Last week, bond and equity markets signaled that the EUR110 billion bailout from the EU-IMF for Greece would not do the trick of restoring confidence. The MSCI Europe index lost nearly 14% in dollar terms. Today, European stock markets are surging on the announcement of a vastly expanded EUR750 billion bailout program involving the European Union, the European Central Bank and the IMF. In that context, here's a prudent approach to the question: Are European stocks a buy?
Three themes for safety
In terms of asset allocation, I think investors should be underweight European shares right now -- even after this morning's announcement. Nevertheless, it is likely that last week's turmoil created pockets of value in European markets. Safety first! Investors who wish to bargain-hunt for European stocks would do well to keep the following themes in mind:
- Low leverage
- Sustainable income return
- Defensive and/or export-oriented sectors
Actually, the same themes are equally applicable in the U.S. right now, given the environment. Here are a few ideas of companies that may fit one or several of those themes (these are ideas, not recommendations; make sure to perform your own due diligence before investing):
Banking: UBS
On April 30, I wrote: "In the immediate future, my recommendation would be to avoid European banks altogether." As if on command, The MSCI Europe Banks index fell 18.5% in dollar terms last week, while the MSCI EMU Banks index fell 21.8%.
I don't recommend investing in European bank shares unless you are doing so with true "risk capital" and you have some time and expertise to devote to analyzing them. If you are steadfast about buying European bank shares, I'll repeat my advice of April 30th: Favor Swiss banks UBS and Credit Suisse over their Eurozone-bloc peers.
Indeed, the Swiss banks are better capitalized than most of their European peers, their home market is outside the Eurozone, and they have low exposure to the sovereign debt of Greece, Portugal, or Spain. In 2009, UBS derived the overwhelming majority of its revenues from two countries: Switzerland and the U.S.; Europe excluding the U.K. represented less than 6% of the total.
Furthermore, as a traditional safe haven, Swiss banks stand to benefit from any turmoil in Europe, as wealthy Europeans seek to protect their assets against the risk of a bank collapse, as well as from a charged-up taxman looking for funds to fill gaping European budget deficits.
None of these qualities prevented the shares of both of these banks from losing 10.5% last week; on the basis of 2011 earnings-per-share estimates, both look attractively priced at first glance (UBS's price-to-earnings multiple is 7.6, Credit Suisse's is 6.9).
Telecoms: Telefonica
Telefonica is headquartered in a country that is considered at-risk of contagion to the sovereign debt crisis (at 55%, Spain's public debt/GDP level is actually relatively low, but external private debt is substantial). However, there are a number of factors at work here to mitigate the risk: Domestically, Telefonica is the national carrier; meanwhile, it generates a hefty share (40%) of its revenues in high-growth markets in Latin America.
Telefonica's dividend yield is around 8% and, at a glance, the dividend looks well-covered by operating cash flows. That level of yield certainly takes the sting out of waiting for a revaluation in the shares, which trade at 8.1 times estimated 2011 earnings-per-share.
Energy: Total
Total (France) and Shell (U.K./ Netherlands) are two of the three largest oil and gas "majors" in Europe (the third being BP). Right now, both stocks look similarly attractive from multiple facets, including a high dividend yield (above 6%), low valuations (price-to-earnings multiples under 8 on the basis of 2011 EPS estimates), and low levels of debt. In both cases, investors can consider that the dividend is rock-solid.
Integrated oil companies are exposed to commodity prices and, consequently, to the level of economic activity. European growth is already lagging behind most regions; a double-dip recession would certainly impact these companies. Another less-obvious risk: Companies that generate as much cash as oil majors are an easy target when governments are trying to raise taxes (see the new 40% tax on resource companies that the Australian government proposed at the beginning of the month).
This isn't over until the fat Eurocrat sings
While today's stock price increases erode some of the attractiveness of the ideas I have described above (the price multiple and dividend yield data is based on Friday's closing prices), they may still be worth pursuing. Even if that is no longer the case now, investors should keep them in their back pocket -- my sense is that this is hardly the end of the matter in Europe, as politicians and bureaucrats have shown no willingness to address the root causes of the crisis (trade / consumption / competitiveness imbalances, lack of a European fiscal union, etc.).
The credit crisis has turned the investing landscape upside down, with advanced economies' finance now looking more like those of a banana republic. In that context, Tim Hanson explains how to make more in 2010.
