Three European stocks with high levels of free cash flow

Each week, a professional investor tells MoneyWeek where he’d put his money now. This week: Patrick Vermeulen, fund manager, JP Morgan Europe Focus Fund.

After five years of strong performance by European equities, markets have taken a breather. This is a good moment to reflect on what will drive performance going forward.

The broad consensus is that economic growth in Europe will be pedestrian for the foreseeable future and this will have significant implications in differentiating corporate winners from losers.

We are witnessing great change, globally and in Europe, in the way business is done. Think of concepts such as e-commerce, 3D-printing, the internet of things, the Cloud, and so on.

There is also significant change under way in Europe as the crisis countries re-emerge with more competitive economies. All of these developments are threatening existing business models, while also creating significant opportunities.

On the one hand, we are investing in well-managed companies that have a proven track record and can deliver high levels of free cash flow. We look for companies generating more cash than can be reinvested into the business without diluting returns.

An example of this is DCC (LSE: DCC), which distributes fuel and gas to households, petrol stations and small businesses. This business has naturally high barriers to entry and is not capital intensive, meaning that it is able to generate high levels of free cash flow.

The industry is fragmented across Europe with many of the oil majors selling off their own distribution operations to focus on their core businesses. This creates ample opportunities for companies like DCC to redeploy their free cash flow into cheap, small acquisitions with substantial synergy benefits while maintaining dividend growth. In our view, DCC has the potential to achieve high single-digit revenue growth for many years to come.

Another example is Sika (Zurich: SIK), a manufacturer of speciality chemical additives for concrete. Its products significantly lengthen the lifetime of concrete, while having a marginal impact on the total cost of a construction project. We like the stock because of its high levels of free cash flow, low capital intensity, and its visible growth as market share increases. Sika has an opportunity to redeploy its free cash into small acquisitions while still growing the dividend.

Meanwhile, we are also finding opportunities to invest in companies undergoing great change as the result of technological advances and changing consumer behaviour.

A good example is Eniro (Stockholm: ENRO), a Yellow Pages-style business in Scandinavia that has reinvented itself for the digital age, finding better and more efficient ways to reach its customers.

While Yellow Pages-type companies in many countries have gone bankrupt, Eniro is making a successful transition into a digital platform that is very user friendly, and based on high levels of local content.

Over the last few years Eniro has invested heavily in technology and in retraining its sales force. It is now at a crossroads, with the growth in the digital business more than compensating for the decline in the paper business.

The stock is trading at a valuation of less than ten times earnings, which we think is attractive. We’re convinced that management will deliver and that the company has strong upside potential.

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