Good European Plays: Smith & Nephew, Anglo American, and WPP Group

Includes: AAUKY, SNN, WPP
by: Zacks Investment Research

European stocks are feeling the affects on the economic slowdown in the U.S., but with growth accelerating elsewhere around the globe, might the European markets be benefiting more than in the past? We spoke with Zacks senior equities analyst Duong Vuong, CFA to find out.

Let’s talk about one of your most recently issued research reports. Which company was it on, and how is it doing?

Recently, I completed an equity research report on Smith & Nephew (NYSE:SNN) . In it, I mentioned we are maintaining a Hold recommendation after the company’s first quarter results.

The company is benefiting from its Earnings Improvement Program [EIP], and the recent stock buy-back should provide support to the stock. The stock is trading below its peers, but with the uncertainty surrounding sales practices at its European subsidiary, there is little upside in the near term.

Smith & Nephew is a U.K.-based global medical device company that employs over 7,000 people and operates in 32 countries. It develops, manufactures and markets orthopedic, endoscopic, and advanced wound management products. The company’s geographical breakdown is as follows: Europe 31%, America 48%, and Africa, Asia, and Australia 21%.

Tell us a bit about the sales practice concerns.

The company’s weak quarterly results were largely related to the ongoing integration of the Swiss orthopedic Plus, a company that SNN agreed to buy in March 2007 for $889 million. The company said that when it started to integrate the business, it uncovered "unacceptable" sales practices in certain parts of Europe, although it didn't specify what those sales practices were. Efforts to improve sales standards hurt first-quarter performance, predominantly in Greece, and will continue to depress performance this year, it said.

The stock is currently trading at 18.0x our 2008 EPADS estimate, which is slightly lower than the average of its peers of 19.6x. However with the uncertainty surrounding Plus, there would be little upside in the near term. We note that our quantitative model also has a Hold on the stock. Our six-month price target is $57.00.

Do you cover any European-based commodity-oriented stocks?

In fact, we do. We are maintaining a Hold recommendation on Anglo American (AAUK). The company is benefiting from strong demand for commodities around the globe and increase production. However, risks to global economic growth remain, and the strength of the South African rand could have a significant impact on future earnings.

London-based Anglo American, Plc is a global leader in mining and natural resource sectors. The company has operations in Africa, Europe, South and North America, and Australia. It operates under the following business segments: coal, gold, platinum, base metals, diamonds, industrial minerals, ferrous metals and industries.

Interesting. Wouldn’t its gold holdings be of higher value in the current market?

Perhaps, but in October 2005, Anglo American announced that it would reduce its shareholding in AngloGold Ashanti. To this end, Anglo sold $1 billion worth of AngloGold Ashanti in April 2006, reducing its shareholding to 41.8%. In October 2007, Anglo reduced its holding further to 17.3%. The decision to reduce and ultimately exit its gold holding relates to the higher relative valuations attributable to pure-play gold companies, rather than as part of a diversified mining group. Anglo said it will continue to explore all available options to exit its remaining stake in AngloGold Ashanti in an orderly manner.

What do your estimates for Anglo look like?

The stock is trading at 14.7x our 2008 EPS estimate, a multiple above that of its peers at an average of 13.0x. Our six-month target price is $35.00. The Zacks quantitative model also has a Hold on the stock.

Do you have any Buy-recommended stocks to tell us about?

We are maintaining our Buy recommendation on WPP Group (WPPGY) after the company’s first quarter trading update. The stock is trading at a discount to its industry median’s P/E. Fundamentally, the company is still growing at a healthy pace with full-year revenue growth of 8.2% on a constant currency basis. Also, the final dividend has been increased by 20%. Our six-month target price is $70.00.

WPP Group, together with its subsidiaries, provides advertising and communications services worldwide. Its Advertising and Media Investment Management segment engage in the design and production of advertisements for various types of media, such as television, cable, the Internet, radio, magazines, newspapers and outdoor locations, such as billboards. Its services also include planning and creation of marketing and branding campaigns.

Underlying revenue growth forecast for 2008 is expected to be even better than 2007 (5%). The company is experiencing rapid growth in Asia, the Middle East, and Latin America, with revenues up 11% in 2007. This group represents the company’s fastest growing geographic segment and there is a huge potential in markets such as China, and the company expects its Asian business to account for one-third of its business within five to ten years.

In China, WPP is already the largest player -- 50% larger than its nearest competitor. This year's results should benefit from the buildup to the U.S. presidential election, the Olympics in Bejing, along with the European Football Championships. The on-going share buyback should support the share price.

What are some of the nuts and bolts behind your Buy rating?

At 15.6x our 2008 EPADR, the stock is trading at a discount to its industry median’s P/E. As such, we see little risk to our forecast which is already some 10% below consensus.

Duong Vuong, CFA is a senior analyst covering the European markets for Zacks Equity Research.