Stock picks to ride recovery as Europe turns the corner
* Careful stock picking key to value as Europe, UK recover
* Financials, auto makers, builders top fund managers' lists
* Exposure to U.S. recovery adds attractiveness
* Strong brands, restructured balance sheets key
By Richard Hubbard and Tricia Wright
LONDON, Aug 8 (Reuters) - It's been a long time coming, but with recovery under way in the UK and signs the euro zone economy may be stabilising, the hunt is on for beaten-down stocks with hidden value.
Not surprisingly, fund managers expect to find the biggest gains in the hardest-hit sectors of the most troubled countries - such as banks, auto makers and builders in places like Spain, Italy or France.
They are quick to add that success will be more a matter of careful stock selection than reliance on a tide that lifts all boats, as growth is likely to remain modest at best and there are still substantial political risks.
"It's definitely a stock-picking environment; it's not going to be about buying a broad range within a sector," said Sandra Crowl, a member of the investment committee at Carmignac Gestion, which has about 55 billion euros under management.
Additionally, solid rallies in European share markets this year, fuelled by loose central bank policies, have stretched some valuations, so they are looking for firms with strong prospects of earnings growth that have got their restructuring behind them.
Xavier Lagrandie, who manages a fund investing in small and medium-sized companies for Lombard Odier Investment Managers (LOIM), said some of the better opportunities can be found in banks and financial firms, even in recession-hit Spain.
He singled out Spain's Bankinter, whose first-half profit jumped more than fourfold as a potential gem in one of the most tarnished sectors. Bankinter's non performing loan ratio was just 4.6 percent at the end of June, compared with 11.2 percent for the sector.
David Walton, a fund manager at Hargreave Hale, highlighted stocks exposed to a pick-up in consumer spending. He pointed to gas burner maker Sabaf, which has been doing well outside Europe, but has been held back by the slowdown on its home continent. Or Dutch bed retailer Beter Bed, which he said recently closed Spanish stores but could benefit from a healthier economy.
Walton noted that in 2010, the pair's earnings per share were at 1.5 euros and 1.3 euros, respectively, and that if they can return to such profit levels and trade on price/earnings (PE) ratios of 15 times, then Sabaf's shares could rise to 23 euros from 12 euros and Beter Bed's to 20 euros from 14 euros.
The return of investors to Europe has been gathering pace as forward-looking numbers such as July's Purchasing Managers' indexes suggest an 18-month long recession across the euro zone may be coming to an end, and a broad recovery in Britain.
The improving data has steadily encouraged investors back into funds targeting the region. Over the last five weeks European equity fund inflows have reached $5.3 billion, compared with $1 billion in outflows over the same period of 2012, according to data from research firm EPFR.
However, with growth likely to be anaemic and the risk of a political blow-up in the euro zone ever present, analysts said another way for cautious investors to improve their chances was to focus on European companies exposed to faster recovery in the United States.
Companies such as British drugmaker Shire, feature on a ranking of stocks with high sales in North America favoured by Macquarie Bank. Shire trades on a 12-month forward PE ratio of 15 times against its 10-year average of 17.7, according to Thomson Reuters Datastream.
LOIM's Lagrandie would add Swiss bathroom products maker Geberit for similar reasons, arguing it was a conservatively managed company ready to benefit from fitting out buildings under construction, he said.
However, some said the benefits of a stronger U.S. economy have already been priced into many stocks.
Another place to look is among firms with strong global brands or products that dominate their markets worldwide that have cut costs, restructured and repaired their balance sheets.
Managers of JPMorgan's Dynamic Europe fund selected non-life insurers Axa and Allianz, both of which have positive earnings momentum after forecasts were revised up when they reported their latest results.
They also like smaller gems like call-centre provider Teleperformance, which trades on a 12-month forward PE ratio of 12.3 times against its 15-year average of 17.7, Thomson Reuters Datastream shows.
For investors focused on the UK, currently leading the recovery across Europe, Citibank strategists like home builder Barratt Developments, currently on a 12-month forward PE ratio of 14.2, compared with its peers on 14.5.
Another area in which European firms excel is research and development. German engineering service group Bertrandt , which should benefit as capital investment picks up, trades on a 12-month forward PE ratio of 13.9 times, below its 15-year average of 17.4, Datastream shows.
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