Observation No. 1: In the U.S., we're seeing signs of economic recovery (lower unemployment, stabilizing GDP, etc.).
Observation No. 2: In Europe, every day brings news from the soap opera that is the sovereign debt crisis.
So, while the Dow (INDEX: ^DJI) and the rest of the U.S. stock market are hitting highs we haven't seen since before the Lehman Brothers blow-up, it seems a good time to check in on European stocks for bargains.
And that's what I did, singling out one stock for your consideration.
How I searched
To be clear, what I was looking for was a "baby thrown out with the bathwater" situation.
In a recovery from a credit crunch, it's the worst, most debt-laden, closest-to-death companies that jump up the most when things get better (see the U.S. stock market March 2009 on). That's not what I was looking for, though, because there are also many scenarios that lead to 100% losses for the weak.
Since we don't know how the European situation will play out, I targeted finding an entrenched company whose services are essential in good times and bad. Ideally, it would be a blue chip selling for a discount -- i.e., a "baby thrown out with the bathwater" situation.
As a start, I ran the numbers on the 174 European stocks traded on major U.S. exchanges and looked for pure cheapness in the one- and five-year price multiples.
Among the candidates that I sorted through were:
Major banks -- Since banks are my specialty, I am biased toward wanting to find a triumphant winner among the beaten down European banks. However, I continue to see better risk/reward propositions in American banks -- many of which are as cheap as European banks such as Banco Santander without as much direct European economic and sovereign debt exposure.
Shippers -- Dry bulk shippers such as DryShips and Excel Maritime Carriers are being valued at fractions of book value that would make even the banks wince. DryShips is down to a third of book value while Excel is down to just a 10th of book value. But as I've pointed out before, the dynamics of the industry don't meet the "good times and bad" criteria.
Blue chips in vulnerable countries -- This would include telecoms such as Spain's Telefonica (NYS: TEF) and Telecom Italia. Intriguing, but all things equal, I'd prefer a blue chip in one of the strongest eurozone countries. Namely Germany or France.
The stock I found
That last bullet point foreshadows the company I'm singling out from the 174 choices. It's France Telecom (NYS: FTE) , the French equivalent to AT&T (NYS: T) or Verizon (NYS: VZ) here in the U.S. But while AT&T and Verizon are up 5%-10% over the past year, France Telecom has been punished by 30%.
The result? A French blue chip that trades at price multiples between six and eight. That's if you look at last year's earnings. Or if you averaged the last five years of earnings. Or if you look at what analysts expect for next year. Or if you factored in its net debt and used free cash flows instead of earnings.
Any way you look at its profitability, France Telecom is dirt cheap. Depending on the metric you choose, it's trading for about half (or less) of what AT&T and Verizon are and is pumping out a tasty dividend yield in the double-digit neighborhood.
Now, a bit of a discount is certainly understandable. Aside from the macro worries surrounding every eurozone company, France Telecom labors under a large debt load, a one-quarter government investment stake that hampers labor flexibility, and new mobile competition from a disruptive, lower price provider named Iliad.
That said, let's remember what we're dealing with here. Aside from being the incumbent wired telecom provider in France, it has a 40% market share in wireless, and -- like so many telecoms around the world -- is pushing broadband services to boost its declining wired business. And despite its name, France Telecom only gets half of its sales from France. Its 226 million customers (!) come from not only France, but other parts of Europe, the Middle East, and Africa. So you've got an AT&T-like blue chip that leverages its resources to compete significantly in risky-but-potentially lucrative emerging markets.
Going back to its risks, I believe each has either a silver lining or a mitigation:
Eurozone risk -- Like all the companies in the eurozone, the sovereign debt risk is present. However, its essential telecom services will be needed to a large extent no matter what.
Competitive risk -- There are always threats to established players, but branding, inertia, scale, contracts, quality (either perceived or real), and deep pockets mean a lot.
Emerging market risk -- With great potential returns come great potential risks. But remember that France Telecom isn't new to the emerging market game. For instance, its numbers in 2011 reflect the negative effect of the Arab Spring on its Egyptian operations.
Government -- Having the government as a one-quarter owner of your business can be good and it can be bad. During a time of crisis, I'll take the government ties, thank you.
Financing -- With a debt-laden balance sheet, a penchant for big acquisitions, and a huge dividend, one of my big concerns is financial flexibility in a credit crunched environment. But it looks like France Telecom is taking this seriously. For 2012, it has canceled share buyback plans, it's lowered its future dividend payouts a bit (though given its current share price, the expected yield would still be around 10%, plus or minus a few percentage points), and it expects to be "calm" on the acquisition front.
Bottom line, here's what I'm seeing: Despite the various real risks present, France Telecom is closer to a blue chip than a cow chip. Its stock is trading at a discount that doesn't give it enough credit for its past history of performance and its solid market position in an essential industry.
But be warned -- this stock isn't for the novice or the risk averse. And before investing in France Telecom, you'll need to bone up on the treatment of foreign taxes on its hefty dividends.
If France Telecom isn't quite your speed or if you're just looking for another idea, there's an unloved area of the market that I find even more intriguing than Europe. I recently wrote a free report about it. The report details a best-in-class company in a beaten down but promising sector. Just click here for instant access. I hope you enjoy it.
At the time thisarticle was published Anand Chokkavelu holds no position in any company mentioned. The Motley Fool owns shares of Telefonica. Motley Fool newsletter services have recommended buying shares of France Telecom. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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