Value Opportunities in the Sovereign Debt Crisis

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Portuguese flag

Presentation by Hugo Roque of

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When Jacob invited me to write on this blog I was most pleased for the opportunity to share some value investing thoughts and investment ideas from european markets and others. I’m from Portugal, which has been recently very discussed on international media because of its public finances doubtful solvency. I will start my contribution to the site with some context of Portugal’s situation right now and some investment opportunities for the contrarian international value investor.

Sovereign Debt Crisis – Portugal’s Situation
The recent sovereign debt crisis that started in Greece disturbed the European markets making its main stock indexes fall appreciably. Portugal has also been highlighted by growing speculation that it may be the following country to enter into probable default scenario. The latest rating agency to say it was the S&P that agreed that today the Portuguese public finances numbers are different from Greek (deficit of 9.4% vs 13.6% of the Greeks; public debt of 76.8% versus 115.1%) but leaves doubts as to the national economy dynamism, predicting that anemic economic growth of the past decade (of about 1% per annum) will remain in the coming years. This should make much more difficult the goal of fiscal consolidation to the extent that deficits reduction will find obstacles of tax revenue realization as a result of economic paralysis and in the reduction of expenditures due to a likely maintenance of a high rate of unemployment. The credit rating assigned to Portugal was A-with negative outlook, that is, with prospects of lower future.

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To combat these problems it has been presented the Stability and Growth Plan (SGP) which aims at a reducing of public deficit to 3% by 2013 and the reversing of the upward trend of public debt. To help meet these targets there as been launched several measures of tax increases and state assets  sales. That is, by 2013 and accomplishing the estimates of the plan Portugal will still incur in deficits (contributing to the escalation of the state debt), our public debt will be slightly higher than the current, although state politic responsables continue to squander state assets, the economy will continue to progress very slowly and without a clear economic growth and productive engine, and unemployment will continue to be high. In short, it doesn’t to be being prepared a real reversal strategy for portuguese economy, but rather an attempt to halt a problem and to then continue to get the same past and poor results.

The Portuguese market has been severely penalized. The main national index, the PSI 20, fell about 15% since the peak on October 2009. Despite the cyclical and structural context in which the country finds itself and even taking into account estimates of rather poor growth, this sharp fall in the Portuguese financial market is mainly based on speculation that Portugal could be in default on its debt. This will be very difficult to happen because, when specifically compared with Greece, Portugal, in spite of all, has greater credibility on its statistics, more sustainable economic indicators, foreign reserves three times higher than those of Greece, relevant reforms in social security area, etc.. Even compared to bigger and stronger european countries like France or Italy, public finance figures and economic prospects are not all that different. In fact these problems I’ve talked about can be consired difficulties of the entire euro area, with some exceptions like Germany, although with different degrees of intensity.

Even if, at the worst short term case scenario, some problem with the Portuguese economy financing surges it will not certainly be in the European Monetary Union (EMU) interests that some of its members enter into default, because of possible disaster consequences for the single currency (Euro) and the sustainability of other countries in very similar situations. Thus, and as is already being done with Greece which has agreed a funding package of 110 billion euros to EMU, at worst, Portugal would be assisted in its debt refinancing, though it would eventually cost more stricter measures of restraint.

Bill Gross, Co-CEO of Pimco, who is starting to invest more heavily on stocks, recently considered  portuguese market and others affected by the sovereign debt crisis, were facing tough challenges but on valuation terms, stocks “are being negotiated at very low PE’s and in some cases they can be perceived as being almost as safe or guaranteed as the country’s public debt due to their international exposure and private nature”.

The value investor always looks for investment opportunities in markets where uncertainty is high but risk is somehow limited. The Portuguese market can presently provide some of these opportunities. Note, however, that each investment must be individually considered, examined and decided, so that, over time, the market will eventually reflect its intrinsic value according to its business performance.

Two Investment Opportunities

Energias de Portugal (EDP) is a energy utility company. With a total of 81% of its results derived from regulated activities, the business of EDP has characteristics of high stability and predictability. Furthermore, over 50% of results have come from outside Portugal providing diversification and operational flexibility to the company. Its renewable energy division is the world’s nº 4 already and the Brazilian market exposure could be important catalysts for future growth. With a price-earnings (PER) of 8.5 and a dividend yield of about 6%, this is a valuable opportunity.

Banco Espirito Santo (BES) is currently the largest Portuguese bank in terms of market capitalization. The net banking income by activity, breaks down as follows: commercial banking (78,3%), investment banking and funding (11%), specialized financial services (5.6%), asset management (% 4.6), other (0.5%.) It has a network of 757 agencies primarily in Portugal. BES has demonstrated a capacity to overcome current situation with solid indicators on a balance sheet level, a strong shareholder structure and an appropriate international diversification strategy, which should enhance the bank’s growth in overseas markets in coming years. This desire has been demonstrated with recent investment in markets like Britain, Denmark and Libya. The bank pays a dividend of around 4% and has a price to book ratio of 0.68 and is making considerable profits. Quite attractive.
Note: These securities do not trade in US markets, only in europe.

Disclaimer: This comment is merely an opinion of the author and not a recommendation to buy or sell. Purchases and sales are the responsibility of the investor as well as profits or losses arising therefrom. The author may have, and probably has positions in securities mentioned. If in doubt, investors should seek to contact their brokers or finacial regulatory authorities.

Hugo Roque

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  1. Nice post Hugo. I am always interested in learning about new opportunities and your right to assume portugal probably has some interesting plays.

    I would just like to note that when investing in the context of a sovereign debt crisis or fear of one, you probably dont want to be buying companies that have a lot of debt (ie Utilities or banks) because their funding costs will inevitably go up as the sovereign interest rate rise. Though as we have seen in the US (with negative swap spreads) sometime corporates are viewed as more safe than countries. But its something to consider.

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