Blood In The Streets, Portugal (Part 2)

by: Paulo Santos

This is part 2 of a multi-part series on the European periphery stock markets (part 1 can be found here). The logic is that, as Baron Rothschild once said, "The time to buy is when there's blood in the streets." The series of articles seeks to look at the major quoted stocks in Portuguese, Spanish, Italian and eventually Greek and Irish stock exchanges, to see if the spilt blood has already produced any incredibly obvious investment opportunities.

In looking at the stocks, I'll try to gauge the sensitivity to internal demand, some factors important to their industries, the multiples they trade at and how the local stocks compare with U.S.-listed alternatives in the same sectors. Obviously to trade some of these markets investors would need an account with a full-service broker.

I started with the Portuguese PSI20 Index. This index has the following 20 constituents (well, actually 19 until September) and in this article I'll cover those bolded:

  • Altri
  • Banco Comercial Português
  • Banco Espírito Santo
  • Banco BPI
  • Brisa
  • Espírito Santo Financial Group (OTC:ESFOF)
  • EDP Renováveis (OTC:EDRVF)
  • Galp Energia (OTC:GLPEF)
  • Jerónimo Martins (OTCPK:JRONY)
  • Mota Engil
  • Portugal Telecom
  • Portucel
  • REN
  • Semapa
  • Sonae SGPS
  • Sonae Indústria
  • SonaeCom
  • Zon Muiltimedia

Espírito Santo Financial Group

Espírito Santo Financial Group is a holding company, whose main asset is its 26.4% stake in Banco Espírito Santo. ESFG also has other relevant positions including a 100% stake in insurance company Tranquilidade and some smaller stakes in health providers.

ESFG is as exposed to the internal demand dynamics and overleverage of Portuguese society as BES, but might represent a closer position to the Espírito Santo family than BES itself. It's probably a better buy than buying the bank directly, but seems too risky anyway, given the complex structure.

Taking into account its earnings report for 2011, these are the multiples that ESFG presents today (all values are in euros):

For comparison purposes, Bank of America (NYSE:BAC) trades at a similar price/book (0.35 vs 0.32 for ESFG) without the grief of holding a Portuguese financial entity. ESFG manages to present a lower P/E but remains scary due to all the leverage involved (at ESFG and BES levels) given the circumstances Portugal finds itself in.


EDP is the major electricity utility in Portugal. A former monopoly, it has been privatized over the years. It still acts under a regulated regime where returns are dictated by a sector regulator (ERSE), though the market is being gradually opened to competition. EDP also has some gas distribution (propane) assets both in Portugal and Spain, as well as electricity generation and distribution in Spain and Brazil.

Although some impact from a drop in Portuguese internal demand is to be expected, the utility nature of EDP's business should keep it reasonably insulated from any major business downside. During 2011, 58% of EDP's EBITDA was generated outside Portugal (though that offers little help, as much of the remainder came from Spain). Also, 90% of EBITDA came from regulated activities (which are usually a lot more stable).

One important detail regarding EDP's business is that electricity rates have been kept below what the rules called for, both in Portugal and Spain. This has built up a "tariff deficit," that is, an amount that EDP ought to recover from the consumers in the future. This makes EDP look more in debt than it really is.

Taking into account its earnings report for 2011, these are the multiples that EDP presents today (all values are in euros):

Finally, we can say that a true bargain has emerged. Although EDP's debt precludes its EV/EBITDA from being as low as we'd like, what we still have here is an gas and electricity utility trading for 4.7 times earnings, 0.6 times book value and yielding 10.4%. This certainly compares favorably even with U.S. utilities like Duke Energy (NYSE:DUK), which trades at 19 times earnings, 1.3 times book value and yields 4.6%, or American Electric Power (NYSE:AEP), which trades at 10.2 times earnings, 1.4 times book value and yields 4.5%.

EDP Renováveis

EDP Renováveis is one of largest renewable energy providers in the world. EDPR is focused on wind energy, which is borderline competitive without subsidies, though those and tax credits are still very important in the sector. Its main shareholder is EDP, with a 77.5% interest, but 22.5% of the company trades freely in the market.

EDP Renováveis has operations in Europe (Spain, Portugal, France, Belgium, Poland and Romania), the U.S. and Brazil. Almost half (45.7%) of its EBITDA comes from the U.S. Its operations in Europe are dominated by its presence in Spain, with 60.3% of its European generation capacity being held there, and just 16.8% being in Portugal.

Although EDPR is not really subject to the internal demand erosion coming from austerity measures, it does have a number of risks, namely:

  • In the U.S., there are doubts about the renewal of the production tax credit, which pays 2.2 cents/kWh for a wind project's first decade in operation adjusted for inflation. Although EDPR's existing capacity wouldn't be hit if this measure is not extended, it would make it harder to continue growing in the U.S.;
  • Generally, the pressure on governments to control budget deficits can be an headwind for renewable energy, though this risk is higher with solar energy;
  • More importantly, low natural gas prices due to the shale boom in the U.S. can disturb wind's economics, especially after the production tax credit is exhausted. On the other hand, rising natural gas prices can be a boon.

Finally, there has been some speculation that EDP might choose to delist EDPR by buying back the remaining float.

Taking into account its earnings report for 2011, these are the multiples that EDPR presents today (all values are in euros):

All in all, though on some measures EDPR is not incredibly cheap (I am thinking about the 23.2 P/E), in others it already seems attractive, such as the 0.4 times book value and 6.8 times EV/EBITDA for a rare, renewable energy pure play.

Regarding U.S. stocks for comparison purposes, it's actually hard if not impossible to find any other pure play wind park operators quoted in the U.S. markets. Most wind parks in the U.S. are held within much larger, diversified, utilities. This also shows the uniqueness of EDPR.

Galp Energia

Galp is a large Portuguese petrochemical company, with a presence in exploration, production, refining and distributing oil products. Presently the company is slanted toward refining and distribution, however it has made a large investment exploring offshore crude deposits in the Brazilian coast, and in the future its production component will be significantly larger, as can be gleaned from the company's annual report:

The Company aims to produce more than 70 kboepd in 2015 and more than 300 kboepd in 2020. These targets are supported by Galp Energia's reserves of 709 million barrels of oil equivalent (Mboe) and 2,672 Mboe in 3C contingent resources as of the end of 2011

Galp presently has a large exposure to the Iberian (Portugal, Spain) markets, in its refining and distribution segments. However, refining margins are usually set on a broader market so aren't really as exposed to the Iberian economic dynamics. As for the distribution margins, those could conceivably be hit. Exploration/production margins, as that segment ramps up, will also be set on a worldwide scale.

Taking into account its earnings report for 2011, these are the multiples that Galp presents today (all values are in euros):

As it stands, Galp seems reasonably valued, not incredibly cheap. Sure, it's not very vulnerable to Portuguese internal demand dynamics, but still one would hope that the general stock market panic would drive it cheaper. In terms of U.S. quoted companies, Exxon Mobil (NYSE:XOM) is present in all of Galp's segments, and it trades for a significantly cheaper P/E of just 10.2 times, though it's a lot more expensive in terms of price/book value, at 2.5 times versus Galp's 1.2. XOM is also cheaper on an EV/EBITDA basis, trading at 5.8 times versus Galp's 7.7. Finally, XOM yields a bit more at 2.7% versus Galp's 2%.

All in all, Galp doesn't yet trade at distressed levels and is thus not an obvious opportunity.

Jerónimo Martins

Jerónimo Martins is a large-scale distribution company operating hypermarkets and supermarkets in Portugal and Poland. It also has a small (3% of revenues) industrial operation.

Jerónimo's fast growth in Poland has insulated it from the slow Portuguese economy. Indeed, 63.5% of Jerónimo's 2011 EBITDA and 58.8% of revenues already came from Poland. This had another effect, however. It also insulated Jerónimo from the drops in the Portuguese stock market. No blood to see here.

Taking into account its earnings report for 2011, these are the multiples that Jerónimo Martins trades at today (all values are in euros):

Basically, Jerónimo Martins trades with the multiples of a growth stock, with a P/E of 23.2 times, EV/EBITDA of 11.3 and price/book of 5.6 times. No distress to be found here, for sure. A comparable U.S. stock would be Costco (NASDAQ:COST), also growing briskly and trading at a P/E of 26.2 times, EV/EBITDA of 10.5 times and price/book of 3.3 times - basically similar levels. Given the food distribution component, we might also compare Jerónimo to The Kroger Co. (NYSE:KR). Kroger is growing slower, but also has lower multiples, with P/E at 20.4 times, EV/EBITDA at 4.9 times and price/book at 2.9 times.

Anyway, what we can learn from Jerónimo is that the market is not panicked enough to throw out the baby with the bathwater, so no discount here.

Conclusion up to this point

After going through 10 different Portuguese stocks, only one seems a clear opportunity (EDP), while another - for slightly different reasons - might be interesting (EDPR). Some of the banks (BCP, for instance) might conceivably be cheap but are too reliant on political decisions, which might end up diluting shareholders heavily (and then again, might not).

(to be continued)

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.