Cash from fallen angels

In times of market turbulences in the USA and in Europe, caused by uncertainties about the economy, fears of a double dip recession, concerns about sovereign debt and possible implosion of the Eurozone, equity markets are under pressure. This is partly justified because any forthcoming recession would put a dent into EBIT of corporations and likely therefore a dent into the future free cash flow of companies. On the other hand, markets are also hammered down by emotions, by the king amongst them: fear.

This can lead to undervaluation of companies and cheap shares. Whether the latter is actually the case is best ascertained by doing a proper valuation. When blue chips or near-blue chips are succumbing to selling pressure people sometimes talk of fallen angels. Unless a company’s business is seriously hurt, it’s unlikely to cut its dividends, especially if it opted for a dividend policy of  continuously increasing annual dividends rather independent of the yearly profit levels. Low share price and sustained or increasing dividend lead to a high dividend yield, i.e. income. Let’s look at the fate of three blue chips that feature high dividend yields these days, and focus on the technical picture.

Telefonica (ISIN: ES0178430E18), the Spanish telecoms company. It features a price earnings ratio PE of 6.57 (trailing 12 months) on Yahoo and a dividend yield of more than 11%. That is ‘huge’. What happened to the stock? In Nov 2007 it peaked at ~ EUR 23.00, since then tumbled to EUR 13.93 on Sept 16, that’s a fall of > 39%. The turbulences in Europe have taken its toll; a bit of less operating profit in the first 6 months but still good growing revenues from Latin America;  plus it recently announced a new corporate organisation. Chart-wise the stock is in a downtrend specifically since May 2011. Noticeable from a distance: (1) wrongly layered moving averages, (2) a steady down-trend in on-balance volume and (3) MACD taking a bath in negative territory since about May 2011. When a spark ignites the imagination of investors, the future is bright, as the stock is close to the 2008 bottom, possibly not much more to fall and because the company has been a renowned organisation.

Total (ISIN: FR0000120271), the French oil company. It features a PE of 6.5, again pretty low, and a dividend yield of around 7%, one could argue pretty high. The stock peaked (as by now one would assume) in 2007 at above EUR 60.00 and since then tanked to a level of ~EUR 33.00. That’s a drop of about 45%. Compared to 2007, fundamentals and specifically the beliefs in the kind of future cash
flow must have changed significantly to justify such a decline. Think discounted cash flow analysis: To knock down 45% of market value, one has to downgrade the outlook for free cash flow quite a bit and/or increase the market value of debt in good measures. Total showed a decrease in net income from 2007 to 2009. More recently it suffered more costs for maintenance/repair and disruption of production in Libya. Apart from that it boasts a series of good news too and is considered a top-notch oil company. Chart-wise the stock has sunk below the 2008 financial crisis bottom. From a helicopter view to see: (1) Uptrending accumulation/distribution (2) MACD recovering from massive negative depth (only featured back in 2008 in similar form) and (3) moving averages rather flat since early September. A very narrow Bollinger Band promises exciting times ahead.

E.ON (ISIN: DE000ENAG999), the German gas and electricity company. Yahoo gives it a PE of 11.30. The dividend yield is today about 7.1% Aha, yet again a pretty decent yield. So then, what happened to E.ON (nice name, isn’t it? Like Electricity switched on). E.ON is a fantastic story and has hopefully made many people (nearly) rich. 1995 the stock price was about EUR 10.00. On 10 Jan 2008, its closing price was EUR 50.93. That’s a gain of 409%. Since then, the share price has dropped to now EUR 15.62 on Sept 16. Oh dear! It even sliced through the support from the early 2009 bottom. So then, want went wrong? Net income shows volatility, but the dividend has been kept constant since 2008. E.ON has been impacted by the fear created by the nuclear accident in the wake of the Tsunami in Japan and the plan of the German government to exit from nuclear energy by 2022. Early September E.ON announced cost cutting plans, including cutting up to 50% of jobs at its HQ and 10,000 or so jobs elsewhere in the group. The company seems to have embarked late on a move into renewable energy, which now is clear on the agenda of the German government and in other countries as well. Good news is that the firm’s management acknowledged own mistakes. Thus, the cost cutting program is on and with a bit of perseverance the company will see its fortunes improve again.

Anyway, from above examples, one wonders: What’s the interest rate one gets these days for a cash deposit? Take a fallen angel with potential to stand up and unfold its wings again. A dividend yield of 7% or more with any capital gains as unexpected bonus, if one assumes the angel has hit rock bottom, could amount to a decent total return over a full year.

Disclaimer: The author is neither intending to provide or is giving any financial advice. No investment recommendation is made. Above corporations are solely mentioned for the purpose of illustration.