of the region, according to Mitchell.
He noted: “We continue to find a number of compelling investment opportunities in continental Europe, as we believe the market has not yet fully reflected the strength of the recovery.
“In addition, while we are cautious on the UK economy due to Brexit uncertainties, there remains a number of attractive bottom‐up stock opportunities on offer here in Britain.”
The first is Lloyds Bank, which has been unloved for much of the period following the global financial crisis, but it has recently come back into fashion and backed by managers including FE Alpha Manager Neil Woodford.
“Lloyds, the largest domestic UK bank, boasts the lowest cost income ratio in the industry at 46 per cent, having reduced operating costs by £2bn over the last six years – while it also has the leading 21 per cent market share in digital banking,” Mitchell said.
“The key growth opportunities for the group are consumer finance, SME [small & medium enterprise] lending and financial planning.”
Despite its market share and the recent positive rhetoric around the stock, it has traded in a similar fashion to the wider banking sector, falling by26.48 per cent over the last 10 years compare with a 27.86 per cent decline for the FTSE 350 Banks index.
Performance of stock vs sector over 10yrs
Source: FE Analytics
The bank still faces a number of challenges, including regulatory risk and slower economic growth which could require higher loan loss provisions in the unsecured book, Mitchell explained.
While this is an issue, the fund manager said current trends remain very encouraging for the bank and therefore he is positive on the stock moving forward.
“The net interest margin has continued to edge higher – despite lower interest rates and provisions remain at very low at 12 basis points, while the business continues to be highly cash generative.
“The underlying return on tangible equity is 16 per cent and the common equity Tier 1 ratio is a high 13.5 per cent. Trading on 1.2x book and yielding almost 7 per cent – it offers strong value.”
The other UK stock catching his eye is British Airways owner International Consolidated Airlines.
Unlike the banking stocks, IAG has been on a strong run, returning 120.56 per cent over the last decade, as the below chart shows.
“Operating through the British Airways, Iberia, Vueling and Aer Lingus brands it is the third largest airline group in Europe and sixth largest in the world,” Mitchell said.
As such, the stock is “uniquely positioned” as it derives some 65 per cent of its profit from lucrative long-haul premium market – a growing proportion of which is driven by less‐cyclical premium leisure business.
Perhaps more importantly however is that the management have had a strong focus on costs which have come down 1 per cent per annum in recent years.
“Management is especially focused on Iberia, at 12 per cent return on invested capital [ROIC], as well as turning around Vueling,” he noted.
Overall, the group is generating a 15 per cent ROIC while the balance sheet remains strong with net debt to EBITDA falling from 1.8x at end of 2016 to 1.5x currently.
Performance of stock over 10yrs
Source: FE Analytics
“Current trends are strong, with passenger unit revenues rising by 2.2 per cent in the third quarter and trading on 6x prospective earnings and yielding over 4 per cent, its shares also appear good value,” said Mitchell.
Turning to Europe, the manager said there are a number of sectors that look attractive but singled out the technology and semiconductor sectors for special attention.
In the former sector he suggests travel industry tech provider Amadeus, which offer products including real-time search, pricing, booking, ticketing and processing (which links together travel providers with travellers).
“The business is split into two main businesses distribution and IT solutions. The distribution business continues to have good growth prospects with the travel industry is growing at 4 per cent per annum and it continues to gain market share – from 26 per cent to 43 per cent over the last 14 years,” he noted.
Meanwhile, the IT solutions business is growing even faster at more than 10 per cent per year, and Mitchell said the division, currently worth €300m could rise to €1bn by 2022.
In the latter sector, French semiconductor group STM is also a good play for investors, he said, as it keys-in on up-and-coming sectors such as the smart driving and internet of things (IoT) phenomena.
The geographically-diversified company is spinning out its legacy set top box business which should yield around $170m in annualised cost savings.
Meanwhile, other parts of the business look strong, with half of its revenues from the microcontroller and automotive divisions, where it is positioned second and third in the world respectively.
“With a broad range of different technologies, STM is positioned to benefit from the emergence of areas such as autonomous vehicles, home automation, health and even drones are presenting dynamic growth opportunities,” Mitchell said.
Mitchell has run the €132m SWMC European since its launch in 2011, during which time it has returned 68.24 per cent, beating the FO Absolute Return sector by 44.15 per cent.
Performance of fund vs sector and benchmark since launch
Source: FE Analytics
The long/short strategy is most heavily weighted to France, Germany and the UK, with 27.8 per cent in industrials, 25.2 per cent in technology stocks and 14.1 per cent in financials.
Additionally, some 56 per cent of the 30 stock portfolio is made up of companies with an above-average sensitivity to the business cycle with around half of these in traditionally labelled cyclicals.
The fund has a clean ongoing charges figure of 1.98 per cent.