Saturday, June 12, 2010

Bargain Hunting Through Europe

¹²A Bargain Hunting Expedition Through European Equity Markets

By Trader's Narrative | 3 June 2010

According to the Bank of America Merrill Lynch survey of managers, institutional investors are reducing their exposure to European equities as a result of the EU sovereign debt crisis. While this has hit the financial sector the hardest, there is an opportunity for savvy, long term investors to scoop up the baby that is thrown out with the proverbial bathwater. Right now, we have the proverbial wind at our backs for an expedition through European equity markets. Well, several winds in fact.

For starters, the Euro has an incredibly negative sentiment which from a contrarian point of view creates an important floor. Two, world markets are at what seems to be the low of a short term correction. And finally, there is a gaping maw where we used to find European equity markets.

You have to be really careful, though, as you tip-toe around Europe's markets since a huge portion of any country's capitalization is made up of banks. If you feel really brave you can sift through them but for this exercise I've ignored them completely since there are so many better value candidates to choose from. When it comes to the financial sector in Europe, I think the risks are too many and the rewards not commensurate. At least at this moment. As well, even if we have already seen the worst of the banking crisis in Europe, the banks there will be dealing with it for some time.

All of the candidates listed below fit Jeremy Grantham's criteria of "high quality" stocks. They are large, well capitalized stocks with well established and defensible franchises. As well, they currently sport single digit PE ratios and large dividend yields with a history of stable and growing dividend payments.

Here are the candidates from Spain:

BME (Bolsas Y Mercados Espanoles)
This is the holding company of the securities markets in Spain (including the regional stock market exchanges in Madrid, Barcelona, Bilbao and Valencia as well as the derivatives, bond markets and clearing which is MEFF). A US equivalent would be the CME Group (CME) or NYSE Euronext (NYX).

BME has a price earnings ratio of 9.90 and a dividend yield of 8.81% (or 10.82% if you count the extraordinary dividend payment). It closed today at 18.23 Euros a share. It is trading in the middle of its 2 year price range (high of 27.17 Euros on September 29th 2009 and low of 13.36 Euros on March 6th, 2009).

Telefonica (TEF)
Telefonica is the largest capitalization stock in the Spanish market and the holding company for several telecommunication services firms that operate in Europe as well as in Latin America. This geographic diversification is one of great benefits of Telefonica. Being so large, it trades on multiple exchanges and has ADRs that trade in New York under the symbol TEF. Telefonica has a price earnings (P/E) ratio of 9.26 and a dividend yield of 8.26%. It closed today at 15.85 Euros and is trading very close to the lows from late 2008 and early 2009.

Gas Natural
Gas Natural (GAS) is a utility company which engages in the sale and distribution of natural gas and the generation of electricity. GAS has a price earnings ratio (P/E) of 9.72 and a dividend yield of 6.52%. It closed today at 12.17 Euros a share and is trading perilously close to its multi-year low of 8.53 Euros/share on March 19th, 2009.

FCC (Fomento De Construcciones Y Contratas)
FCC is one of the largest construction companies in Spain. It is also one of the largest waste management firms operating in the collection, treatment and elimination of solid urban waste. As well, they manage and maintain sewer systems. They also have a significant presence in Latin America.

FCC's real estate and construction business has been under extreme pressure but their other divisions have provided support for the top line. FCC has a price earnings ratio (P/E) of 7.8 and a dividend yield of 7.595%. It closed today at 19.75 Euros/share, very close to a major support level going back to 1998.

ACS (Actividades De Construccion Y Servicios)
ACS operates mainly in construction and concessions (roads and tolls) as well as utility services (electricity, natural gas and telephone). ACS has a price earnings ratio (P/E) of 10.52 and a dividend yield of 6.8%. It closed today at 30.26 Euros/share which is slightly higher than were it was in March 2009.

Here are two candidates from Italy:

Enel (Ente Nazionale Per L'energia Elettrica)
Enel is a utility company in Italy that generates, distributes and sells electricity. Enel has a price earnings ratio (P/E) of 6.45 and a dividend yield of 6.73%. It closed today at 3.80 Euros/share which is not far from the low of 3 Euros/share it dropped to on March 2009.

ENI is a large integrated energy company involved in the exploration of oil and gas around the world. As well, it generates power and has an oil field services division. ENI has a price earnings ratio (P/E) of 11.72 which is the highest so far on our shopping list. It has a dividend yield of 6.60%. It closed today at 15.54 Euros/share. Since bottoming at 12.30 Euros/share in early March 2009 it has traded sideways. ENI also has ADRs that trade in the US.

Here are two candidates from Germany:

Deutsche Telekom
Deutsche Telekom is the largest integrated telecommunications company in Germany. It operates around the world in both Western and Eastern Europe as well as the US. Like Telefonica (above) it also has an ADR that trades on the NYSE under the symbol DT.

DT has a price earnings ratio (P/E) of 18 which is rather expensive, at least for a "value" stock. But it has a very juicy dividend yield at 8.41%. It closed at 9.30 Euros/share today and really hasn't gone anywhere for the past 8 years, trading in a very narrow range.

E.ON AG is involved in (conventional and nuclear) power generation and distribution. E.ON has a price earnings ratio (P/E) of 5.63 and a dividend yield of 6.07%. It closed today at 25.65 Euros/share which is in the middle of its 52 week range.

RWE is involved in the generation, trading, transmission and supply of electricity and gas. It operates in Western, Central, and Eastern Europe as well as the UK. RWE has a price earnings ratio (P/E) of 9.42 and a dividend yield of 6.0%. It closed today at 59.06 Euros/share which is not far from the low of 46 Euros/share it dropped to on March 2009.

Here are two candidates from France:

Vivendi is a large communications and entertainment company. Vivendi has a rather high price earnings ratio (P/E) of 23 but an enticing dividend yield of 8%. Not surprisingly, the chart looks anemic with a narrow trading range under the tech bubble top of 2000.

France Telecom
FT is the largest integrated telecommunications company in France. It sports a 14.66 price earnings ratio (P/E) and a dividend yield of 9.04%. Similar to Vivendi, it has traded in a narrow range after imploding from the tech bubble in 2000.

These are not the sexiest companies you're going to find. In fact, most of them are in the most boring sectors of telecom and utilities. But then again, this was a shopping list of value companies that are able to sustain very healthy dividend payments and offer protection by being cheaply priced.

From a technical point of view, they are building massive bases from which they will in time be able to assault their old highs. In the meantime, patient investors can benefit from a yield that is several times higher than bond rates and inflation. Have I missed any? If you know of a company that fits the criteria, let me know.


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