PIGS that roar!

Source: Datastream

Source: Datastream

After such a good run by the wider market, as well as by the stocks selected by the screen, I’ve been faced with a bit of a problem. Despite the fact that the last year’s screen was far less demanding in its criteria than a genuine Neff screen should have been, this time around only one stock passed all the tests. A central problem was that valuations have become a lot more demanding and the best way around this I’ve been able to find is to relax the key valuation criteria.

When hunting for value, Mr Neff, a famous US fund manager who ran the Vanguard Windsor fund for 31 years, liked to use a ratio based on a stock’s PE divided by expected total return (TR). TR is made up of expected EPS growth plus dividend yield. Last year’s screen demanded that this PE/TR ratio was less than one. This year the screen only demands that stocks have a PE/TR ratio that is less than the median average of about 1.8. The 156 stocks screened are made up of all the constituents of the blue-chip indices of the PIGS. While the relaxation of the valuation criteria is far from ideal, the reality is that this screen is simply going to have to move with the times if it is to have much relevance this year.

The other criteria used by the screen are based on Mr Neff’s strategy of avoiding stocks that are either undervalued or overvalued, and looking for solid growth fundamentals. Another minor relaxation to last year’s screening criteria is that the companies have been allowed to fail one of the six historic annual EPS or revenue growth tests.

CNH Industrial

CNH Industrial (E: CNHI) is one the stocks from last year’s screen that is back for a second time but under a new guise. The major corporate event over the past 12 months that prompted a change of name from Fiat Industrial was its merger, completed in September, with now-eponymous US tractor maker CNH. Fiat Industrial already owned most of CNH but bought up the remaining 12 per cent in a shares-and-cash deal. A new equity structure has also been created and the shares are now listed in New York as well as Italy. The deal makes the company the world’s third biggest capital goods player. Management has also said the move represents a significant shift in focus away from recession-ravaged Italy and towards the US. Indeed, there are strong hopes that the group can boost the sale of Iveco trucks and vans in the US.

But trading news from the expanded group has not been that encouraging so far and there are a number of headwinds that it faces. One of the biggest concerns is that the US agricultural equipment market, which accounts for two thirds of group profits, could be weak for some time to come due to an increase in crop production and consequent crop price falls - the main determinant of heavy equipment demand. Meanwhile, continued economic weakness in Europe is weighing on Iveco’s margins and the ongoing softness of the non-residential US construction market, where it sells equipment, is another negative factor. That said, much of this news should already be in the price and the shares trade at a discount to international peers. This suggests good potential upside if headwinds ease and if management can impress investors with post-merger strategic initiatives. Broker Natixis puts a sum of the parts target price on the stock of €11 (£9.21).

*Based on long-term forecasts

Source: S&P CapitalIQ

Distribuidora Internacional

Spanish food retailer DIA (E: DIA) operates in something of a sweet spot thanks to its focus on convenience stores and fringe-of-town discount mega stores. Despite its significant exposure to Spain, where trading conditions have been tough for some time, it has performed well, boosting margins despite falling like-for-like sales. Given the tough backdrop there are fears that margins will inevitably come under pressure, though. The group is also struggling in France with brokers predicting operations there will make a loss next year.

But France could actually provide some excitement for DIA investors despite the tough prospects. This is because management has recently hinted that the sale of the French business is a possibility. Brokers believe conditions for a sale are reasonably good at the moment despite the outlook. And not only would a disposal stem potential losses, but broker Natixis estimates that redeploying funds to invest in emerging markets, in countries such as Brazil where the group has a fast growing presence, could boost average EPS growth by as much as 9 per cent. Regardless, the group is already expanding in emerging markets, and emerging-market sales accounted for 27 per cent of the third quarter total. In local currency terms, emerging market profit growth came in at 41 per cent in the first nine months of 2013, although this dropped to 19 per cent once currency movements were accounted for.

GTECH

Last year’s PIGS screen picked out GTECH (I: GTK) but under its previous corporate incarnation of Lottomatica. The name change reflects the lottery operator’s desire to integrate more closely with its US arm, the eponymous GTECH, which was acquired in 2006. The group’s operations in the Americas have been driving growth this year with strong demand for lottery tickets and gambling equipment. The group has been achieving good growth from its Italian lottery business recently too, although this has been offset by declining machine gaming revenue. The group has also been hit by a recent one-off €30m out-of-court settlement with the Italian government over a gaming machine dispute.

While the solid underlying trading at GTECH is encouraging, the real excitement next year could come from the potential for the group to win new contracts to run lotteries with opportunities existing in Greece, Turkey and Ontario.

Viscofan

Shares in Spanish meat-casings company Viscofan (E:VIS) plummeted at the end of October when the group announced a big third-quarter earnings disappointment. The main culprits for the underperformance, which led to high single-digit cuts to earnings forecasts, were the strength of the euro coupled with a strong rise in input costs, including energy. The market took fright at the fact that Viscofan hadn’t managed to pass more of the cost increases on to its customers. Chinese factory start-up costs have also weighed on recent results.

That said, the casing business continued to benefit from underlying volume growth and there was an improvement in the sales mix in the third quarter, even if the negative factors more than offset these positives. The company has also been making some operational efficiency gains. And after a punishing share price fall, much of the disappointment should now be priced in providing some opportunity for the shares to re-rate should the backdrop start to improve.

*Based on long-term forecasts

Amadeus IT

Despite putting in an exceptionally strong performance over the past 12 months (see table) shares in travel technology group Amadeus (E:AMS) continue to qualify for our screen based on the softened valuation criteria. In fact, the shares look pretty good value compared with its peer group, with broker Natixis pointing out that the 2014 enterprise-value-to-cash-profit ratio of about 10 times is some way below the sector average of 11.5 times. What’s more, there are many reasons to feel positive about Amadeus at the moment. For one thing, the group stands to benefit from the rise in air passenger numbers which is currently being seen. The group also continues to win market share as it gains new big-name clients. And while the IT solutions business recently reported on a soft quarter, a strong end to the year is expected.

The group is very cash generative and broker JP Morgan forecasts that net debt may represent as little as one times cash profits by the end of the year. Given the low debt levels, there are growing expectations that the group may return cash to shareholders through buy backs or a dividend boost.