By Victor Reklaitis, MarketWatch
A frequent complaint is that the runup by the FANG stocks appears overdone.
Whether that’s true or not, investors still want to hold big tech names showing solid growth. As a result, there are all sorts of efforts to identify such companies, while steering clear of the usual U.S. suspects — Facebook /zigman2/quotes/205064656/composite FB +0.44% , Amazon.com /zigman2/quotes/210331248/composite AMZN +0.57% , Netflix /zigman2/quotes/202353025/composite NFLX +2.47% and Google parent Alphabet /zigman2/quotes/205453964/composite GOOG +0.76% /zigman2/quotes/202490156/composite GOOGL +0.79% , plus Apple /zigman2/quotes/202934861/composite AAPL +0.39% and Microsoft /zigman2/quotes/207732364/composite MSFT -0.51% .
Dutch chip-making equipment provider ASML Holding /zigman2/quotes/206208657/delayed NL:ASML -1.38% /zigman2/quotes/210293876/composite ASML -0.28% and German software giant SAP /zigman2/quotes/203458330/delayed DE:SAP -0.31% /zigman2/quotes/207905606/composite SAP -0.09% just might fit the bill. They are pacesetters with room to run, according to Benjamin Segal, portfolio manager for the Neuberger Berman International Equity fund, which counts those two stocks among its largest holdings. “When you come to Europe, you’ve got essentially those two companies that are leaders in their industry,” he says, in discussing stocks on par with the FANG gang. “The rest of European technology is basically consulting firms.”
Scandinavia’s Nokia /zigman2/quotes/203672305/delayed FI:NOKIA +1.99% /zigman2/quotes/207421390/composite NOK +2.75% and LM Ericsson /zigman2/quotes/207544813/delayed SE:ERIC.B +6.18% are big tech names, but Segal advises avoiding them, saying they’re essentially suppliers to the telecom industry, which isn’t inclined to spend lavishly these days. They also face stiff competition from Chinese rivals that are state-influenced, have low costs of capital, and don’t share the same profit motive.
“When you’ve got a big competitor that isn’t looking at profits, and you’ve got a very price-sensitive set of customers, that isn’t a particularly appetizing recipe for sustainable returns,” says the portfolio manager.
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Neuberger Berman prefers to buy dominant players in the higher-margin software industry, such as SAP. It’s also bullish on ASML, even though the company sells hardware, producing lithography equipment for semiconductor manufacturers. That’s because ASML has a lead in its sector thanks to its innovative extreme ultraviolet (EUV) technology, he says. Plus, demand for chips looks set to remain strong thanks to an expected boom in connected devices, the so-called Internet of Things.
“There is such ongoing demand and investment for semiconductors as we move into an IoT world, where we’re going to have chips in the toaster, the refrigerator, the car, our cattle, the supply chain, and everywhere,” he says.
He isn’t alone in highlighting European players benefiting from the IoT. Chip companies like Austria’s ams /zigman2/quotes/205647546/delayed CH:AMS -1.54% and Switzerland’s STMicroelectronics /zigman2/quotes/207734906/composite STM -0.56% “tend to fly beneath the radar,” but they’re “playing a pivotal role in this technological revolution,” says Anis Lahlou-Abid, co-manager of JPMorgan Asset Management’s Europe Technology Fund, in a recent commentary for Financial News .
ASML shares have appreciated from 107 euros to €133, a year-to-date gain of more than 40%, so they’re no steal. The company trades around 30 times earnings and 26 times forecasted forward-year earnings, well above Japanese rival Canon’s /zigman2/quotes/210242912/composite CAJ -0.04% 21 and 19, respectively. Yet Neuberger’s Segal isn’t fazed by the price. He says it will take time for ASML to step up deliveries for its EUV systems, and investors are anticipating the ramp-up.
“It’s 30 times this year, but it’s 24 times next year, and it’s 19 times the next year. So your multiple compresses by 40% in two years, and that’s because of the growth you’re getting,” he says. Investors are betting the company “is going to deliver two, three, or four pieces of equipment in the next couple of years, but in 2019 or 2020, it’s going to be 10, 15, or 20 pieces of equipment.”
Risks for ASML, which also trades on the Nasdaq through American depositary receipts, include the possibility that major customers such as Intel could slash their spending on equipment because of a financial crisis or other shock. The company could also stumble from manufacturing problems or a competitive breakthrough product.
Neuberger Berman likes SAP due in part to its broad suite of enterprise resource-planning software, as well as a migration to the cloud that has made it easier for smaller companies to use SAP and Oracle’s /zigman2/quotes/202180826/composite ORCL -1.47% offering, broadening that market. “The enterprise software market is growing, and SAP’s share within that market is, too,” Segal says.
SAP shares trade at €90, or 20 times forecasted forward-year earnings, above Oracle’s P/E of 17. That valuation is “more than reasonable” for a business “growing organically and sustainably at close to 10% in a low-growth world,” Segal says. The stock is up roughly 9% in 2017, after pulling back since June as investors expressed disappointment about SAP’s profit margins. “The one caveat that we have with SAP is that margins haven’t expanded to the extent that you would expect,” Segal says. It should happen soon, but it’s a big problem if it doesn’t, since it’s been a key expectation among bulls, he adds.