By Conrad de Aenlle
LONG BEACH, Calif., April 25 Economic turmoil in
Spain, Portugal and other southern European countries has
depressed their stock markets to the point where they look
downright cheap. But the favorable price-earnings ratios and
dividend yields - some in double digits - could be deceiving.
Those enticing dividend payouts could always be cut; many
already have been, and woeful growth prospects - the
International Monetary Fund forecasts at least a second straight
year of economic contraction for Portugal, Spain, Italy and
Greece in 2013 - make the low valuations seem justified.
The advice of professional investors such as Harry Hartford,
co-manager of the $2.2 billion Causeway International Value Fund
, is that if you want to bottom-fish in such brackish
waters, be careful what you hook.
"Undoubtedly the markets look cheap based on earnings and
dividend yields, but you have to analyze companies case by case
to see whether they make sense," said Hartford, whose fund has
outperformed the average large-capitalization value fund by
about a three-to-two ratio since it was introduced in 2001.
"It would be an unwise move by investors to say they're
going to buy a basket of stocks in Italy, Spain, Portugal or
Some of the investments in his portfolio are turnaround
stories that have middling to high valuations based on reported
earnings and compared to their apparently cheap neighbors.
The companies he mentioned typically have experienced
difficult operating conditions or poor decision-making by
executives. Now, their business climate is improving and faults
are being corrected. As they continue to recover and profits
improve, their valuations will come down, he predicted.
EDP Energias de Portugal SA, for instance, an
electric utility that trades at nine times trailing earnings,
compared to 7.4 for the average global utility, "has gone
through a variety of management missteps over the last decade",
The company took on too much debt, he said, much of it for
renewable energy projects that bore little fruit. While Hartford
acknowledges the company still is debt-burdened - its ratio of
long-term debt to equity is 250.52 percent - he sees management
focused on generating cash flow and bringing debt down.
His other selections include Snam SpA, an Italian
utility, and Tecnicas Reunidas SA, a Spanish company
that builds energy infrastructure such as refineries and power
Snam, at about 16 times trailing earnings, is more than
twice as expensive as the average utility stock, but Hartford
believes that its 13.3 percent return on equity - profits
expressed as a proportion of the company's net asset value - in
a sector where ROE is otherwise negative, justifies the high
multiple, as does its 6.7 percent yield.
Tecnicas trades at about 15 times trailing earnings, roughly
two-thirds the valuation of the energy services industry, and
its ROE is 34.5 percent, more than double the industry average.
Hartford points out that the share prices of EDP and Snam
have risen around 10 percent in the last few weeks. That makes
them "not as undervalued as they were", in his view, but he
finds them still to have "fair risk-adjusted returns".
Hartford's selections are heavily exposed to economic
conditions in their home countries. Nick Kaiser, manager of the
Sextant International Fund, a strongly performing
large-capitalization foreign stock fund, would rather own
companies that earn money from outside the region.
"There are many companies worth looking at that are based in
Italy or Spain but do business in (other) places," he said.
These companies often trade cheaply, in his view, because
investors are fixated on the addresses of their headquarters
instead of their financial results. Avoiding them "just because
they're located in Italy or Spain is silly", he said.
An example is Santander. The Spanish bank has
extensive interests in Latin America and Britain, and trades at
less than 10 times trailing earnings, one-fourth the average
valuation of global financial services companies.
Its dividend yield is a whopping 11.2 percent, and "it looks
like they'll be able to pay it", Kaiser said, alluding to the
dividend cuts that some European companies have inflicted on
The research firm Markit reports that over the last four
years, there have been 38 dividend cuts or suspensions among the
46 banks in the Eurostoxx 600 Index, which encompasses companies
across all of Europe. What convinces him that Santander's payout
is safe is its financial strength; it is as well capitalized as
institutions like Wells Fargo & Co, he said.
Kaiser also owns and recommends the main Iberian telephone
companies, Telefonica SA in Spain and Portugal Telecom
, in large part because most of their customers are in
Latin America, where he expects stronger economic growth.
Telefonica is dirt cheap, trading at roughly four times
trailing earnings, compared to 17.5 for the average
telecommunications company, and its return on equity is higher,
19 percent versus 15 percent. One reason it's such a bargain is
that the company has suspended its dividend in the interest of
shoring up its balance sheet.
The situation is the reverse for Portugal Telecom. It has a
much richer valuation - 16.6 times trailing earnings, still
slightly below the sector average - and its yield is about 15
percent. "The stock has done quite well as investors have bid it
up to get the dividend," he said.
Kaiser holds all three stocks. He said he would consider
selling if their valuations rose above those of their industry
John Buckingham, manager of the vaunted Al Frank Fund, a
value-focused outperformer, owns Portugal Telecom, too, even
though he warns that its dividend might take a hit. He likes the
company's management and thinks the 3.38 billion euros ($4.4
billion) on the company's balance sheet leaves it room to sell
assets and keep a healthy cash flow.
He plans to hold the stock until it hits $6.35; it closed
Wednesday at $5.10. A modest dividend cut "would still leave
them with quite an attractive yield", he said, one that he is
happy to benefit from while he waits.
Buckingham also holds Eni SpA, an Italian energy
concern, and has a target price of $66 for the stock, well above
its Wednesday close of $46.57. He says he believes that Eni's
low-cost mix of exploration and production projects makes it a
true bargain, rather than one of the many southern European
companies that just look that way.