Italy is going through its most difficult time since World War II ended. An endless recession coupled with high unemployment has deteriorated investor sentiment. That said, there are bright spots that should be taken into account. For starters, politicians already agreed to push for much-needed labor and tax reforms. On the other hand, some macroeconomic indicators such as a current account balance in surplus territory, low private-sector leverage and low foreign liabilities are ameliorating the outlook for the Eurozone’s third-biggest economy. Here I present my top three Italian equity ideas.
Betting on contracting spreads
Buying banks is always a good idea when you think economic momentum is poised to gain traction. I don’t expect the Italian economy to boom anytime soon, but I do believe all the bad news is reflected in market prices. Besides, there are two positive aspects that should help Italy’s strongest banks going forward:
Since Italian banks own a relevant share of Italy’s public debt, contracting spreads to German bonds should boost quarterly results.
As many smaller Italian banks are facing unavoidable doom, the strongest banking institutions are destined to build market share.
Taking into account what I mentioned above, I would go long Intensa Sanpaolo, which makes up to 90% of its sales in the local market and its one of the strongest banking houses in Italy. Moreover, trading at 40% price to book value, 9.9 times P/E and paying a 4.1% cash dividend yield, I believe all the bad news has already been taken into account by Mr. Market.
Low valuation reflects a tough scenario
The troubled Telecom Italia S.p.A. (ADR) (NYSE:TI) might be a good, although risky, long idea. A very tough competitive environment in Telecom Italia’s main markets (Italy and Brazil, where Telecom owns TIM Brasil) is making the company lose EBITDA, and I expect this trend to continue until 2015. Not only the top line is suffering (by 6% in 2013), EBITDA margins (at 40%) are also contracting despite management’s efforts.
Even with such an unexciting outlook, I think it there might be an opportunity at Telecom Italia S.p.A. (ADR) (NYSE:TI). The stock’s market price is already reflecting weak sales, weakened margins and an increased risk of a further downgrade to the the company’s credit rating. Telecom Italia trades at 2013 3.2 times EV/EBITDAX and 4.2 times P/E while producing a +20% equity free cash flow yield (versus 10% for peers). Besides, paying a 3.3% cash dividend yield its a great alternative for long-term investors willing to run some risks. After all, the company owns a huge share of the Italian and Brazilian mobile markets, something which is not easy to replicate.
Great fundamentals at a reasonable price
Within the European oil-and-gas sector, my top pick has been for a while the Italian local champion Eni SpA (ADR) (NYSE:E). The company, which is 27% owned by the government, is a sustainable cash-flow generator and it looks cheap relative to its peer group. Besides, operationally, the company should start outperforming its peers after a somewhat disappointing 2013 (I expect less than 1% production growth in 2013, below Eni’s guidance of 2%). I believe Eni’s plan to grow its production by 4% year over year until 2016 is realistic given the company’s large upcoming oil projects. I also think Eni shall be able to sustain its great 130% reserve replacement ratio (a top-tier ratio among large oil companies).
Eni SpA (ADR) (NYSE:E)’s huge gas discoveries in Mozambique and cost-cutting plans make it a good investment case taking into account the share’s market price. Eni trades at 8.5 times P/E, 1 time the company’s book value and pays a 6.9% cash dividend yield while planning a $4 billion share buyback during the period 2014-2016.
Foolish bottom line
The three stocks named above are hugely different not only because they operate in different spaces within the Italian economy but also because they represent different risks. Eni SpA (ADR) (NYSE:E) is, by far, the safest bet and the one I would recommend without any doubt. Meanwhile, Intensa Sanpaolo is a good play given its price and the bank’s leverage to the performance of the Italian economy. Telecom Italia S.p.A. (ADR) (NYSE:TI) is a great idea if you can bear a huge amount of price volatility. The stock most definitely looks cheap, but cheap can always get cheaper. You should always remember: “Price is what you pay and value is what you get.” Italy looks inexpensive. It’s time to start thinking of going long.
Federico Zaldua has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.
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