Three Eurozone Stock Tips

Wall: So, you're here to tell me your three stock picks; fire away.

Tenerelli: Okay. I picked two actually in Spain for today, representing the fact that I have 15% of my fund in Spain. I think they are great opportunities and over the years I found that often where the thick of the crisis is, is where there often presents the greatest opportunities. So, the first one will be actually the Spanish Stock Exchange, which is called Bolsas y Mercado, or BME; simply the Spanish Stock Exchange which is mostly equities, trading on 12, 13 times P/E; huge EBITDA [earnings before interest, taxes, depreciation and amortization] margins, greater than 80% EBITDA, 82% EBITDA margins actually; generates a lot of cash; doesn’t require lot of capital expenditure to run the business. The biggest risk is competitive exchanges, which we’ve seen getting share in different markets. The biggest one being Chi-X and the most well-known one.

BME has been very competitive and very well run, so that the alternative exchanges have actually taken very little market share over the years that they’ve been trying to enter the market. It stands now at about 14% and was about 4% couple of years ago. So, BME is very effective with their pricing strategy to fend off competition. The interesting part is it trades on a 7% dividend yield, which if you think about what you're getting in your bond investments, is…

Wall: Very attractive.

Tenerelli: Very attractive, and also shows how cheap equity markets are, especially in Southern Europe, and a great opportunity. It has net cash, so there is very little risk to that dividend and also it is very cyclically depressed. So the P/E multiples I’m giving you, which are 12, 13, which are reasonable, are on volumes, which are down 70% from the peak. So, the interesting thing is as volume start to recover in the market and people go back to investing in Spanish equities, this company will ride the benefit of that and have good earnings growth over the next few years and generate a lot more cash to be able to pay the dividend out. So, I think it's a great story and is a large position in my fund.

Wall: Your second Spanish stock?

Tenerelli: My second Spanish stock is a television station actually. There has been great consolidation in the media sector in Spain because advertising revenues have fallen so dramatically due to the crisis. There were four free-to-air stations which have been merged into two free-to-air stations. All of the public stations no longer take advertising and have had their budgets cut and content budgets cut dramatically because of the crisis.

So, there are only two places in Spain on television to advertise now if you're a large multinational and want to get your product and brand put across the Spanish consumer. So in old fashioned terms we call that a duopoly, which tends lead to very favorable pricing and very favorable business conditions. At present, however, the companies aren’t – the P&L [profit and loss] doesn’t look that great and the companies aren't doing that well, because advertising has fallen so dramatically. But as that starts to recover, which it already has signs that it’s stabilizing and starting to bounce off the bottom, I expect the margins to expand in this company dramatically and earnings are double subsequently for the next few years.

So, we're talking about a company which will dramatically increase its earnings; is again net cash, has a very healthy balance sheets and no risk on financing whatsoever. We estimate that at sort of a mid-cycle multiple this company is still trading on 5 times P/E, even if it's had a decent run this year. So I think it's sort of a company that will unfold and drive – have very strong earnings growth over the next several years that investors can ride that growth in stock appreciation.

Wall: Its name again?

Tenerelli: Mediaset Espana (TL5).

Wall: Your third stock pick?

Tenerelli: My third stock pick is actually a financial, and I chose that because financials also in my fund have great representation. I’m overweight financials. I think that they are and will be a big driver of equity performance going forward. They're trading at – in general they're trading at discounts to book value, significant discounts the book value in many cases. As the economy recovers, provisions decline, interest rates go up allowing for more margin on net interest and the top line net interest margin and commissions come back as we all start to get more active in the markets.  They’re going to have a good earnings power and earnings growth over the next few years.

The one in particular I have chosen is Sanpaolo Intesa (ISP), which is an Italian bank, trading at 0.5 times its book value and we estimate will make its cost of capital and ROE next year at 9% ROE. So, I have little understanding why a bank that’s going to make its cost of capital trades at a discount of 50% to its book value. So, I think that valuation will normalize and probably quite quickly. Bank Intesa is the most conservative Italian bank, a well-run entity, flat costs for years, very effective, very conservative management; right now are suffering from a low interest rate environment, which doesn’t let them make great spread on their banking business and also a lack of commissions, which we all have lived through and understand. All of that will normalize and…

Wall: Will it be a volatile sort of normalisation?

Tenerelli: I don't think so. Evidence shows now that provisions are starting to come down in Italy. They haven’t had a great provision cycle. There hasn't been a real estate crisis in Italy. Italians have a lot of cash, personally there's not a lot of personal debt in Italy. SME sector has been hit somewhat, but SMEs in Italy are competitive. So I think it's going to be a quite gradual, but purposeful recovery. So, I don't think there is risk of great volatility even with the stock.

Wall: But all three are sort of a longer growth story?

Tenerelli: Longer growth story, a slow grind, slower recovery, but at 0.5 times book there is a lot to go for. So, I think it's quite interesting.

Wall: Dean, thank you very much.

Tenerelli: Thank you.

Wall: This is Emma Wall for Morningstar TV. Thank you for watching.