An opportunity in European shares amid the volatility?
The prospect of a trade war has overshadowed positive developments in Europe’s economic outlook. Shares in many sectors trade considerably below Fair Value.
Just when European stocks looked to have turned a corner, they got whacked by the Trump tariff meltdown. A new report by Morningstar’s Michael Field and Fabienne Pfeiffer says this has brought the European market back from a fairly valued level to one with more potential upside.
Macro improvements overshadowed
Trump’s tariff announcements have overshadowed several positive developments for Europe’s economic outlook in recent months.
Inflation fell even closer to the European Central Bank’s 2% target level. There was also a better-than-expected fallout from the election in Germany, where parliament has already greenlighted a EUR 500 billion investment fund to support the country’s struggling industrial complex.
Overall, sentiment towards Europe’s largest economy improved and growth expectations for the wider continent ticked up. Along with the large valuation gap between European and US shares going into 2025, this helped Europe-domiciled shares start the year strongly.
Figure 1: Performance of equity regions in first quarter of 2025. Source: Morningstar
Trump’s tariffs and the prospect of a trade war, however, derailed this and caused equities in Europe to record falls similar to those seen elsewhere.
“An escalating trade war with the US has cast a large shadow over the improving macro situation we spoke about in the first quarter” says Field. “We are mindful that this situation could be quickly resolved, but it is likely to get worse before it gets better.”
Nonetheless, there could be a couple of potential positives for investors.
For one, Field says, Trump’s announcements have provided a wake-up call for European leaders on the importance of self-reliance. And while European shares no longer screen that cheaply versus the US, they do appear to offer considerably better value than Australian shares in general.
Figure 2: Intrinsic value weighted Price to Fair Value by region (as of April 4). Source: Morningstar
With every European sector’s Price To Fair Value averaging under 1 as of April 4, our analysts appear to see plenty of opportunities at the individual stock level. Here are three undervalued European stocks that our analysts think have strong competitive positions and could be resilient to tariffs.
DSM Firmenich (AMS:DSFIR)
DSM-Firmenich is one of the world’s largest consumer chemicals companies. It provides specialised and often highly engineered ingredients, flavours and fragrances to customers across several end markets that include nutrition, health and beauty. It also has an animal nutrition business that it plans to divest.
Specialised ingredient and flavour companies often boast formidable competitive advantages. This often comes down to the fact that a flavour or ingredient’s formulation can be complex and generally remains a trade secret of the supplier, not the client.
This makes it nigh on impossible for a competing supplier to replicate, which introduces switching costs to the client because key elements of a product’s taste or texture may be lost. New and smaller players in the industry also have to face multinational clients’ preference for suppliers with global operations.
Our DSM Firmenich analyst Diana Radu thinks that DSM-Firmenich can grow its revenues at a mid-single digit clip through 2033. She also expects higher profit margins later in that period as cost-cutting opportunities from the merger of DSM and Firmenich in 2021 come through.
Diana thinks the company’s shares are worth EUR 130 each and opted to hold her Fair Value estimate steady despite the recent tariff announcements.
DSM-Firmenich gets around a quarter of its revenue from the US and largely caters to this demand through local manufacturing rather than exporting. Inputs that can’t be sourced at scale in the US might end up costing more, but Diana thinks that most of these costs could be passed through to clients.
Rheinmetall (FRA: RHM)
Rheinmetall is a leading global defense contractor focused on military vehicle systems, ammunition and electronics. While it has a well-diversified portfolio – including major programs in the US – the major opportunity right now appears to be a large uptick in European defence spending.
Our Rheinmetall analyst Loredana Muharremi says that European defence budgets are set to increase by around 35% over the next five years. She expects Rheinmetall’s native Germany to lead this charge, increasing its spend to 3.5% of GDP by 2029-30 and an average of 3% in the midterm.
This is some increase from the 1.5% of GDP spent on defence in 2023, and Muharremi sees a US 1.8 trillion opportunity in higher European equipment spending by 2030. She notes that Rheinmetall has historically captured between 20% and 45% of this spending, depending on the country.
Rheinmetall has been awarded a Wide Moat due to the global defence industry’s high barriers to entry. These stem not only from strict regulation given the nature of the products being manufactured, but from the huge upfront investments needed in product development and testing before a sale is made.
Muharremi says it is too early to gauge the full effects of tariffs on European defence contractors. However, she sees little direct impact on them for now. Many of these firms, including Rheinmetall, proactively increased their US manufacturing footprints to protect against tariff related risks.
Her Fair Value estimate for Rheinmetall shares currently sits at EUR 2220.
Kering SA (PAR: KER)
Kering owns several well-known luxury brands including Gucci, Balenciaga, Bottega Venetta and Yves Saint-Laurent. Our analyst Jelena Sokolova thinks that Kering and its peers in the luxury industry can offset tariffs through higher prices and the fact that luxury consumers often shop abroad.
Jelena thinks that Kering’s stable of luxury businesses, led by the iconic Gucci brand, leaves it with a good platform for future growth. She feels that Gucci should continue to benefit from strong pricing power and desirability, while other Kering brands have significant untapped potential in new geographies.
Jelena’s Narrow Moat rating for Kering stems from the iconic and highly recognisable nature of its key brands and the conspicuous nature of its products. This has given Kering a license to increase prices significantly over time – even during the Covid crisis – and reap consistently lucrative profit margins.
Taken together, Jelena expects revenue growth of around 5% per year from the Gucci brand over the next decade and similar performance from the likes of Bottega Veneta and YSL. She thinks Kering can keep around 25% of its sales in operating profits and that the shares have a Fair Value of EUR 448.
Two things to consider
Individual shares should only be considered as part of a deliberate investing strategy. You can find a five-step guide to forming your strategy here.
Allocating to global shares also brings its own set of trade-offs, for example the tax treatment of dividends that aren’t fully or partially franked. Shani wrote about the tax treatment of overseas shares and ETFs here.
