5 Undervalued European Stocks

Morningstar Director of Equity Research for Europe Alex Morozov highlights five stocks which are trading significantly below their fair value

Alex Morozov, CFA 2 July, 2018 | 2:19PM
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BT is trading below its fair value estimate according to Morningstar equity analysts

Telefonica SA (TEF)

Telefonica is leading the European communications market into converged services. Additionally, it is laying extensive amounts of fibre to better compete with cable operators in providing fixed broadband services.

It acquired E-Plus in Germany and GVT in Brazil, which strengthens its position in both countries and provides lots of opportunities for cost savings. We don't believe the market appreciates how well the firm is positioned and its margin expansion opportunities, which has caused its stock to trade at a wide discount to our fair value estimate.

BT Group PLC (BT.A)

While narrow-moat BT Group has had some issues in the past two years that caused its stock to decline, we believe the sell-off is overdone. BT is the incumbent telecom operator in the United Kingdom. In 2016, it acquired EE, the largest wireless telecom operator in the country. The company now has the largest fixed-line telephone, broadband, and wireless telephone subscriber bases in the country. Additionally, it is the only operator in the U.K. that owns both a retail fixed-line and wireless network.

We believe this provides BT with an advantage in selling a converged package of these services plus pay TV. The company has been slow to market its converged services, but we believe now that it has reached an agreement with telecom regulator Ofcom regarding Openreach, its U.K. business that owns its fixed-line network and wholesales access to it to other operators, we expect a more aggressive marketing push into converged services during calendar 2018.

BT has been hurt by the widening underfunding of its pension plan as interest rates have declined in the U.K. We think interest rates have bottomed and are more likely to increase from here. We believe the benefit on the pension will be greater than the hit on higher interest on its bonds, the reverse of what happened as interest rates declined. We also think the company has dealt with its problems in Italy and will be able to improve its revenue in its global services division.

The market appears to believe that BT's problems will continue, and possibly worsen, whereas we believe business can improve over the next few years. In the meantime, the stock yields 6.3% and the company has increased its dividend for each of the past seven years. Additionally, because it is a U.K.-domiciled company, there is no foreign tax withholding on the dividend.

Imperial Brands PLC (IMB)

Imperial is the unloved stock in a sector that is very much in favor. The market is valuing tobacco stocks based on their exposure to heated tobacco, the emerging category that is achieving impressive growth in Japan and select markets around the world. We are bullish on heated tobacco, and we think a valuation premium for those leading and developing the category is appropriate.

However, we think the market is overestimating the value of the first-mover advantage, and if heated tobacco gains traction in other markets, particularly the U.S. and Europe, we expect Imperial to leverage its wide moat and follow Philip Morris, British American, and Japan Tobacco into the space with its own technology. Imperial's current multiple discount of 9 times P/E is much larger than the historical discount, and we think this is unjustified.

Roche Holding AG (ROG)

We think the market underappreciates Roche's drug portfolio and industry-leading diagnostics, which conspire to create sustainable competitive advantages. As the market leader in both biotech and diagnostics, this Swiss healthcare giant is in a unique position to guide global healthcare into a safer, more personalised, and more cost-effective endeavor. The collaboration between its diagnostics and drug-development groups gives Roche a unique in-house angle on personalized medicine.

Also, Roche's biologics constitute three fourths of its pharmaceutical sales; biosimilar competitors have seen development setbacks while Roche's innovative pipeline could make these products less relevant by their launch

GEA Group AG (G1A)

We believe management's clumsy handling of its restructuring program has clouded the market's view of wide-moat GEA's long-term value. At issue is a disappointing margin performance and guidance combined with a top line has that suffered in the past two years from overcapacity in dairy processing equipment, as well as an extraordinarily weak milk price hurting dairy farming orders.

We continue to expect margin expansion over the next several years but believe the market has overlooked the nearer term opportunity for earnings growth to return in 2018 from orders outside of dairy. Our analysis of the company's order intake shows that while dairy processing orders have been declining by 8% per year for the past three years, the rest of the order intake has grown by 3%. Food, for example, bakery, ingredients and pasta, is now the largest category and grew at 5% organically over the same period.

GEA supplies food and dairy processing equipment specializing in decanters and separators that determine a product’s texture and consistency, essential to brand creation for food companies, and together with food safety standards create high switching costs for its customers. Nearly another third of its equipment is used in food processing to make products such as edible oils, instant coffee, and baked goods.

As GEA is a leading global supplier and number-one or -two player in nearly all its markets, it will benefit over the long term from increasing food production demand to feed the world's growing population as well as increasing urbanization demand for convenience food.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
BT Group PLC139.10 GBX-1.49Rating
GEA Group AG40.08 EUR-1.38Rating
Imperial Brands PLC2,067.77 GBX-0.83Rating
Roche Holding AG260.60 CHF2.28Rating
Telefonica SA4.14 EUR0.00Rating

About Author

Alex Morozov, CFA  Alex Morozov is the director of the health-care team at Morningstar.

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