Until the bond markets signal “all clear” and the spreads between the bonds of Europe’s problem children and German bunds shrinks to something more manageable, I expect European stocks to be volatile.
But volatility by itself is nothing to fear. If you buy the right companies at the right prices, volatility is not really a form of “risk” but instead a well-presented opportunity. And I believe that Europe is ripe with such opportunities today. My investment rationale can be summarized as follows:
- While the sovereign debt crisis is not “over,” the risk of a Lehman Brothers-style meltdown is. The European Central Bank’s offer of virtually unlimited credit to banks, meaning any bank failures, should they happen, will be orderly.
- Europe’s politicians are gradually muddling their way towards institutional steps that should restore some amount of confidence to the markets — such as constitutional amendments requiring balanced budgets.
- Europe’s political paralysis and capital market volatility are not without consequences — the eurozone as a whole is probably already in technical recession.
- Continental recession or not, many of Europe’s finest blue chip companies have a global client base and large exposure to growing emerging markets. Five years of on-again, off-again crises have pushed down the prices of many European companies to levels we may never see again in our lifetimes.
The following Italian energy company is an example of these well-presented opportunities.
Investing in Italy
Italian energy giant Eni (NYSE:E) is an integrated energy company engaging in the exploration, production, transportation, transformation, and marketing of oil and natural gas across five continents.
Energy stocks did not have a particularly great 2011, up just 2.8% by Standard & Poor’s calculations. Investors instead flocked to consumer staples, utilities and health care — shunning the more cyclical sectors. As risk aversion begins to recede in early 2012, I see this trend reversing and I expect the more cyclical sectors to lead.
Yes, a deep recession in Europe would curtail energy consumption and likely would mean lower oil and gas prices globally. But it would appear that quite a bit of bearishness already is factored into energy prices and into the prices of energy stocks — Eni certainly is no exception. It trades for just 8 times earnings, 1 times book value and 0.5 times sales. (In comparison, Exxon Mobil (NYSE:XOM) trades for 10 times earnings, 2.5 times book value and 1 times sales.) Eni also pays an excellent dividend of 6.8%, more than triple that of Exxon.
Italy currently is ground zero in the European debt crisis, and few investors are willing to touch Italian stocks at the moment, but their squeamishness has created what I consider to be a fine opportunity in Eni. The company’s true risk of financial distress is low — its debt to-equity ratio is a very modest 50% — and even if I am slightly off on the timing, investors can collect the dividend checks until sentiment improves.
Oh, and as an added sweetener, Eni also is the best placed among major oil companies to profit from the rebuilding of Libya. Among European nations, Italy has the best and longest-lasting relationship with the Libyan government, and the current government has indicated that Eni’s contracts signed by former dictator Muammar Gaddafi will be honored.