John Haskell’s presentation from the Spring 2016 Grant’s Conference, titled, “Mispriced Securities In Latin America.”
Mispriced Securities In Latin America
Opportunities abound in Latin America for fundamentals-based investors. Sometimes misunderstood as only a play on China and commodities, Latin America, mired in political scandals and buffeted by capital outflows, posted the worst regional equity returns in the world last year. As of March 31st 2016, the region has lost a cumulative 54% in dollars from its 2011 peak. The market dislocation has left many securities substantially mispriced. One of the most attractive and asymmetric risk-reward investment opportunities today is to buy shares and debt of resilient companies, trading at a discount, that are focused on the domestic economy and the secular advance of the middle class. They span the Andean markets of Chile, Colombia and Peru, as well as Brazil, Mexico and Argentina. They compete in sectors as diverse as telecom, packaged foods, retail, cement, engineering services, hydroelectric generation, and banking.
John Haskell will take the opportunity at Grant’s Spring 2016 Conference to present specific investment ideas.
Market and macroeconomic context
The purpose of this memo is to provide market and macroeconomic context ahead of that discussion. Three key points:
- Markets in Latin America have a history of high volatility for dollar-measured investors. The MSCI Latin America Index is down 54% from 2011 peaks. For dollar-based investors there are three components of returns: corporate earnings, valuation multiples, and currencies:
- Corporate earnings across the region have declined 18 to 64% in local currency from 2011 to 2015.
- The cyclically-adjusted P/E multiple for Latin America has collapsed 50% since 2011.
- Currencies have depreciated between 13% and 51% since 2010.
- Current valuations are undemanding compared to other regions. Latin America trades at a 53% discount to the cyclically-adjusted P/E multiple of developed markets and an 17% discount to global emerging markets.
- Stronger economic growth trends will resume over the next 12 months, benefiting investors who position themselves today. These trends are supported by favorable demographics and, especially in the Andean region and Mexico, by low inflation, manageable fiscal deficits, free trade, and strengthening democratic institutions.
A history of extreme volatility (and opportunity) for dollar-denominated investors
The region’s equity markets have declined 54% in dollars since 2011 peaks. If history is a guide, investors now have an opportunity similar to that of buying assets at large discounts coming out of the 2008 financial crisis, as equity markets have reached comparable levels.
The region has experienced four market crashes since 1995, surpassed in percentage terms by their subsequent rallies. Dollar-based investors experienced losses of 54% to 68% over periods of six months to 2.6 years: in 1997-1998 during the Asian financial crises and Russian default, in 2000-2002 during the “dot-com” bust and September 11th terrorist attacks, in 2008 during the financial crisis, and now. Following each period of market capitulation (the present excluded, so far), patient and contrarian investors then realized substantial returns. Investors in Latin America in late 1998 reaped 122% in the next one and a half years. Starting in September 2002, the market delivered 30%+ annualized returns over the ensuing five and a half years, sustained by a commodity “super-cycle.” Oil
rallied 375% from $28 a barrel to $134. Other energy, materials and foods items rose in tandem, in an unprecedented broad-based commodity rally, fueled by demand-side industrialization and urbanization principally in China. After losses from the financial crises in 2008, Latin American markets rebounded 185% in two and a half years.
January 2016 may have marked the end of a 4.8-year decline that wiped out 67% of market value from peak to trough. Even so, as of March 2016, Brazil remains 66% from its April 2011 peaks and in line with 2008 lows. Colombia is off 60% from February 2013 peaks. Chile and Peru have declined 51% and 43% respectively from 2011 peaks. Argentina and Mexico are relative outperformers. Argentina has lost 31% in dollars. Mexico has lost 27% since peaks in April 2013.
Three drivers of returns: corporate earnings, valuation multiples, and currency impact
Three components drive dollar returns for investors: changes in corporate earnings and cash flow, expansion or contraction of valuation multiples paid by the market, and currency gains or losses. All three explain the current market downturn.
Corporate earnings in Peru declined 66% between 2011 and 2015 in local soles. Earnings in Colombia are down 64% from 2012 peaks in pesos. Brazilian companies earned 47% less in 2015 in reais than in 2011. Lower commodity prices impacted the energy and materials sectors in these three countries, especially.
Mexican and Chilean companies have posted relatively resilient earnings, declining 22% and 18% respectively from peaks in local currencies. Multiples on earnings paid by the market have contracted 50% on a cyclically-adjusted forward price-to-earnings basis. The market pays just 9.3 times the average of the past 10 years’ earnings compared to 18.4 times just five years ago.
Snapshot multiples (not cyclically adjusted) are selectively below average, though less so due to presently depressed corporate earnings. Forward price-to-book multiples between 1.4x and 1.9x are below long-term averages in Brazil and the Andean countries. Mexico currently trades at 2.6x price-to-book, a premium to its 2.4x fourteen-year average.
See full PDF below.