Three European stocks for the long term

published 31 May 2012

Each week, a professional investor tells MoneyWeek where he'd put his money now. This week: Trygve Toraasen, fund manager for the JO Hambro Capital Management All Europe Dynamic Growth Fund.

Greece faces fresh elections and questions about its future in the euro. Meanwhile, contagion fears are now reflected in rising Spanish and Italian government bond yields. But stock pickers must remain composed, avoid these big picture distractions and take a longer-term view on the outlook for Europe's companies and their growth prospects.

It is important to remember that the continent remains home to a number of world-class companies. Many are still enjoying growth in Europe and beyond, even if the overall economic growth profile for the eurozone is currently weak. Taking a five-year investment view, we look for companies that operate in a particular niche where growth is high and accelerating.

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These companies may be domiciled in Europe but have the potential to become global players. Their growth may be being driven by the expansion of their businesses in fast-growing markets such as Asia. They may alternatively be exploiting pockets of growth within the overall more sluggish European or North American economies.

In our experience, Europe's mid-cap stocks are the best hunting ground for companies with the growth characteristics we look for. Mid-cap companies are large enough to be decent businesses but small enough to still have significant growth potential. This creates a very appealing risk/reward ratio. Here are three firms that are undervalued and well placed to exploit profitable niches.

Swedish radiation therapy company Elekta (Stockholm: EJXB) is an ideal example of a European-based global market leader operating in a lucrative niche. Ageing populations are creating opportunities within the medical technology field and Elekta is a direct beneficiary. The cancer patient population is growing rapidly with more people developing the disease as they live longer. This creates a significant tailwind for Elekta's business.

What's more, company's revenue streams are geographically highly diverse: Swedish sales represent a small proportion of Elekta's total sales and revenue growth, with about one third being derived from Asia and other markets.

A more familiar name for UK readers is Rolls-Royce (LSE: RR). It is enjoying accelerating revenue growth off the back of the oil and gas markets where end-user capital expenditure is increasing. The civil aerospace market is also seeing strong traffic growth. Cost-cutting measures and operational leverage (a high ratio of fixed to variable costs) are also enabling the company to expand its profit margins towards industry-average levels.

Furthermore, the company's management team is focused on cash generation and on using less capital. Collectively, these factors should boost returns.

The third stock is Eurofins (Paris: ERF), a French food and pharmaceutical testing business. This is another European company exploiting a profitable niche. It is benefiting from revenue growth as a result of increasing regulation, longer supply chains and outsourcing and its profit margins are expanding rapidly after a period of investment.

However, despite Eurofin's superior profit growth prospects, the stock is valued at a discount to the largest players in the wider inspection and testing field.