Two Italian Opportunities
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Italy has been going through a tough recession (or should I say crisis?) caused by an overvalued currency and inner competitive problems related to its own rigid labor laws. Right now, a 10.6% unemployment rate and stagnant GDP growth, which is expected to close at -2.3% in 2012, has crippled the country and the valuations of Italian enterprises.
Betting on the Eurozone's ability to find its course out of the woods at some point without a Euro breakup, I believe there is huge value to be found at some high-quality, non-financial companies. Below are my two Italian bets.
Eni (NYSE: E), the Italian national oil champion that is 30% owned by the Italian government, is my strongest bet. The company has great prospects and unmatched cash flow generation capabilities. Eni just set a 2012-2015 strategic plan that aims to increase oil & gas reserves, cash flows and, ultimately, a larger payout for shareholders. The company is also intending to focus on its main business: Oil/Gas upstream and downstream.
With the strategic plan in mind, Eni sold 30% of Snam (the gas distribution company) for $4 billion and reduced net borrowing to equity from 46% to 31%. Besides this, Eni is aggressively increasing reserves; the company made a huge gas discovery in Mozambique and had exploration success in Libya, Ghana, and Pakistan.
But not everything is just a plan. On the operations side, Eni increased operating profit by 13.9% year on year for the last nine months and, producing a cash flow of over $13 for the same period, it can afford to pay the 5.1% dividend yield on its ADRs. Moreover, E aims to increase dividends at a 4% yearly rate going forward.
The increase in production and sales were the key for good operating results; oil and natural gas production was up 8% in the last three quarters compared with 2011. The strategic plan aims to increase production at a 3% CAGR from 2012 until 2021, so it seems more good news is on the way for shareholders.
At $44 per ADR, the company trades at x5 EV/EBITDA multiple and x8 forward P/E. Those multiples seem fair at first sight, but don't reflect Eni's market leadership and pricing power. It's important to think about Eni's competitive position; the company, with a 30% market share at the Italian retail segment, has a different nature than most international oil giants because Eni enjoys huge pricing power on Italian consumers – see my articles at Warrentrades.
Telecom Italia (NYSE: TI), the Italian Telecom company, has hardly been hit by margin compression related to price competition in mature markets the same way one of its major shareholders, Telefonica (NYSE: TEF), was. Besides, both companies are suffering the heavy weight of carrying too much debt on their balance sheets. Prospects are not perfect, but even with a probable share issuance on the way I think there is value that is not yet reflected at current prices.
The business environment is difficult: analysts are expecting Italian mobile growth to worsen year over year as a result of the price cutting environment, and they expect revenues in the Italian market to fall around 7% for next quarter; but operations in Brazil and Argentina might help mitigate some of the suffering being felt in the local market. I expect Brazilean operations to represent a 17.4% of EBITDA in 2012 and operations in Argentina represent a 9.5% of the $15 EBITDA. Both markets enjoy strong top line growth, and I would expect them to become a bigger part of the total company going forward
Telecom Italia represents the most geared play in the sector, with an adjusted equity 2013E FCF yield of 19% already reflecting a terrible environment and a 2012 EV/Ebitda multiple of x3.6. I think dividends are at risk (TI has a flexible dividend policy) but, as in the case of TEF, as the environment ameliorates dividends will be there for shareholders. I would say Telecom Italia is worth the bet.
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