I read the article “Why Spain Might Be the Best Place to Invest Now” and decided to put it in my “to research” list.
The article made a very simple and easy-to-understand point, and it can be explained by a very simple graph below.
Instead of just blindly buying the whole index of the blue chip stocks in Spain, called IBEX 35 (see the Wikipedia article), It is strongly advisable to look at the individual companies. After all, an index is as good as the stocks in it. After only a brief glance some surprising things come to light (dividend yield based on the price of the stock on May 11, 2012, index weights based on 1 Jan 2011).
Our task is made easier here because almost 80% of the weight is in only nine of the stocks, as listed above. One more thing that jumps out is that the dividend yield is quite high for these companies, but they have mostly paid the dividends for this year and you will need to wait at least six months to get them (except Iberdrola which pays in July).
Let us look at these companies in a bit more detail. We are looking for a few things:
Telefonica SA
Some of the worrying things about Telefonica (TEF) are as follows:
The company has some fantastic opportunities and growth in Latin America, which is thrown around a lot as something to buy Telefonica for. As far as the balance sheet of the company goes, it is quite ugly. From an income and growth perspective the company is quite desirable.
Banco Santander and BBVA
Given that these two are banks, I will be hard pressed to judge them on any of the three points.
Iberdrola
This is a utility company, and a debt-to-equity ratio of 1 is not that bad for a company in this industry. The company is cheap on almost all metrics, and the dividend seems quite sustainable. The company has a very predictable customer base and revenue. This investment might end up being a very good value, if the current downtrend goes on for while.
Repsol YPF (REP)
The company should be renamed to Repsol because YPF was forcefully nationalized by the Argentinian government. On a valuation basis I do not see it as a better deal than BP or Total. Given the seizing of YPF is at least worth $10 billion to Repsol the drop from the 52-week high of €10.4 billion, this seems like a overreaction from the market. The problem is that Repsol is going to have a hard time getting the money back from Argentina. It has filed a case against the country in New York and this is going to go through a long and arduous process. The company might end up being a great deal at this price, but there is a lot of risk with this investment at the moment.
Inditex
The company owns a lot of well-known brands like Massimo Dutti, Zara, Pull and Bear, etc. The majority of the stores are company owned and the company has no debt. This is one of the companies I will gladly buy. Let us look at the figures which the company has managed to pull off.
The problem is that the company is not cheap. The P/E is 22 and the stock has largely survived the drop in the Spanish market.
Abertis Infrastructures
Abertis has too much debt, with nearly €13 billion in debt, €393 million in cash and €3 billion in equity. The company has €15.4 billion in goodwill and intangibles. I hesitate investing in this stock because of this issue.
ACS
Again, too much debt.
Gas Natural (EGAS)
The company distributes gas and LNG. It also generates and sells electricity in the Iberian peninsula. The company has P/E of 7 and dividend yield of 8.45%. The company looks quite cheap, but I pause at the high debt/equity of 1.65. I would rather buy GDF Suez which is in a similar business, has debt to equity of 0.89, and dividend yield of 9.21%.
Verdict
So, if you look at the IBEX, you can probably find one business which satisfies all of our basic requirements of an understandable business with good balance sheet and attractive margin of safety. This is no reason to invest in the whole index, even after such a huge drop in the stock market. Although if you can analyze the banks (BBVA and Santander) and find them attractive, you will probably not buy the index anyway.
The article made a very simple and easy-to-understand point, and it can be explained by a very simple graph below.
The projected return of the Spanish market for future years is more than 17.5%. This is based on an economic growth of about 4% a year, a dividend yield of 6% and a valuation reverted to the mean of 7.5%. It is very likely that the Spanish economy may not be able to grow 4% a year in the next decade, but the high dividend yield of its stocks and lowest valuation may reward patient investors.The point plays quite well from a value investing perspective. Given the set of problems with euro and the high employment in Spain, anything related to Spain is being doubly punished. With such a wide sell-off in the market, there are bound to be some good deals around.
Instead of just blindly buying the whole index of the blue chip stocks in Spain, called IBEX 35 (see the Wikipedia article), It is strongly advisable to look at the individual companies. After all, an index is as good as the stocks in it. After only a brief glance some surprising things come to light (dividend yield based on the price of the stock on May 11, 2012, index weights based on 1 Jan 2011).
| Company | Sector | Dividend | Ex div date | Index weighting | Debt/Equity |
| Telefonica | Telecommunications | 12.71% | Nov 7, 2011 | 20.67% | 3.14 |
| Banco Santander | Banks | 11.95% | Apr 13, 2012 | 19.03% | - |
| BBVA | Banks | 7.85% | Apr 16, 2012 | 9.86% | - |
| Iberdrola | Electricity and gas | 9.42% | Jul 13, 2011 | 9.16% | 1.01 |
| Repsol YPF | Petrol | 7.83% | Jan 10, 2012 | 7.57% | 0.98 |
| Inditex | Fashion | 2.62% | May 2, 2012 | 5.43% | 0.00 |
| Abertis | Car parks and motorways | 11.12% | Apr 12, 2012 | 2.32% | 3 |
| ACS | Construction | 14.86% | Feb 7, 2012 | 2.14% | 4.97 |
| Gas natural | Electricity and gas | 7.9% | Jan 9, 2012 | 1.88% | 1.65 |
| Total | 78.06% |
Our task is made easier here because almost 80% of the weight is in only nine of the stocks, as listed above. One more thing that jumps out is that the dividend yield is quite high for these companies, but they have mostly paid the dividends for this year and you will need to wait at least six months to get them (except Iberdrola which pays in July).
Let us look at these companies in a bit more detail. We are looking for a few things:
- A good balance sheet. This is very desirable given that Spain and Europe is going through so much.
- A very good margin of safety. If we are going to invest there, it must offer us a tantalizing deal.
- A business which we can understand. If we don’t understand the business then the second point is moot, as we will not be able to judge what the margin of safety is.
Telefonica SA
Some of the worrying things about Telefonica (TEF) are as follows:
- The company has €66 billion in debt. The company pays €2 billion in interest every year. The interest seems to be well covered though, given that the company makes a lot of money.
- The current market cap is €49 billion. The FCF has been quite stable at around €8.4 billion. With a €66 billion in debt and €6 billion in cash the EV is more than 109 billion. This gives us a EV/FCF of 13 which is not very cheap. Compare this with France Telecom.
- The company’s intangibles plus goodwill is on a uptick and has gone from €36.4 billion in 2007 to €53 billion! Compare this with the total assets of Telefonica which is €129.6 billion and equity of €21.6 billion. The tangible book value is negative €32 billion!
The company has some fantastic opportunities and growth in Latin America, which is thrown around a lot as something to buy Telefonica for. As far as the balance sheet of the company goes, it is quite ugly. From an income and growth perspective the company is quite desirable.
Banco Santander and BBVA
Given that these two are banks, I will be hard pressed to judge them on any of the three points.
Iberdrola
This is a utility company, and a debt-to-equity ratio of 1 is not that bad for a company in this industry. The company is cheap on almost all metrics, and the dividend seems quite sustainable. The company has a very predictable customer base and revenue. This investment might end up being a very good value, if the current downtrend goes on for while.
 * |  * |
Repsol YPF (REP)
The company should be renamed to Repsol because YPF was forcefully nationalized by the Argentinian government. On a valuation basis I do not see it as a better deal than BP or Total. Given the seizing of YPF is at least worth $10 billion to Repsol the drop from the 52-week high of €10.4 billion, this seems like a overreaction from the market. The problem is that Repsol is going to have a hard time getting the money back from Argentina. It has filed a case against the country in New York and this is going to go through a long and arduous process. The company might end up being a great deal at this price, but there is a lot of risk with this investment at the moment.
Inditex
The company owns a lot of well-known brands like Massimo Dutti, Zara, Pull and Bear, etc. The majority of the stores are company owned and the company has no debt. This is one of the companies I will gladly buy. Let us look at the figures which the company has managed to pull off.
 * |  * |
The problem is that the company is not cheap. The P/E is 22 and the stock has largely survived the drop in the Spanish market.
Abertis Infrastructures
Abertis has too much debt, with nearly €13 billion in debt, €393 million in cash and €3 billion in equity. The company has €15.4 billion in goodwill and intangibles. I hesitate investing in this stock because of this issue.
ACS
Again, too much debt.
Gas Natural (EGAS)
The company distributes gas and LNG. It also generates and sells electricity in the Iberian peninsula. The company has P/E of 7 and dividend yield of 8.45%. The company looks quite cheap, but I pause at the high debt/equity of 1.65. I would rather buy GDF Suez which is in a similar business, has debt to equity of 0.89, and dividend yield of 9.21%.
Verdict
So, if you look at the IBEX, you can probably find one business which satisfies all of our basic requirements of an understandable business with good balance sheet and attractive margin of safety. This is no reason to invest in the whole index, even after such a huge drop in the stock market. Although if you can analyze the banks (BBVA and Santander) and find them attractive, you will probably not buy the index anyway.
