Best European Stock Ideas Today: 10/24/2014

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Includes: BPCGY, EBKDY, GSK, IR, KBCSY, PSO, SWMAY, TLTZY, TYEKY, UL, VOD, VOLVY
by: Aviate

1. The importance of Sunday
2. RBS, Ireland and KBC
3. Telco/Vodafone: a play on price, at least its second derivative
4. The other large-cap dividend re-weight candidate, GlaxoSmithKline
5. ThyssenKrupp: rebound continues
6. Volvo: good conference call: cost savings program now clear
7. Trader watch

1. The importance of Sunday

The AQR results will be published at 11 a.m. GMT Sunday with a press conference following at 11:30 a.m. The consensus expects c11-15 banks will fail. Names most cited include Banco Comercial Portugues (OTCPK:BPCGY), BMPS, Banco Popolare, Erste Group (OTCPK:EBKDY), some of the Greeks and a non-quoted Landesbank. Ex failures, the release should act as a positive catalyst by lifting a negative risk that has hovered over the sector for most of this year. It removes uncertainty and should help lower funding costs, especially in the periphery. Should it lead to more lending it creates a virtuous cycle, one that links to the TLTRO where at the March tender banks can borrow up to 3x the improvement in net-lending (ECB lending survey, next Thursday, is critical here as well). It could also be the catalyst to ignite long-needed consolidation, especially in over-banked regions like in Italy. Banks are outperforming QTD despite a market meltdown (interesting). They provide the vast majority of potential EPS upgrades, have outperformed already this year and yet are poorly owned (think tracking error/performance chasing), have policy at their back and are cheap. Now, before we get carried away there are of course huge risks, and these are rents, not owns (ex the bond-like ones) but due to what we have written these past few weeks, we remain tactically overweight Banks into year end.

2. RBS, Ireland and KBC

While we suspect this is known to the specialists, it was news to us. KBC (OTCPK:KBCSY) has large un-utilized provisions in its Irish book, a region growing at a 7% GDP clip and with house prices rising 13% YoY. RBS recently wrote bank 300m in provisions for its own book, and if KBC were to follow the impact on earnings could be material. We understand they have provisioned €2.5bn for Ireland vs. expected profits of €1.5bn this year… and on 9x next year?

Not a bank we know well, but food for thought.

The one we know better is RBS, and we remain a buyer (here).

3. Telco/Vodafone: a play on price, least its second derivative

Interestingly, the EU commissioner for the digital economy Oettinger says the EU should promote mergers of small regional IT and telecommunications companies, saying the EU telecom market is too fragmented, too unprofitable and the goal must be to allow companies to make "fair profits." He also doesn't object to loosening net neutrality. These are supportive comments and go to the heart of our comments on pricing yesterday.

We continue to find Vodafone (NASDAQ:VOD) interesting.

The staples sector is well owned for safe yielding plays but this earnings season is not doing you any favors. The overwhelming theme is pricing pressure. So for a stock like Unilever (NYSE:UL) now seeing 2.7% price deflation in EU - it's harder to justify the high multiple you pay for "earnings resilience, when this resilience is being questioned (NB this is just a European phenomenon for now). The flip side of course is to look for high-yielders with pricing power, or those well versed in price deflation where the rate of decline is improving. As discussed, telcos could stand out here, especially after what the CFO of Orange (NYSE:ORAN) said yesterday "the end of phone bill repricing is approaching."

Vodafone yields 6% vs. Unilever's 3.8%….

NB: Riccardo puts a buy on Tele2 (OTCPK:TLTZY) today, interestingly it is making a 14-year high.

4. The other large-cap dividend re-weight candidate, GlaxoSmithKline

We would continue to buy GlaxoSmithKline (NYSE:GSK) shares as well (here)

5. ThyssenKrupp: rebound continues

We know Kone (OTCPK:KNYJY) well (and are very bullish) and while that is a much better business than ThyssenKrupp (OTC:TYEKY) and has much higher margins, its equity is perhaps not worth 2x what is currently implied in the ThyssenKrupp price. Assume a more reasonable discount, say 30%, and market multiples for their other businesses ex the steel business, and you get close to the share price, meaning very little implied value for steel making is quite a powerful swing factor. In steel TKA made €245m in EBITDA last quarter, a big acceleration and annualizing at over €900mn. Steel peaked at €1.7bn, but that's many years off but perhaps not unfair to assume mid-cycle potential of c€1bn and a 5x multiple, another €5bn added to their EV of €14.8bn, or 25% upside. The reason we think it's interesting to look at steel now is the big costs, ore and energy have collapsed recently, whereas HRC prices have held-up (are up 2% since July). Demand in the biggest market has seen a jump in Industrial production (see German PMIs yesterday) and a return to expansion in construction (construction PMI at 50). This comes at a time when the world seems to have given up on Germany, and TKA is rebounding from one of its most oversold conditions in years.

Stay long.

6. Volvo (OTCPK:VOLVY): good conference call: cost savings program now clear

A good Q3. The US is bailing out both trucks and CE (trucks weak in LatAm and fading in EU, CE disaster in China and EU waning) and FX tailwind will get stronger probably in Q4. It marks a change it would seem. The big change is on the cost saving program, which has come in for criticism and as evidenced on the call. Many analysts still don't understand it, not helped by how it was explained.

On costs, management is taking structural (permanent and non-volume related) cost savings from SEK 6.5bn to SEK 10bn, within the same time period as the previous, i.e. by end of 2015. This means we should expect to see this difference in the FY16 accounts versus 2012 accounts. It's a clean net number, net of FX too. So far only 2.4bn has been done (at just OVER the half way stage). So there are big savings to come. The confusion comes because the previous plan had 6.5bn of structural (below gross margin) and 2.5bn of "other" - but this other, which has been delivering cannot be measured properly, and is being dropped altogether. It's still there and will help, but can't easily be demonstrated. Management is sticking its neck out and making the number clear.

So with pricing good on the model cycle (EU still to come in trucks), volumes flat, cost savings, FX tailwind and lower amortization charges (from cap R&D), Volvo has a chance of getting back to proper margins, well above where the worst fears were.

7. Trader watch

i) Ingersoll Rand (NYSE:IR) + 4% in the US.

Closely correlates with Schneider.

ii) Pearson (NYSE:PSO) CFO leaving

Clearly not a positive.

iii) Swedish Match (OTCPK:SWMAY), stay long.

Headline figures all beat, keeps dividend policy unchanged. Q3 Rev SK3.4bn vs. 3.37bn est., Q3 OP 989mn vs. 963mn est., Q3 net income 695mn vs. 679mn est. Q3 snus and snuff margin 44.8%. Keeps dividend policy. Outlook sees Scandi snus market to continue to grow in 2014, and the US market for moist snuff/snus to grow in 2014, but US market for cigars to remain highly competitive.

iv) More

Riccardo has a new buy on Tele2 today. He reiterates his buys on Derwent London, Givaudan (OTCPK:GVDNY), Swedbank (OTCPK:SWDBY) and he's still bullish REITs. He reiterates sells on Andritz (OTCPK:ADRZY), Subsea 7 (OTCPK:SUBCY), Richemont (OTCPK:CFRUY), Volvo and Michelin (OTCPK:MGDDY).

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