I’m in Barcelona, Spain. I’m here to see firsthand what’s going on, as Europe lurches closer to full-on crisis.
In just a moment, I’ll tell you about an “A-List” Spanish stock that’s selling for “D-List” prices – a rock-solid bargain, in other words.
But first some background on the wider picture of what’s happening on the ground here…
Greece, Ireland and Portugal have already collapsed under the strain of rising bond yields. And they have been forced to turn to the EU and the IMF for rescue funds.
Spain and Italy are hanging in there. Just. They can still borrow money in the bond markets. But the cost of borrowing is rising.
What the “Spreads” Are Telling Us
The different crisis levels in each of the PIIGS are reflected in how much more each country has to pay out in interest on 10-year loans relative to Germany – considered by bond investors to be the safest of all European borrows.
This is called a “spread.” And it is usually measured in basis points – with each one equal to 1/100th of 1%. Put very simply, the bigger the spread the less confident bond investors are in a country’s ability to pay back its debts.
Right now, spreads on 10-year bonds over yields on German bonds are 1,340 basis points for Greece, 875 basis points for Ireland, 818 basis points for Portugal, 240 basis points for Spain and 190 basis points for Italy.
A spread on 10-year German bonds for Spain of 240 basis points seems mild compared to Greece, Ireland or Portugal. But these countries are effectively bankrupt. The spread for Spain is still worryingly high.
Of course, if you live in one of the PIIGS, you probably couldn’t care less about bonds spreads. You’re too busy dealing with the so-called “austerity measures” – what you or I would call spending cuts – your government is busy shoving down your throat.
Cuts are needed, goes the logic, because by cutting spending you reduce your reliance on deficit financing (basically, borrowing to spend).
But this isn’t going down too well on the streets of Athens or Lisbon…or Barcelona, where I am now.
Tens of thousands of people here have taken to the streets here in protest. They’ve set up camp in the main square, Plaça de Catalunya. And they’ve clashed with riot police, who were recently filmed attacking peaceful protesters with batons and firing on them with rubber bullets.
This isn’t Tahrir Square yet. But it’s not far off either.
Beware: Groupthink at Work
Against this backdrop of fiscal uncertainty…biting cuts…and mass protests, most people don’t want to touch Spanish-based investments.
As a result, many of them are selling at “bargain counter” prices.
Whenever I see a set up like this, I ask a very simple question: Is the level of fear justified? In many cases, it’s not. It’s simply groupthink at work.
One stock I have my eye on is Spanish-based telecommunications giant Telefonica S.A. (NYSE:TEF).
Telefonica is what I call an “A-List” stock. It’s been around since 1924. It provides services you can easily understand to a big customer base – 290.5 million people worldwide.
Even better, Telefonica has great return on equity – the amount of net income the company returns as a percentage of shareholder equity – of 43.68%. That’s a very healthy figure indeed.
And margins are impressive too. Telefonica’s pre-tax profit margin is 22.44% – again a very healthy figure.
Telefonica stock is selling at a bargain valuation. As I type, it’s trading on a P/E of just 7.38. This puts it in the bottom 20% of the overall market.
And the company’s dividend yield is huge – at 8.2%. This means for every $1,000 you invest in this stock, Telefonica will pay you $82 back a year.
(That’s almost three times what Uncle Sam will pay you to lend him money for 10 years. The yield on the 10-year Treasury note is a measly 3.9%).
An Emerging Market Powerhouse
But what about Spain? Isn’t it going down the tubes? Won’t Telefonica hemorrhage customers?
Hardly. Telephone calls aren’t the type of thing you cut down on to a large degree in a recession. People will still use their landlines…and their mobiles. Plus, they’re unlikely to stop using the Internet, another service Telefonica provides to its customers.
And even if the Spanish all unplugged their phones tomorrow, Telefonica still has a huge global customer base…much of it in fast growing overseas markets such as Brazil (my favorite BRIC).
In fact, Telefonica stands shoulders above other companies in the MSCI EAFE Index – which tracks stocks in Europe, Australasia and the Far East – in terms of its sales exposure to emerging markets.
More than 60% of its business is outside Spain. And just under half its sales revenues come from emerging markets.
The market has it wrong on Telefonica. It sees a Spanish company. And it’s selling it based on fears over a debt blow-up in Spain.
But I see an emerging market powerhouse selling at bargain counter prices. Telefonica is a great buy at its current valuation.