Bet On Italy's Political Deadlock With These 4 Stocks

Summary

• As I had anticipated, the Italian elections held on March 4th failed to result in a clear winner or in a parliament majority.
• At this point, even new elections would hardly change this state of affairs.
• The Italian economy will benefit from the current stalemate, as I previously explained.
• Accordingly, Italy could become a good optionfor patient investors within the next 3-4 years.
• I have selected four Italian companies with anexcellent risk/reward potential to wisely bet on Italy.

In my previous article about Italy, it didn’t take a crystal ball to predict what would have happened.

It’s highly unlikely that a government led by only one (or two) political faction will be formed, due to the combination of political fragmentation and ineffective electoral law.

At this point, the different political parties could even decide to continue with Paolo Gentiloni’s temporary government, in order to avoid a quick drop in approval ratings if the social and economic conditions worsen.

Instead, early elections are very unlikely to happen, despite being constantly proposed by the various political leaders, because the Italian President Sergio Mattarella is clearly against them. Moreover, due to the current electoral law, new elections will almost certainly result in the same situation we are facing now.

Italy will probably benefit from a minority government

As I already explained in my previous article, a scenario like the current one will probably turn into the best opportunity for Italy at the moment.

If we had a clear political majority, it would support a government inclined to boost its approval ratings by promoting popular deficit spending measures and fueling a useless controversy with the European partners.

Since the day after the vote, the Italian stock index has performed better than the S&P 500 (NYSEARCA: SPY):

Source: Yahoo Finance

This trend is deemed to continue at least until there is a government with a clear political majority.

Patent Box

During the second half of the year 2015, Italy introduced a new tax break for firms that make a profit from certain intangible assets, like trademarks and patents, software, design, know-how, etc.

We are talking about a considerable tax relief that will consistently increase the profit margins of eligible Italian companies. It starts with a 30% tax benefit for the 2015 fiscal year up to 50% in 2018 and the years after.

Due to the complex calculations, companies that want to take advantage of such tax benefit are forced to contact the Italian Tax Authority and reach an agreement with them.

Naturally, this takes time. That’s why it wasn’t until last year that we saw an improvement in profits due to such tax break, in the form of tax refunds for the previous fiscal periods.

Therefore, it is now worth taking this into account when we evaluate investments options within Italian companies.

Four companies to consider in order to take advantage of the Italian golden opportunity

Ishares MSCI Italy Capped EFT (NYSEARCA: EWI) or the cheaper Franklin FTSE Italy ETF (NYSEARCA: FLIY) are both valid options (the latter is right now traded at a significant discount compared to its NAV).

Their holdings list is almost identical:

Top 10 Holdings (65.69% of Total Assets)
Intesa Sanpaolo	11.18%
UniCredit SpA	10.41%
Enel SpA	9.88%
Eni SpA	9.26%
Assicurazioni Generali	5.75%
Fiat Chrysler Automobiles	5.35%
Ferrari	3.94%
Atlantia SpA	3.85%
CNH Industrial	3.33%
Snam SpA	2.74%

Click to enlarge

Author’s elaboration

The first two holdings are the biggest Italian banks. The fifth in the list is the largest Italian insurance company. Here, I don’t like the exposure to the credit sector very much, to be honest.

Credit and Real Estate are dead money right now in Italy. It is not easy to predict how and when these two sectors will eventually turn around.

I would rather buy shares of four Italian companies that have a strong presence in foreign markets.

The first on my personal list is Cembre S.p.A.(BIT:CMB);

Next are, in alphabetical order: Interpump Group S.p.A.(MILAN:IP), Natuzzi S.p.A. (NYSE:NTZ) and Prada Group S.p.A. (OTCPK:PRDSY).

All these companies are very interesting for the long run, so this article will be a sort of initial overview of all of them.

Here, I will provide the most important information and a brief description. In the future, you will be able to read more detailed articles about them, if you follow me.

I have recently begun to initiate positions on these stocks for me and my family.

Cembre

This wonderful company is headquartered in Brescia (a small town close to Milan, Italy’s financial capital) and is the European leader in the manufacturing of electrical equipment, like crimp-type connectors and related installation tools.

About 40% of the net sales comes from the Italian market and the manufacturing takes place in the factories Cembre owns in Italy (Brescia) and in the UK (Birmingham).

Sales grew more than 9% in 2017, with some specific remarkable production lines like railway products, cable markers and cable glands, exceeding the total sales average growth rate (cable markers in particular grew 21% and they represent now 17% of total sales).

Source: Company’s presentation

Gross profit stands at 52%, indicating a terrific company moat, and the operating profit is 17% (pretty good). This number will probably go up in the years to come, considering that the company has already reached an agreement with the Italian Tax Department for a patent box tax benefit for the years 2015, 2016 and 2017, amounting to €3.9 million. The tax break will continue and probably increase in the future, giving the company additional cash to invest into the development of its business.

	2013	2014	2015	2016	2017
Revenue	105	114	122	123	133
Gross Profit	52	58	64	66	71
Gross Profit %	50%	51%	52%	54%	53%

Click to enlarge

Company's Gross Profit performance, all data in Million €

Cembre’s total capitalization is less than €0.5B, with an interesting low price-to-book value of 2.8 without intangibles.

The company pays a remarkable dividend to its shareholders (average yield of 3.6% in the last 16 years).

Interpump

This company is located in Emilia (the same region of Ferrari, Lamborghini and Ducati, if you know what I mean) and has for the umpteenth year beaten the analysts' estimates, increasing its top line by 17.7% and its net income by almost 40%.

Using a clever strategy of acquisitions, this top-class high-pressure pump manufacturer has managed to grow its top line from €297M to €1087M and its EBITDA from €68M to €249M in the last thirteen years (10.5% Compounded Average Growth Rate). It’s worth noting that even in 2008, in the middle of the last world financial crisis, Interpump managed to be profitable with an EBITDA of €48M.

This is how the group performed against S&P 500 and Dax Index in the last years:

Source: Yahoo Finance

The company's organization is divided into two production departments: water jetting (with a world leadership in the high-pressure plunger pistons for water and other fluids) and hydraulics.

The Group realizes only 18% of its turnover in Italy, with the hydraulics division (the largest of the two with about 64% of the company's turnover) selling about 22% in Italy.

Source: Company’s presentation

It’s worth mentioning that about one third of the water-jetting revenues come from after sales service.

Its gross profit is currently at 38.1%, in acceleration from a 5-year average gross profit of 36.6%, and its operating profit is more than 18%.

	2013	2014	2015	2016	2017
Revenue	557	672	895	923	1087
Gross Profit	203	245	318	338	414
Gross Profit %	36%	36%	36%	37%	38%

Click to enlarge

Company's Gross Profit performance, all data in Million €

This is the FCF trend over the last years:

Source: Company’s presentation

Two of the latest company acquisitions (the Spanish Inoxpa and the Italian Mariotti&Pecini) are highly strategic, allowing Interpump to enter the fluid handling market space.

The two companies will be able to create promising synergies, as mentioned in the last annual report. Thanks to Inoxpa, the Mariotti & Pecini group (leader in the design and production of mixers and mixers used in the chemical, pharmaceutical, cosmetic and food industries) will have greater sales opportunities in foreign markets.

This also integrates Inoxpa's product line with its proprietary technology for magnetic transmission agitators.

Source: Company’s website

Another interesting early acquisition for 2018 is GS-Hydro, a company that revolutionized the piping industry with the invention of non-welded pipe assembly technology. Interpump reported to have paid a total acquisition price of €9M for a company that, in 2017, according to estimates, realized €60M in Sales, €4M in EBITDA and €3M in Net Cash.

Natuzzi

I already covered this small cap furniture company, whose headquarters are in Apulia, a lovely region in the south of Italy (disclaimer: I live there, but it’s truly charming, I swear!).

Natuzzi S.p.A. is an international company, with shops (both franchised and directly operated) all around the world and more than 90% of its net sales realized abroad.

The recent Joint Venture with Kuka (Jason Furniture) paves the way for a new and very promising scenario for the group.

At a price lower than its tangible book value per share, I find today’s level an interesting entry point for long term investors.

Prada

The worldwide famous Italian fashion design company has gone through a difficult time in recent years. Decreasing turnover trends and falling profits caused the group's share price to lose more than 70% between 2014 and 2016.

The minimum of about $5 reached in January 2016 was surely too low and, in the following two years, the group’s shares in fact gained more than 100%, definitely outperforming the market.

Even at current levels, however, with a P/B value of about 3.63, the stock does not seem expensive, especially if we consider that, among the assets, the considerable brand value of the group is only partially accounted for.

Source: Statista

The 2017 results seem encouraging, with a gross margin increase to 73.5%,

Source: Company’s presentation

together with the group' sales profits finally growing in the second part of the year (+1% at constant FX):

Source: Company’s presentation

The FCF is more than $200M with a Capex structure, however, modified compared to 2016 (plus corporate & industrial and minus retail expenses).

Prada ends 2017 with 2 net shops openings (25 openings and 23 closures) and 140 renovation and/or relocation projects.

The data reported are not yet affected by the tax benefit related to the patent box that the group is still negotiating with the Italian tax authorities. When the picture becomes clearer the general situation will look even better.

Prada Digital Transformation

Prada intends to hasten the company’s digital transformation with the goal of recovering from the declining profits and sales of the past few years.

Last December, the company launched its first e-commerce platform in China with enhanced on-line services like:

• Shipping from main Prada stores
• In-store pick-up
• Integration with social WeChat and Alipay

Source: Company’s website

In 2018, a project based on cloud computing and the Microsoft Data Platform will start.

The idea is to collect, in an integrated way, data from the interactions with customers from sales points, e-commerce and social networks, in order to diversify strategies and develop targeted marketing actions.

This strategy is already delivering interesting results, especially with respect to younger audience.

Conclusions

As I previously anticipated, the Italian political stalemate, resulting from the predictable outcome of the March 4 elections, is probably destined to last for a long time.

The resulting climate of uncertainty will lead both Italian and European economic and political players to face the future with greater attention and commitment.

The Italian economy as a whole will benefit, as it happened in Portugal and Spain, two other Mediterranean countries that have experienced a similar political situation over the past few years.

In order to capitalize on this situation as much as possible, my advice is to start allocating part of the equity portfolio to these four Italian companies: Cembre S.p.A, Interpump Group S.p.A. Natuzzi S.p.A and Prada Group S.p.A.

These groups operate in different sectors (Fashion, Design and Furniture, Mechanical and Electrical Equipment), but they all have a decidedly low risk/reward ratio to current prices.

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.

Analyst’s Disclosure: I am/we are long NTZ, IPGLF, PRDSY. 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.