Monday, 23 July 2018

Too late now?

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Investors love an emerging market. Central and Eastern Europe has been popular with investors for years but while its markets are emerging in terms of size, many argue that post-accession they don’t offer the same value as those further east. Solomon Teague reports.

Central and Eastern Europe has seen a rapid improvement in its equity markets in recent months and years, according to Thomas Farthofer, portfolio manager of Griffin Capital Management’s €700m Eastern European Fund. Poland has seen particularly good progress, and offers the best opportunities in the region (discounting Russia and the CIS).

Yet the view of the region is not universally positive. “Most of the returns available in this region have been extracted,” said Anton Khmelnitski, director at Polar Capital.

“There is not much mispricing left between this region and Western Europe. If anything it might even be more expensive as a growth premium has already been priced in.”

Poland is a considerably larger market than its neighbours and has a good supply of large companies into which foreign funds can easily invest without breaching their liquidity requirements.

This has been fuelled in part by increasingly active Polish institutional investors and a growing number of hedge and long-only funds snapping up Polish assets, driving up liquidity. Martin Majdaniuk, co manager of Baring Emerging Europe, which manages around US$5.5bn in the region broadly (including Russia, the CIS and Turkey), compared the Polish equity market to that of Denmark in terms of size.

Poland enjoys a small current account deficit, relative to those of its neighbours in the region, and benefits from a stable currency, Majdaniuk noted. Of all the countries in the region it has been the most successful in attracting foreign investment. It enjoys higher industrial activity than most of the region and the large number of Poles living in Western Europe and sending money back home – €4bn in 2007 – provides a major fillip.

The other market in the region offering sufficient liquidity and choice to arouse substantial investor interest is Austria, said Farthofer. As well as having a mature equity market in its own right, numerous companies with operations throughout Eastern Europe are listed in Vienna, giving good regional exposure. Raiffeisen Bank exemplifies the trend that is evident not just in financial services but infrastructure, energy and construction. Even Vienna airport offers this broad exposure, being a regional hub, Farthofer added.

But for investors looking for real growth potential, they are better looking further east, for example to Ukraine, said Khmelnitski – the second largest consumer market in Europe, he said, and a country that is where Central and Eastern Europe was 10 years ago.

Things being as they are in the global credit markets, Majdaniuk expressed caution over countries relying on the interbank market to finance their deficits. In Hungary, Romania and the Baltics, where reliance on energy imports is particularly high and domestic consumption has outstripped levels in Poland, this is a particular problem, and current account deficits higher are worryingly high.

Banking has provided one of the most compelling opportunities in the region, according to Griffin’s Farthofer. He believes the negative sentiment surrounding the sector has infected individual cases where the fundamentals remain sound, and sub-prime exposure is minimal, even if the cost of funding has risen. Plenty such examples can be found in Central and Eastern Europe, he noted, where valuations of banks have plummeted around 15% year to date.

Hitherto Barings has avoided banking, but Majdaniuk agreed in the last six months valuations have dropped to levels that are, in some instances, quite attractive. He is considering investing in banks that are not reliant on external funding via the interbank market, and which have strong balance sheets, as they have been hit unfairly by association with a sector ravaged by the credit crunch.

Majdaniuk identified the infrastructure trend as a strong play in the region. Engineering and construction companies in Poland, for example, are likely to benefit from major improvements set to take place throughout the country, with EU funds pumping into the region over coming years set to buoy local companies, several of which are listed in Warsaw. The retail and consumer manufacturing sectors are also a strong play, Majdaniuk said, in Poland and elsewhere.

Farthofer cited the region’s telecoms sector as a fruitful hunting ground for investment ideas. Telecoms companies are highly cashflow positive, he said, commonly paying a dividend yield in excess of 5%.

The commodities super-cycle trend – prevalent in Russia and the CIS – is also available to a lesser extent in Central and Eastern Europe, Majdaniuk added.

But ultimately the region offers opportunities for stock pickers, despite the size of the investable universe.

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