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.

martinzaldua has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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