After what is shaping up to be an extremely successful 2017 (approaching a stunning 30% return in USD). I want to provide my stock picks for 2018. These might be quite contrarian positions, and I'm looking forward to your views in the comment section.
The great thing about telecom companies is that they have a stable revenue stream that is quite predictable and thus low risk. The downside is that many telecom companies like AT&T (T) and Verizon (VZ) are highly levered and sold off much of their infrastructure to companies like American Tower (AMT) and Crown Castle International (CCI). This makes these strong stable companies a lot more risky than I would like. Abroad, however, especially in Asia, telecom companies have many of the same characteristics but did not leverage the balance sheet.
I especially like Nippon Telegraph and Telephone (NTT), the dominant telecom company in Japan, which also owns much of the countries broadband infrastructure, which is spitting out cash at a rate significantly above earnings. The company trades at a PE ratio of 12.7 while boosting a 2.8% dividend. In addition, it is regularly buying back significant amount of stock both from the government and on the open market. Net debt is only 3.2 trillion yen, which is only 28% of the market capitalization.
While Japan has its problems like a declining population NTT has a strong defensible position which might perform well in a recession due to its defensive position and the existing carry trade which tend push up the value of the yen when it reverses in a global recession.
Personally, I'm not very bullish on China, but if one has a different view on that country and is bearish on Japan, one might want to look at China Mobile (CHL). It has many of the same characteristics, but I'm slightly worried that the Chinese government might use it to bail out a failing competitor.
Furthermore, I like CK Hutchison (OTCPK:CKHUY) which is a conglomerate with significant telecom exposure, great management, and low net debt. The merger in Italy of its telecom assets with VEON (VEON) is creating significant synergies, and the conglomerate gets most of its earnings from stable utilities. The company has a P/E of 11 and is my largest personal holding. For more on this fascinating conglomerate managed by Li Ka-Shing, click here.
Broadcasting and broadband
Historically, broadband players have significantly outperformed its telecom brethren because of their superior cash flow and lower competition. Many consumers have no choice in their broadband supply, which leads to expensive prices. While Comcast (CMCSA) is an interesting investment, especially with the abolishment of net neutrality, I personally would like to invest in this sector with legendary Cable Cowboy John Malone. In addition, I'm more inclined to invest abroad where cable subscription prices are less outrageous and thus cord-cutting less of a thing.
Liberty Global (LBTYA) (LBTYK) is the largest international broadband company with 25 million customers in various European countries. The company has recently sold its small Austrian operations to Deutsche Telecom (OTCQX:DTEGF) for $2.2B. This divestiture is at a valuation significantly above the rest of the company and might lead to additional share repurchases and a revaluation of the company. Another possible value drive is a merger with Vodafone (VOD), which comes up regularly in the news. In the meantime, the company is throwing off cash which is used for significant share buybacks and the buildout of its network. Especially, project lightning in the UK is interesting since the additional cost deteriorate its standard valuation metrics but increase shareholder value. More information on Liberty Global can be found here.
While I in general like to invest in tangible assets, it has become clear to that some companies have strong intangible assets that result in strong tangible performance.
Discovery Communications (DISCA) (DISCK) is such a company. While it already had a strong run because of the Fox (FOXA) acquisition by Disney (DIS), I think the stock might have further to run. The company which is famous for its namesake, Discovery Channel has strong viewership and has seen earnings and cash flow increase steadily over the years. The stock lost more than 50% of its value because of fears related to cord cutting and the acquisition of Scripps Network (SNI). While cord-cutting is a real threat, I think the problem is slightly overstated and exacerbated in the US by inclusion of expensive live sport in all the bundles. The acquisition of Scripps is a smart move in my opinion since it gives Discovery a stronger negotiating position and allows Discovery to bring popular Scripps programming abroad. A totally different catalyst for Discovery are the European viewing rights for the Olympic games for the next 6 years. This might allow for additional growth, which is so highly valued in today's market.
Downside of all Malone's companies is that they have a significant debt load and no dividend. While debt is always prudently structured and easily covered by cash flows, it still is a reason for concern with the possibility of rising rates. Especially in the case of Discovery Communications, this is important because to finance the acquisition and retain its investment grade rating, the company had to stop its share buyback program till debt is reduced to more reasonable levels.
It is no secret that the Italian economy is saddled with too much debt. Many banks are struggling with bad loans and have to do significant writeoffs. The situation is not good but improving. Unemployment is still high at 11% but declining from 13%, while youth unemployment is at 35% but down from 43%. Household debt to GDP is only 41.4% and declining together with total private debt. These improvements make it likely that the worst might behind us, and banks might benefit from lower writeoffs on loans. My favorite Italian bank is MedioBanca (OTC:MDIBF) because of its strong balance sheet and exposure to asset management. In addition, MedioBanca is the leading Italian investment bank which can profit from the restructuring of loans and the recovery of business sentiment. While the stock has increased significantly, it is still trading below book value, a P/E of 11 and has an attractive yield of 3.88%. The main risk is that the Italian economy does not continue to improve slowly but is hit hard in another recession. I think the chances of that happening are quite small, but given the serious amount of debt the company has on its balance sheet and relatively small but growing deposit base, MedioBanca could be vulnerable.
French car manufacturers
While they might not have the stellar reputation that their German counterparts once had Peugeot (OTCPK:PEUGF) and Renault (OTC:RNSDF) are performing great recently. Peugeot has turned around its operations under a new brilliant CEO named Carlos Tavares. Due to significant cost-cutting, Peugeot is currently enjoying high 7.3% margins and is sitting on a huge pile of cash. The acquisition of Opel from General Motors (GM) did not really put a dent in it because of the low acquisition price. Opel was making losses for 17 straight years, and GM desperately wanted to get rid of it. If Peugeot can turn Opel around like it did with its own operations the company is a ridiculous bargain. Especially given the potential synergies that are created by adding scale and becoming the clear number 2 in Europe behind Volkswagen (VLKAY). Peugeot has reinstated its dividend this year, but the yield is only 2.81%, and it sports a P/E of 9 while holding close to 50% of its market value in net cash. For investors with access, it might be interesting to invest in Groupe FFP which has a significant holding in Peugeot.
Renault as its close French competitor is an interesting value play as well. Due to its 43% holding in Nissan (OTCPK:NSANY), one might argue that Renault is the holding company of the largest car manufacturer in the world. The Renault-Nissan alliance is growing rapidly and has a strong electric lineup. Due to a smart investment in Russian leading car manufacturer AvtoVAZ, sales are accelerating even further. In addition, it helps Renault benefit from a recovery in Russian car sales. Renault trades at a P/E of 5.5 has a decent balance sheet and pays a 3.74% dividend. The company is also attractive as a sum of parts analysis given its stakes in Nissan, Daimler (OTCPK:DDAIF) and AvtoVAZ. For more information on this cheap car company with leading position in electric cars, click here.
Why these stocks
The US market has been in a long-term bull market, which has caused me to look more abroad. Increasing rates make bonds more competitive, which might be a problem for bond surrogates like high dividend paying stocks, especially when the dividend coverage is poor and the growth prospects limited. The gap between bond and equity returns is a lot higher in Europe and Japan. This is caused by both lower interest rates and lower valuations for equity. While I think the above-mentioned stocks have most upside, it might be a good idea to invest in some high quality companies like Brookfield Asset Management (BAM) and Berkshire Hathaway (BRK.B) as well even if they might approach full value. I would caution investors to be careful with expensive stocks which are deemed safe. Like Coke (KO), US Telecommunication, and US utilities. Those stocks do not seem to have much growth potential are commonly highly leveraged and only sport dividend yields, which are either not high enough or not supported by cash flows. These stocks are likely to underperform in bull markets due to their defensive nature and in bear markets due to their high valuation and debt load.
While some of my stock picks have clear risks like the cyclic tendencies of the car market or the potential for accelerated cord cutting, the companies trade at cheap valuations and can therefore have attractive returns even if the situation deteriorates somewhat. In addition, some companies are extremely stable and have rock-solid balance sheets and are unlikely to deliver returns in most market environments. That next year might deliver satisfying investment returns to all.
Disclosure: I am/we are long BAM, BRK.B, RNSDF, CKHUF, MDIBF, DISCK, LBTYK.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I hold shares in Groupe FFP.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.