Barron's : Italy Survives “No” Vote and Dodges Disaster

Italy Survives “No” Vote and Dodges Disaster
The rejection of Renzi’s proposed reforms leaves markets unruffled, in part because Italy’s economic prospects are improving.

Crisis? What crisis? The European market reaction to Italy’s landslide rejection of proposed constitutional reforms last week was remarkably sanguine, given that, from an investment viewpoint, the country’s referendum vote delivered the worst possible result.
It was a stinging rebuke to Prime Minister Matteo Renzi’s efforts to streamline the country’s lawmaking process, leading to his resignation and a period of political uncertainty at a delicate time for Italy.
Renzi’s downfall has scuppered for now the sort of business and labor reforms that some economists say Italy needs to boost competitiveness. It also raises the spectre of an early election and the possibility that the anti-European Union, anti-establishment Five Star Movement will expand its political influence.
Despite that, when markets opened the day after the Dec. 4 vote, the Stoxx Europe 600 index rose 0.6%. The euro—which had fallen 0.9%, to $1.0564, as the referendum result unfolded—bounced back to around $1.0732 over the following two days, before slipping again later in the week.
ODDEST OF ALL has been the market impact on Italy’s banks, some of which were already buckling under a hefty burden of nonperforming loans. Italian lenders account for about half of all the bad loans held by listed euro-zone banks. Two of the country’s biggest, UniCredit (ticker: UCG.Italy) and Banca Monte dei Paschi di Siena(BMPS.Italy), are trying to raise new capital. The “no” vote has made that task harder by possibly deterring would-be investors.
The day after the referendum Monte Paschi stock plunged 4.2%, but by Thursday it was almost 12% higher than on the last trading day before the Italian vote. It fell back again on Friday following news that the European Central Bank had denied the bank’s request for more time to raise the capital it needs, shedding 10% on the day to leave it only 0.3% higher on the week. UniCredit initially dropped 3.4% after the vote but was up just under 20% on the week. Investors expect the government will now have to pump taxpayer cash into at least one of the banks.
Marco Pirondini, executive vice president and head of equities, U.S., at Pioneer Investments, says Italian banks have underperformed for most of the past eight years.

“They’re very, very cheap,” he says. “In many cases, they trade more like options than investments. They seem to be up and down 10% every other day. There are a lot of risks that honestly are very difficult to analyze, but a lot of that is in the price. For more adventurous investors, there could be some opportunities here.”
Pirondini points out that Italian banks are mainly in need of capital to meet more-stringent regulations. “It’s because they are being pushed to become safer, not because they are about to go bust,” he says. “In many cases, they have more capital than in the past 20 years, even after taking account of the nonperforming loans, so this is not a distressed situation.”
Pirondini adds that although the calm market reaction to the referendum was largely because pollsters had accurately predicted the outcome, it is also attributable to the country’s improving economic prospects.
“Italy is a big manufacturing country, and the global economy is recovering. Manufacturing PMI [purchasing managers index] in the past few months has been improving everywhere in the world, as are other leading indicators,” he says. Apart from boosting the country’s economy, such growth will go some way to lifting the credit quality at Italian banks.
Above all, the referendum hasn’t made Italy’s situation any more complicated.
“We don’t have a new constitution, but we’ve been working with the old one for more than 50 years,” Pirondini says. “For Italy, it’s more of the same. We were hoping for a change, but it isn’t traumatic.”
PERHAPS THE BEST ILLUSTRATION of that point is the recent performance of Italy’s 10-year government bond yield. For much of last week, it had hardly changed from the market close of about 1.9% before the referendum.
It rose to 2.03% on Thursday, but only because the ECB slightly disappointed investors’ expectations. The bank extended its bond-buying program to the end of 2017 but said it would reduce the scale of its monthly purchases to 60 billion euros ($63.67 billion) from €80 billion in April. Many economists had expected the monthly amount to remain the same.
That slight upward pressure on Italian benchmark bond yields still leaves them well below the heady 7.56% they reached in November 2011, when Italy was at the epicenter of the euro-zone sovereign-debt crisis. (Bond prices move inversely to yields.)
“This isn’t Brexit. Nor is this an Italian government being replaced by forces the market doesn’t trust,” Pirondini says. In Italy, it’s simply business as usual.

Barron's : London Hedge Fund Conference Serves Up 6 Attractive Stocks

London Hedge Fund Conference Serves Up 6 Attractive Stocks
Charter Communications could double or triple, and an Italian defense firm could rise 80%.

A U.S. cable company, a couple of auto suppliers, and a European defense play were among the tips from investment professionals at the fifth annual Sohn London Investment Conference on Thursday.
Most of the stock picks were European companies, a reflection of the speakers’ areas of expertise but also, perhaps, the attractive valuations in the region, where stocks have declined 3% this year and trade for just 14.6 times estimated earnings for the next 12 months. There were only two short ideas, and one of those was for Australian banks.
From left: Christopher Hohn, founder, TCI Fund Management; Canadian Pension Plan Investment Board Senior Portfolio Manager Dureka Carrasquillo; Bodenholm Capital CEO Erik Karlsson. Clare McGregor
Charter Communications (ticker: CHTR) could “double or triple” in value in the years ahead, on top of an impressive 38% gain in 2016, said TCI Fund Management founder Christopher Hohn. The manager, whose firm is a shareholder and owns 4.4% of the stock, bases his thesis on the prospects for top-line growth fueled by rising subscriber numbers and higher prices, share buybacks, and an “inevitable” bid from Verizon Communications (VZ).
Charter, recently $277 a share, passes 49 million American homes but has only 26 million customers. “Charter has not achieved its potential,” said Hohn, who is bullish on cable as the dominant provider of broadband infrastructure in the U.S. and sees “significant margin opportunity.”
It is also a play on cable mogul John Malone, whose Liberty Broadband (LBRDA) is Charter’s largest shareholder with a roughly 20% stake. “It has always paid to be a shareholder in Malone’s enterprises,” said Hohn.

Mobileye (MBLY) and Autoliv (ALV) were pitched as stocks that potentially could double in value. Jerusalem-based Mobileye is a software company that develops technology for camera-based advanced driver-assistance systems. It supplies equipment to more than a dozen automakers. A new product, EyeQ4, will improve detection of moving objects. It’s due to reach the market in 2018.
At $36, Mobileye’s shares are down 26% in the past three months following the termination of an agreement with Tesla Motors (TSLA) in the summer after a fatality involving a vehicle with an autopilot function.
But earnings are growing fast. Mobileye is forecast to report net income of $247.5 million, or $1.04 per share, on $491.4 million of revenue in 2017. That compares with projections for 2016 of $169.2 million in net income, or 71 cents a share, on $350 million in revenue. Canadian Pension Plan Investment Board senior portfolio manager Dureka Carrasquillo likes Mobileye’s earnings visibility. She reckons the stock could be worth $74.
Erik Karlsson, founding partner and CEO of Bodenholm Capital, was so confident about Autoliv’s prospects he pledged to donate £1,000 to charity for every investor at the conference who buys the stock in the next couple of weeks if it declines in value in the next 12 months. It could cost him: The conference, which raises money to fight pediatric cancer, had 450 attendees.
From left: Elif Aktug, senior investment manager, Pictet Asset Management; Anne-Sophie d’Andlau, co-founder and managing partner, CIAM; Bo Börtemark, co-founder and portfolio manager, Carve Capital.
Stockholm-based Autoliv manufactures air bags and seats and boasts a 38% market share. That could grow to 50% due to problems at one of its main rivals, Takata(7312.Japan), which has been forced to recall millions of air bags linked to numerous deaths and injuries. Net income is forecast to rise to $694 million in 2018 from $597 million this year, while earnings per share are projected to increase from $6.78 to $8.04.
And with net debt estimated at just 20% of Ebitda (earnings before interest, tax, depreciation, and amortization) by the end of this year, Autoliv could buy Takata, or at least parts of it, said Karlsson. He suggested Autoliv’s shares could double in the next two years.
Another recommendation with lofty expectations to meet was Italian aerospace and defense company Leonardo-Finmeccanica (LDO.Italy), which more than doubled over the past three years despite political interference, leadership turmoil, and weak oil prices.

Elif Aktug, a senior investment manager at Pictet Asset Management, suggested current management had made a positive impact with a restructuring program and the sale of underperforming businesses. She calculates that operating free cash flow, 65 million euros in 2014, could reach €700 million in 2017.

Taking into account improving helicopter end markets, a normalized valuation multiple, and the portfolio restructuring, Leonardo-Finmeccanica’s sum-of-the-parts value could be €24.30, or about 80% above its latest share price.
BO BÖRTEMARK, CO-FOUNDER and portfolio manager at Carve Capital, tapped infrastructure operator Ferrovial (FER.Spain), whose shares are down about 20% in 2016. He’s particularly excited at prospects for a private toll-road project in Toronto, which is expected to launch its second phase next year. Ferrovial has a 43.23% stake in the project. Its other major asset is London’s Heathrow Airport, which was given approval in the fall to build a third runway, increasing capacity.
These could be catalysts for Ferrovial to reduce the 21% gap to its net asset value, an historical high. Börtemark sees 30%-50% upside for the shares.
ACTIVIST INVESTOR Anne-Sophie d’Andlau, co-founder and managing partner of CIAM, recounted an ongoing battle to unlock value in Euro Disney (EDL.France), owner of the Paris theme park. Walt Disney (DIS), which owns 77% of Euro Disney, is accused by activists of trying to take the French company private at €1.25 a share last year, following a debt-for-equity swap in which its stake almost doubled. Activists, including CIAM, are challenging approval of the deal by the French regulator.
D’Andlau said that Euro Disney undervalues the rights to land by €1.9 billion, or €2 to €4 a share. The rights were granted by the French government 30 years ago as an incentive for the company to build its theme park.
Disneyland Paris, Europe’s largest tourist attraction with 15 million visitors annually, hasn’t made a profit in 15 years. D’Andlau blames Walt Disney for charging excessive royalties and fees. “It seems Walt Disney has spent too much time studying its Scrooge McDuck cartoons,” said D’Andlau, who estimates the enhanced value of the land rights and reimbursement of overpaid royalties would make Euro Disney worth €5 a share. The stock was up more than 10% Friday, to €1.18.
Disney said in a statement: “We consider the allegations to be false and unfounded.”

Barron's : Gaining Traction: Goodyear Could Rise 25%

Gaining Traction: Goodyear Could Rise 25%
The tire maker benefits from cost cuts and growing demand for lucrative 17-inch tires.

Goodyear Tire & Rubber has been outracing its own share price. Since 2007, the year before the world economy went kablooey, company revenue has fallen by about $4 billion to an estimated $15.3 billion this year. That’s because management has walked away from low-value business to pursue profits ahead of volume. Earnings per share are expected to approach $4 this year, up from $1.66 in 2007. Goodyear shares peaked at over $36 that year. They recently sold for $32.18. At that level, about eight times earnings, they’re 57% cheaper than the Standard & Poor’s 500 index.
Key concerns about the stock (ticker: GT) seem overstated and more than priced in. Some investors might view the company as a short-term beneficiary of low oil prices, and thus at risk of a rebound in crude. But while lower materials costs have helped results, companywide efficiency gains have been a bigger driver. A possible peak in North American light-vehicle sales is also a concern, but Goodyear makes more on tire replacements than on new vehicles. A boom in big tires could attract more competition. Then again, new entrants could have a difficult time matching Goodyear’s ability to keep today’s dizzying menu of tire types and sizes in stock at dealers, and its new online system to streamline the buying process.

“Getting tires is not like getting your iPhone upgraded,” Goodyear Chief Executive Richard Kramer told Barron’slast week. “But we’ve got a connected business model that makes the process easier for consumers.”
There’s also an enthusiastic share buyer on the horizon: Goodyear itself. The company appears poised to generate $5 billion in free cash cumulatively through 2020. That compares with a recent stock market value of $8.4 billion. Over the past two years, most of the company’s free cash flow has gone toward debt and pension payments. From here, it could spend nearly all of it on share repurchases and dividends. The dividend yield is only 1.3% now; expect payments to rise quickly in coming years. Look for shares to inflate to a more appropriate level, too. Goodyear could hit $40 in a year for a gain of 25%.
BASED IN AKRON, OHIO, Goodyear began production in 1898—of bicycle and carriage tires, horseshoe pads, and poker chips. It rolled out tires for Henry Ford’s Model T in 1907; developed synthetic rubber tires in 1937; and pushed into radial designs in the 1960s, when it made its billionth tire. Along the way, it had a hand in blimps, tank tracks, and Corsair fighter planes, too. Today, Goodyear holds about a 10% share of the worldwide tire market, putting it third behind overseas rivals Michelin (ML.France) and Bridgestone (5108.Japan). Last year, operating income grew 18% and topped $2 billion for the first time in Goodyear’s history. It would have grown 27% if not for currency head winds. Management aims to get to $3 billion in operating income by 2020.
Part of the growth will come from a continued shift to larger tires, including in the U.S., where Goodyear leads in tires for new vehicles. Demand for 17-inch and larger models has more than doubled since 2010, and management expects it to double again by 2020—much faster growth than the rest of the market.

Partly, that reflects strong sales of pickup trucks, sport utility vehicles, and crossovers, but it’s also about looks. Many cars now come with the option of upgrading to larger wheel sizes. Broadly, larger tires bring in about $25 apiece in gross profit, compared with just $9 for smaller ones, Goodyear estimates. It gets better: As customers buy more cars with larger wheels, they create a lucrative base of future replacement demand. Replacement tires of 17 inches and larger bring in about $32 in gross profit apiece. Goodyear gets 70% of its revenue from replacement tires.
Last month, Barron’s recommended shares of CarMax (KMX), based in part on signs of a coming boom in used-car sales (“CarMax: Ready to Step on the Gas,” Nov. 19). A surge in new-car leases in recent years is now giving way to a flood of off-lease vehicles coming up for sale. Goodyear is poised to benefit from the same market shift.
THE COMPANY’S NEW online ordering service at Goodyear.com lets customers buy tires, have them delivered to a garage, and make an appointment for installation. That’s a play for younger drivers, but it’s also an effort to simplify tire-buying in an era of what CEO Kramer calls SKU-proliferation, a reference to stock-keeping units used to identify different products. Buyers can choose tires for fuel efficiency, sport handling, off-road driving, seasonal driving, and more.

Additional wheel sizes adds another layer of complexity. For Goodyear, that complexity serves as a barrier to entry for smaller players who compete mainly on cost.
Material costs have been rising. Tires can be made from rubber, oil, synthetics, and steel, among other things. An index of these tracked by Morgan Stanley peaked at 216 in 2011, bottomed at 53 early this year, and recently topped 80. But Goodyear’s operating margins have improved by more than seven percentage points over the past five years, and the company says less than one point of that has come from savings on materials. Most has come from a cost-cutting drive and a shift to higher-value tires.
Last quarter, Goodyear lowered its guidance for full-year operating income to a range of $2 billion to $2.025 billion, from its earlier range of $2.1 billion to $2.2 billion. Management blamed that on weak truck-tire orders. Dealers have been destocking ahead of expected new tariffs on Chinese truck tires, which could hit retroactively.

Wall Street was disappointed because the company had reiterated the higher guidance only a month earlier at an upbeat presentation to investors. Shares lost 9% in a day. They’re now down 1% for the year, even though earnings per share are seen growing 18%.
“Tires never grow in a straight line,” says Kramer. “Nothing has changed our long-term strategy or outlook.” JPMorgan recently named Goodyear a top value pick for 2017, with a price target of $43. Its analyst on the stock, Ryan Brinkman, expects the commercial-vehicle tire weakness to begin to reverse as soon as the first half of next year.
LIKE MANY U.S. industrial businesses, Goodyear has benefited from a Trump bump, but in its case, the stock gain merely offset its earnings-day selloff. That’s a buying opportunity. A rise to $40 in a year would leave the stock at only about nine times earnings. Also, Goodyear’s tax rate is expected to hover around 30% in coming years, meaning it could get a modest benefit from a widely expected cut in the corporate tax rate.
Speaking of the president-elect, investors buying shares today of U.S. manufacturers with overseas plants should estimate their Twitter risk. Goodyear is opening a new factory in Mexico next year, where it has not had a manufacturing presence in 15 years. The plant will serve Mexico, Brazil, and other countries throughout the Americas, the company says, which could include the U.S. But the company has a third of its global workforce in the U.S. and says it isn’t moving any U.S. jobs to Mexico.

>>> US Close Dow +0.72% S&P +0.59% Nasdaq +0.50% Russell +0.12%

 Market Summary: Strong Week Ends on Upbeat Note

The stock market wrapped up a strong week with another uptick on Friday. The S&P 500 gained 0.6%, extending its weekly advance to 3.1% while the Nasdaq Composite rose 0.5% to end the week higher by 3.6%.

Overall, the Friday affair was fairly quiet, allowing the market to continue respecting post-election trends. To be fair, small caps underperformed today, but the Russell 2000 (+0.2%) still ended the week ahead of other indices, jumping 5.7%.

Equity indices climbed off their opening levels thanks to strength in sectors like health care (+1.2%), consumer staples (+1.4%), and technology (+0.7%). The three influential groups provided an early boost while most of the remaining sectors saw inflows as the day went on. The relentless push higher invited another extension of gains during the final hour, suggesting performance chasing and short covering remained present in the market.

Biotechnology was among the early sources of strength, but the industry group retreated from its high into the afternoon. The iShares Nasdaq Biotechnology ETF (IBB 269.67, +1.15) added 0.4% after being up 2.6% at the start.

The intraday fade in biotech caused the Nasdaq Composite to slip behind the broader market in afternoon action. However, the Nasdaq ended comfortably above its flat line thanks to daylong strength in technology. The top-weighted sector received support from some of its largest components, which overshadowed losses among chipmakers. The PHLX Semiconductor Index lost 0.4% with Skyworks (SWKS 76.93, -2.59) leading the index lower despite a 4.9% spike in Broadcom (AVGO 179.09, +8.38). The stock was on the rise in reaction to upbeat earnings/guidance and a quarterly dividend hike to $1.02 per share from $0.51 per share. Another tech name, Finisar (FNSR 33.41, -0.72) retreated 2.1% despite above-consensus results and upbeat guidance.

The technology sector gained 4.2% for the week, ending only behind financials (week-to-date +4.8%). The economically-sensitive group started the day under pressure, but recovered to end little changed as the yield curve continued steepening. Treasuries retreated throughout the day, sending the 10-yr yield higher by six basis points to 2.47% while the 2-yr yield rose two basis points to 1.14%. The 2s10s spread expanded to a fresh 2016 high of 133 basis points.

The energy sector (+0.4%) ended with a modest gain, but could not catch up to crude oil, which spiked 1.3% to $51.49/bbl ahead of tomorrow's meeting in Vienna between OPEC and non-OPEC members.

Investor participation was below average as fewer than 900 million shares changed hands at the NYSE floor.

Economic data included Wholesale Inventories and Michigan Sentiment:

  • Wholesale inventories decreased 0.4% month-over-month in October, as expected, following an unrevised 0.1% decline in September. Wholesale sales were up 1.4% on the heels of an upwardly revised 0.4% increase in September
    • Inventory-to-sales ratio moved down to 1.30, which points to the potential for some improved pricing power if demand continues to pick up
  • The preliminary reading for the University of Michigan Consumer Sentiment Index for December checked in at 98.0 (consensus 94.3), up from the final November reading of 93.8
    • Consumers responded more frequently with the assertion that they had heard on the news that new economic policies will have a positive impact versus a negative impact

Monday's economic data will be limited to the November Treasury Budget statement, which will be released at 14:00 ET.

  • Russell 2000 +22.2% YTD
  • Dow Jones Industrial Average +13.4% YTD
  • S&P 500 +10.6% YTD
  • Nasdaq Composite +8.7% YTD

>>> US Gapping down

Gapping down
In reaction to disappointing earnings/guidance:
  • XTLY -22.3%, DLTH -18.7%, RH -17.8%, DTEA -16.1%, NCS -7.3%, FRED -3.6%, LAYN -2%, MTN -0.6%
M&A news:
  • SBGL -15.3% (acquired SWC for $18.00 per share)
Select EU financial related names showing weakness:
  • DB -3.7%, PUK -3.2%, SAN -2.3%, RBS -2.3%, LYG -2.2%, BBVA -1.9%, CS -1.8%, ING -0.9%
Select metals/mining stocks trading lower:
  • HMY -5.7%, GFI -4.5%, MT -2%, AU -1.9%, PAAS -1.5%, GDX -1.3%, RIO -1.2%, ABX -1.1%, NEM -0.9%
Other news:
  • SCON -28.2% (prices $10.2 mln offering at $1.50/share)
  • MVIS -21.8% ( announces proposed public offering of common stock)
  • USAC -8.7% (prices 4.5 mln shares of common stock at $16.25 per share)
  • AIRG -6.1% (prices 1,352,941 share offering at $17.00/share)
  • FRO -1.7% (mandates Arctic Securities to assist in a contemplated offering for issue of 13,422,819 new shares for gross proceeds of $100 mln)
  • WSM -1.3% (RH sympathy)
Analyst comments:
  • BCS -3.5% (downgraded to Underperform from Neutral at BofA/Merrill)

>>> US Gapping up

Gapping up
In reaction to strong earnings/guidance:
  • CCRC +15.3%, FNSR +8.1%, ENZ +7%, AVGO +5.6%, FGP +1.5%
M&A news:
  • SWC +19.7% (to be acquired by Sibanye (SBGL) for $18.00 per share)
Select Macau related names showing strength after Macau Authority says mainland bank card ATM withdrawals in the ATM amount per day to remain unchanged; individual transactions will be limited by 50%:
  • WYNN +7.4% ,MPEL +6.7% ,LVS +6.5% ,MGM +3%
Other news:
  • IDXG +49.5% (seeing continued strength)
  • OPHT +6.2% (ticking higher, Point72 Asset Management discloses 5% passive stake )
  • BIIB +5% (presents Phase 1b data for aducanumab)
  • AMD +2% (among stocks with favorable commentary on Thursday's Mad Money)
  • ESRX +1.8% (following Citron's Left appearance on CNBC)
  • TSM +1.5% (reports Nov sales increased 46.7% YoY to NT$93.03 bln)
Analyst comments:
  • FLR +1.7% (upgraded to Buy from Neutral at Citigroup)
  • AZN +1.4% (upgraded to Outperform from Mkt Perform at Leerink Partners)
  • LNC +1.4% (upgraded to Outperform from Sector Perform at RBC Capital Mkts)
  • HIG +1% (upgraded to Outperform from Sector Perform at RBC Capital Mkts)