I am tired of listening to market pundits talk about whether one should be "long or short Europe," or the extent of a company's "exposure to Europe." Since at least the advent of the euro, the economies of the Eurozone and investment opportunities have never been so fractious on the continent. The trajectory of the economies of the northern European economies and southern European economies and their respective sovereign bond yields have headed in opposite directions. Can we really lump together a Portuguese bank and an exporting German industrial into the same asset class?
Given the flight of capital from the Eurozone in part due to investors painting the entire region with too broad of a brush, are there high quality, low volatility investments that can be made in Europe? In a recent article, I discussed Dividend Aristocrats, which are S&P 500 (SPY, IVV) constituents that have followed a policy of increasing dividends every year for at least 25 consecutive years. Since Standard and Poor's began keeping index data on these consistent dividend payers at the end of 1989, the S&P 500 Dividend Aristocrats index has subsequently had a higher average return than the S&P 500 (12.05% vs. 9.82%) while having less variable returns (15.11% standard deviation of annual returns vs. 18.67%).
Standard and Poor's also produces an index of consistent dividend payers for European companies, the S&P Europe 350 Dividend Aristocrat index. The index is designed to measure the performance of the constituents of the S&P Europe 350 index that have increased dividends for at least the last ten years, and have a market capitalization of at least $3bn and actively traded float. Since the beginning of the year, while the broader S&P Europe 350 has had a total return of 2.6%, the European Dividend Aristocrat components have returned 8%, outperforming even the S&P 500 index's total return of 6.8% (through close of trading on June 28th).
While market prognosticators were tirelessly bemoaning the travails of Europe, a segment of that market was outperforming the broader market in the United States over the past six months. This article examines the twenty components of the S&P Europe 350 Dividend Aristocrat index that have listings on U.S. stock exchanges or liquid ADR's:
- BAE Systems Plc (BAESY.PK), a global provider of defense and security systems. Given the predominance of defense spending in the United States, the company actually has more employees in the United States than the United Kingdom, and generates nearly half of its revenue in the larger U.S. market. Perhaps these facts mute the European exposure aspect, but looming defense spending cuts in the United States also serve as an overhang. BAE's 7.9% indicated dividend yield is twice that of the average of its largest U.S. competitors - Lockheed Martin (LMT) 4.8%, Raytheon (RTN) 3.7%, Northrup Grumman (NOC), and Boeing (BA) 2.5%, and at 7.3x expected 2012 earnings, BAE trades at about a third discount to the 11.4x expected earnings of its U.S. counterparts.
- BHP Billiton Plc (BHP) is an Anglo-Australian mining company, and the largest mining company in the world by 2011 revenues. Given that much of the world's mining assets reside outside of the United States, there is not a great domestic comparison. The only materials company in the U.S. Dividend Aristocrats index is mini-mill steel producer, Nucor (NUE). With a dividend yield of 3.55%, a dominant global presence, and a tremendous track record of increased dividends, BHP, trading at only 10.6x estimated 2012 earnings, is an interesting diversification play for dividend investors who do no see a lot of opportunities in materials names.
- British American Tobacco Plc (BTI), operating in over 180 countries, bills itself as the most international tobacco company. Tobacco is increasingly a developing world story, and the company's $4.3 billion of revenues in Asia-Pacific in 2011 has surpassed its $3.6 billion of revenues in Western Europe. The former geography had a three year revenue growth rate of 16.1%, while Western Europe declined by 9.2% per annum over the same time period. BTI will continue to transition its business profile to faster growing emerging markets. The company pays an indicated dividend yield of 5.72%, about 210 basis points higher than the dividend yield paid by Phillip Morris International (PM).
- Compass Group (CMPGY.PK) provides catering and support services globally, and ranks as the world's largest foodservice company and operates in over 50 countries. Revenues for fiscal year 2011 of $6.8 billion in North America eclipsed the sum of its revenues in Continental Europe ($3.7 billion) and the United Kingdom ($2 billion), which it lists as separate geographical segments. The largest U.S. comparable would be Aramark, which went private in a management-led leveraged buyout in late 2006. At a current enterprise value/EBITDA multiple greater than the multiple Aramark was purchased for in a period of high private equity involvement, Compass Group appears fully valued, and its 2.15% dividend yield is less attractive than some of the other companies on this list.
- Danone (DANOY.PK) is a French-Spanish food products multinational that boasts top positions in fresh dairy products, bottled water, and baby foods. With a 3% dividend yield and a 15.8x earnings multiple, Danone compares very closely to U.S. food giants General Mills (GIS) with a 3.5% dividend yield and 14.1x multiple, Heinz (HNZ) 3.9%, 15.0x, and Kraft (KFT) 3.1% and 14.9x.
- Diageo Plc (DEO), the British-based largest global spirits producer, boasts North America as its largest geographic segment and Asia-Pacific as its fastest growing region. Like most alcoholic beverage businesses, the company boasts a solid balance sheet and ample free cash flow generation. The company boasts low single-A ratings from the three major rating agencies, and has made no secrets that it will increase leverage for the right transaction or to return cash to shareholders. The stable business profile comes with a premium stock price (14.4x enterprise value to trailing twelve months EBITDA), and only a 2.1% dividend yield.
- Fresenius Medical (FMS) is a German company that produces medical supplies most commonly to support kidney dialysis. Its closest U.S. comparable would be Davita (DVA). Fresenius' capital structure features low BBB rated bank debt, and the company, despite its track record of increasing dividends, still pays a nominal dividend yield of 1.3%, the lowest of the European companies listed here.
- GlaxoSmithKline (GSK) is a British-based pharmaceutical and consumer healthcare company, and one of the five largest pharma companies in the world. At 4.9%, its indicated dividend yield is higher than U.S. pharmaceutical peers Eli Lilly (LLY) 4.7%, Pfizer (PFE) 3.9%, Bristol Myers Squibb (BMY) 3.9%, and Abbott 3.2%. While some have called its pipeline into questions, Glaxo remains high single-A rated and has tremendous scale (its market cap is larger than LLY and BMY combined).
- Imperial Tobacco (ITYBY.PK), based in Great Britain, is the world's fourth largest cigarette company behind the aforementioned Phillip Morris International and British American Tobacco as well as Japan Tobacco, and the world's largest maker of cigars and rolling papers. At only 40% of the size of BTI and paying a dividend over 3% lower than its larger British peer, I would prefer British American Tobacco over Imperial Tobacco absent a material valuation difference, and the companies trade very closely on a EV/EBITDA basis (11.2x BTI vs. 10.7x ITYBY).
- Koninklijke KPN NV (KKPNY.PK) has made global news recently as Mexican billionaire Carlos Slim's American Movil SAB purchased a 28% stake in the Dutch telecom leader. With a forecasted dividend yield of 11.6%, it is the highest yielding stock on this list. American Movil has been speculated to push to cut its dividend and use the money to re-invest in the business or pay down debt, which would end its run on the Dividend Aristocrats. The company's debt is rated mid-BBB, which is not out of line with other Eurotels. Like many European companies who favor the bank loan market to the bond market, the company does have a heavy debt maturity schedule it will need to address over the next several years, and reducing the dividend would be the first option.
- L'Oreal (LRLCY.PK), based in a suburb of Paris, France, is the world's largest cosmetics and beauty company. With a dividend of 2.4%, trading at 18x earnings and an EV/EBITDA of 12x, the company appears rightfully fully valued for a mature consumer products company with a dominant franchise. For reference, the company's market capitalization is 10x greater than recent newsmaker Avon Products (AVP).
- Nestle (NSRGY.PK), the Swiss food and nutrition global giant, is the second largest company on the list behind Royal Dutch Shell. A mid-3% dividend and a 12x EV/EBITDA multiple seems in line with other global food players as seen above in the discussion of Danone. Nestle ranked as the most profitable company in the world in 2011. With it's double-AA rated financial profile, and its recent demonstration of its ability to finance itself at very inexpensive levels (5-yr bonds priced in dollars at 1.38%), the company could become more aggressive in returning cash to shareholders than BBB-rated U.S. companies like KFT, GIS, and HNZ. A defensive Eurozone portfolio would begin with a dominant Swiss food company.
- Novartis (NVS), the Swiss pharmaceutical titan, pays a 4.52% dividend yield and trades at only 10.4x estimated earnings. Only Pfizer, the only pharmaceutical company with more sales in 2011 than Novartis, trades at a similarly low multiple amongst U.S. majors.
- Novo Nordisk AS B (NVO), a Danish pharmaceutical company and leader in diabetes treatments, is next on the list. With a dividend yield of 1.8% and trading at 22.8x estimated earnings, it is perhaps less attractive as a dividend growth play than some of the other pharma names mentioned.
- Pearson (PSO) is a London-based publisher and educational materials company. Outside of the tobacco names, publishing is the industry on this list undergoing the most disruptive changes given digitization of printed material. At 10x EV/EBITDA, the company may be fully valued given the technological changes in its business, but the high BBB rated company was able to tap the dollar bond markets in May with a 10-year offering that currently trades to yield 3.45%, well inside the company's 4.67% dividend yield, so the bond market believes that the company's business profile is quite sustainable.
- Roche Holdings AG (RHHBY.PK), the Swiss pharmaceutical and global healthcare company, trades at 11.4x expected earnings and pays a dividend yield of 4.4%, valuing the business similarly to Swiss peer Novartis.
- Royal Dutch Shell PLC (RDS.A, RDS.B), the oil and gas supermajor, trades at a lower multiple of earnings than U.S. oil companies Chevron (CVX), ConocoPhillips (COP), and ExxonMobil (XOM). Like French oil giant Total (TOT), Italian energy leader Eni SpA (E), British Petroleum (BP), and Norwegian Statoil (STO), the European energy majors trade at lower earnings multiples than their U.S. counterparts despite the current sustained pricing premium of North Sea brent crude to West Texas Intermediate. Given the global nature of oil markets and the fact that it is priced in dollars, it was the place presumed least likely to find a European valuation discount, which makes Royal Dutch Shell's 5.22% indicated dividend yield even more attractive.
- Sanofi-Aventis (SNY) is a French multinational pharmaceutical leader. At less than 10x estimated earnings and with a dividend yield of 4.7%, the company appears attractive. Given the preponderance of pharma names on the list, perhaps a reader with more industry-specific knowledge can opine on relative patent expiries and product pipelines of these European drug leaders.
- Tesco (TSCDY.PK) is a British grocer and general retailer and the second largest retailer in the world as measured by profits, trailing only Wal-Mart (WMT). With a dividend yield of 4.84%, the company pays out roughly 2x more to shareholders than its larger U.S. comparable. The company also trades at only 8.5x trailing earnings, but its chairman Richard Broadbent stated today that the company faces economic challenges and uncertainty in all its markets, which drives this relative discount.
- Vodafone (VOD), is a British multinational telecommunications company that ranks as the world's largest in its space by revenues. The company operates in thirty countries, including the United States through its 45% interest in Verizon Wireless. Despite the large stake in the profitable wireless segment of Verizon (VZ), Vodafone at 11x expected earnings trades at nearly a 40% discount to Verizon's 17.6x expected earnings. With an indicated dividend yield of 7.2%, it is also more attractive to dividend growth investors than the 4.55% offered by Verizon.
While many market participants want to lump all European equity investments together, I hope this list elucidates potential opportunities in European companies that compete in global markets, pay increasing and sustainable dividend yields, and may offer a slight discount to comparable U.S. companies.
Disclosure: I am long SPY.
Additional disclosure: While I hold few single name equity exposures, I am long domestic equities, and the long-term portion of my portfolio is tilted towards solid and sustainable dividend payers. I am evaluating re-deploying equity funds from a heavy concentration in the United States.