The Top European Ideas for Your Portfolio

Federico is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Europe is still going through a tough recession. While Germany stays strong thanks to its unparalleled industrial power, countries such as Spain and Italy remain under pressure. That said, investing has a lot to do with expectations. As professor Michael Mauboussin (who is the head of global financial strategies at Credit Suisse) used to say in his classes, investment success equals reality minus expectations. And expectations for Europe are, indeed, remarkably low. Let's see three European companies that might help your portfolio going forward.

A top global sporting company growing earnings at full speed

Adidas (NASDAQOTH: ADDYY) is growing its top-line while ameliorating its earnings faster than ever. The company has an attractive margin expansion story which I expect to fuel an 18% EPS Compounded Annual Growth Rate (CAGR) until 2015 - versus Nike's 12%. Besides, the Adidas brand is having great momentum in emerging economies like Russia and China, where consumers elected Adidas as the top brand (ahead of Nike).

Of course, I cannot forget Adidas's strong balance sheet (it has more than $1 billion in net cash) and the management's focus on increasing shareholder cash returns through dividends (which are growing at 15% year-over-year rate). Adidas trades at 14.8 times expected 2014 earnings while Nike and Puma trade at 18.1 times and 15.2 times respectively.

One airline to look at

Even if its true that nobody made money in the airline industry (except a few world famous people), I think you should keep Ryanair (NASDAQ: RYAAY) in your watch-list. The reason is simple: I think there is huge room for margin expansion in the coming years to +20% EBIT margin from the current +14.5%. This margin expansion should come from a pricing environment that will keep on improving as European seat capacity shrinks and from the company's cost cutting policies.
 
Besides, the company will sustain its focus on its 2014 7% free cash flow yield target, and management has confirmed a planned $1.3 billion return to shareholders in the form of share buybacks and a special dividend over the next two years. Because it is trading at 15.7 times 2014 earnings, I think you should keep this airline on your list of companies to follow closely.

Cutting costs could significantly improve earnings

BT Group (NYSE: BT) is still one of the least efficient incumbent telecom companies in Europe, and the market seems to be under-appreciating the significant cost-cutting opportunities the company could benefit from. On the other hand, BT is growing fast in the high-margin UK high-speed broadband market, which is allowing the company ameliorate its Revenue Per Line (RPL). As a matter of fact, fiber adds accelerated again during the first quarter of the year to 211,000 retail fiber subscribers, versus 200,000 during the fourth quarter of 2012.

Still losing sales at a decreasing, although still very high, 5% year-over-year rate and trading at 12 times 2013 earnings and 5.3 times EV/EBITDA, I think the company is a bet on the recovery of the European telecom market. Moreover, the company has significant margin upside through cost cutting and is one of the very few European telecom companies with a reasonable net debt ratio (1.3 times EBITDA) . The company is expected to pay a 3.1% cash dividend yield this year. Meanwhile, it is generating an 8% free-cash-flow yield.

The Foolish conclusion

The three companies above provide substantial up-side but, at the same times, they also come with great risk. Europe is still in trouble, and European asset prices shall suffer in the event of bad news, such as the recent political trouble in Portugal. Adidas is the only company in this group of three that should stay unmoved by political uncertainties in the Old World. That said, BT Group and Ryanair provide the most up-side if the situation in Europe clears up.  

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Federico Zaldua has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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