With the stock market off to a solid start two weeks into the new year and following a string of mostly positive economic reports, investors have warmed up pretty quickly to U.S. equities. This, of course, has been playing out for a couple of months as market pundits and equity strategists developed and announced their predictions for the new year. While we mostly subscribe to the view that U.S. stocks seem well positioned for a decent run in the years ahead, especially as the U.S economy continues to recover and the Europeans slowly sort out their fiscal mess, we have started to look at European equities as perhaps the best place to hide from the crowd. More specifically, as investors shun the stocks of European companies simply by virtue of their domicile, we think several companies offer compelling investing opportunities for those willing to tune out all the noise.
We do not yet grade companies listed in European exchanges, so our analysis is mostly limited to those with American Depositary Shares. More specifically we have looked for companies with strong MarketGrader scores, of course, but also with compelling valuations and a significant share of their business generated outside of Europe’s sickest areas in the continent’s indebted south. And those domiciled in countries with their own currencies, and thus monetary policies independent of the ECB, seem to us to offer even greater appeal. Among them we find a handful we’ll be highlighting in this column in coming days. The first one, and perhaps one of our three favorites, is Statoil ASA ADS (STO).
Statoil is Norway’s national oil company. It generates 78% of its revenue in Norway, 10% in the U.S. and another 10% across the rest of the world. While Brent crude has traded around $110 a barrel for the better part of the last year, the Norwegian Krone has depreciated by approximately 15% in the last six months against the U.S. dollar, mostly because of the strengthening of U.S. economic indicators, a dynamic that boosts the value of the company’s dollar-based revenues. And as it happens to be, Statoil, with an overall grade of 78.8 (out of 100,) is the highest ranked company among the 18 oil ‘majors’ followed by our system and classified in the Integrated Oil industry. Chevron (CVX) and Suncor Energy (SU) round out the top three in the group.
Statoil’s 12-month trailing net income of $11.4 billion is up 25% from three years ago, which might not seem like a hit-it-out-of-the-park number but considering that in the depths of the global recession two years ago, for the 12-month period ended in September of 2009, the company earned $2.08 billion, the latest results reveal a remarkable comeback as energy demand roared back to life. Of particular importance is the fact that even though capital expenditures have been growing at a year-over-year clip of about 25% in the last four quarters, the company’s free cash flow last quarter almost tripled from the year-earlier period. This helps explain an across the board margin expansion in the last 12 months, with EBITDA margin at an impressive 41.7% and operating margin of 29%.
Statoil’s stock trades at only seven times trailing 12-month earnings despite a two-year EPS growth rate of 134%. Its P/E based on the next 12 month’s earnings estimates is only 9. Furthermore, if the company’s $17.04 billion in cash is subtracted from its valuation, the stock’s trailing P/E would fall to a ridiculously low 5.7.
It’s important too that investors understand the company’s ownership structure, which we think adds to its appeal. The number of shares outstanding has remained virtually unchanged in the last five years, at 3.18 billion, probably as its largest shareholder, the Norwegian government who owns 71% of them, prefers to avoid diluting its stake considering how important the company’s contribution is to national coffers. To put this into perspective, Statoil’s 12-month trailing revenue of $110 billion is the equivalent of 41.5% of Norway’s GDP of $265 billion, according to the IMF’s most recent figures. With such a small float (29%) owned by shareholders other than the government, even a small increase in demand for the stock, such as what would happen once it’s clear that Europe will sort out its current troubles, could drive up the share price pretty quickly. And while at $80 billion in market cap the company’s valuation might seem too high to move to the upside too quickly, at $25 (Tuesday’s close) the stock is trading 40% below its pre-Lehman high of $41.68, reached in May of 2008. And yet when the company reports earnings next month February 9th, if the consensus estimate is somewhat close to the reported number, Statoil is expected to have earned $2.67 per share, above the $2.63 earned in fiscal year 2007, right before the financial crisis brought the world economy to a halt. The company’s return on equity, currently at 26.23% is also almost back to the pre-recession level of 28%.
Statoil’s $20.35 billion on total debt, or $3.3 billion in net debt when cash on hand is subtracted, accounts for only one third of its total capital, giving the company ample room to increase its dividend payout which at current levels translates into a yield of 3.9%. And with interest rates at rock-bottom levels and the company’s excellent return on equity and return on invested capital (52.4%) it would be silly not to continue funding exploration and production projects with additional debt. It would also be silly for investors to assume Statoil is simply another European stock to avoid.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.