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Political Shakedown in Italy: How It Will Affect These Italian ADRs

By Louie Grint – Feb 21, 2014 at 6:05PM

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What's the outlook for Eni, Luxottica, and Telecom Italia?

Italian Premier Enrico Letta resigned last week after the Democratic party withdrew essential support for his government. By breaking the 10-month-old coalition that was ruling the country, the party aims to get the premiership for itself.

The person taking power after Letta will likely be Matteo Renzi, mayor of Florence and a fresh face in Italian politics. However, Renzi will probably face potential attacks from former Italian Prime Minister Silvio Berlusconi's party claiming that he is only taking office because of negotiations within his own party. Let's not forget that Renzi would be the third consecutive prime minister who has not won an election in the country.

How will this political instability affect Italian ADRs?
Let's take a look a three different companies, one related to oil, another in luxury, and a telecom.

First, let's examine Eni (E 2.57%). The company is engaged in oil and gas, petrochemicals, and electricity generation.

Fourth-quarter and 2013 earnings and revenue were not satisfactory for Eni. The company's adjusted net profit dropped 35% year over year to 4.43 billion euros in 2013. The company blamed "extraordinary interruptions to production" and the 4.9% appreciation of the euro against the dollar for the poor results.

Despite the company's performance in 2013, recent international endeavors are encouraging for Eni. The company's discoveries in Mozambique, Cyprus, Congo, Ghana, and Pakistan should give earnings a near-term boost. Eni's execution of its 2013-2016 strategic plan is proceeding relatively well, allowing its production growth target to surpass 4% per year. During 2013 alone, Eni brought six upstream projects online that augmented its portfolio by 1.6 billion barrels of oil equivalent resources.

Regarding the situation in Italy, Eni can withstand the political shakedown. The company's international diversification is outstanding, with upstream operations in Cyprus, Egypt, Vietnam, Indonesia, Pakistan, and Kenya. It also has project start-ups in Algeria, Iraq, Australia, and Russia. The company has liquefied-gas production assets in Angola and a strategic position in nonconventional gas as well.

Stronger than ever
Next, let's look at Luxottica Group (LUXTY). Luxottica is the largest sunglasses and prescription eyewear manufacturer and retailer in the world, with more than 7,000 retail locations.

This company is showing magnificent performance. Net sales hit a record of 7.3 billion euros in fiscal 2013, growing 7.5% year over year. The wholesale division drove the results with 12% growth. The emerging markets -- especially China, Brazil, and Turkey -- brought excellent results for the third consecutive year with an increase of more than 20%.

Fundamentals remain strong for this company, which has economies of scale and a scope that enable it to consistently report high returns on capital. Luxottica's leading brands, Oakley and Ray-Ban, are hard to displace, and the company's global distribution and large retail store base force new entrants to consider using its retail network to reach the scale needed to compete. Luxottica's know-how regarding eyewear technologies and manufacturing capabilities make it less likely license eyewear to competitors. The fact that luxury brands have premium prices helps Luxottica maintain mid-60% gross margins as well, which is respectable.

Finally, here's telecommunications giant Telecom Italia (NYSE: TI). The company operates the only nationwide fixed-line network in Italy and also has the largest wireless business in the country.

Revenue in the first nine months of 2013 dropped 7.6% to 20.4 billion euros as compared to the same period in 2012. This was driven by poor performance in Italy and Brazil.

The company is facing several financial issues. Its fixed-line business, which is about twice the size of the mobile business, continues to shed customers and see sales declines. Its wireless business is also weakening. However, some of these losses are being offset by growth in other areas such as broadband and Internet television.

Italy accounted for 59.2% of total revenue in the quarter. Now that the Argentina business unit (which accounted for 14% of revenue) has been sold, this percentage will be higher. The firm's one growth area has been Brazil, where Telecom Italia owns Tim, the nation's second-largest mobile operator in Brazil. Penetration in the country is greater than 130%, and the growth outlook there is still positive despite a slowing growth rate.

There is a possibility of political interference in this company. It has actually happened in the past, when former Italian Prime Minister Silvio Berlusconi manipulated the country's laws to favor his own media empire. hurting Telecom Italia's media business in the process.

Bottom line
Political issues in Italy are not new. The country has been exposed to several instances in which the prime minister either resigns or has to face a vote within parliament to allow him to remain in power. Italian party power struggles are common and normally generate unstable government coalitions. However, investors should not confuse political instability with political paralysis. The situation is not critical, and Italy will continue to function. Nonetheless, the economy has been stagnant since 2009, and there are no indications that the country will improve in the short term.

Despite the weak performance in 2013, long-term prospects for Eni are positive. The company will probably continue to face volatility in the near term, however.

Luxottica's exposure to Italy is not significant, and the company is solid. However, investors should be careful not to mistake trendy products for a long-term competitive advantage, as fashion trends can change quickly. The company is growing big in the emerging world, which might lead to a correction this year.

The company most exposed to Italy's problems is clearly Telecom Italia. This operator has some issues to resolve, and subscriber growth will not come until the economy stabilizes.

Louie Grint has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.

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