Category Archives: Europe

Europe

Front Row: Short France?

Europe, Global Economy, On the cover, Sin categoría

Front Row represents the personal view of Rodrigo Rodriguez, European Head of developed cash trading for Credit Suisse.

front row 2Milan beat Barcelona on Wednesday… aside of that being a tragedy….I am sure Silvio narrowed the gap on the back of it and on top of that the Fed starts thinking about reducing QE ….BOE gives a mixed message and the banks return less than expected to the ECB on the LTRO. Finally, BOJ thinks they might have moved too far too fast…definitely very bullish signals?…NOT! Continue reading Front Row: Short France? →

European de-industrialization. The "silent Depardieu"

Europe, Global Economy, On the cover, Sin categoría

This article was published in “El Confidencial” on February 1st, 2013

“When you act like Europe, you get growth rates like Europe” Rick Santelli
“The European periphery will likely remain in recession for at least 10 years” IFO Institute

A few days ago I was invited to give a talk at the London Business School and a student asked me what was the biggest mistake of European politics. “The conscious decision to support expensive and inefficient sectors, instead of promoting a process of substitution through quality, price and competitiveness.” Why? Because “picking winners” is easier, public funds are treated as if they belonged to no one, demand estimates are always optimistic and cost does not matter to politicians… Meanwhile, even the most patient investor gives up and leaves.The silent Depardieu.

I admire Gerard Depardieu, an excellent actor. After years of contributing tens of millions in taxes, he decided to leave his country due to the unbearable tax system. It was his right. That is why I use the term “silent Depardieu” to illustrate the process of European de-industrialization  which is essential to understand the current economic environment and the loss of potential GDP.

The de-industrialization of Europe can not be attributed to liberal policies. In fact, if anything it is characterized by the implementation of giant “industrial policies”, Soviet-like plans of public spending on infrastructure, and government support to dinosaur-type national champions in “strategic” sectors. What our politicians call “growth plans.” Hundreds of billions … in debt.

The problem created by these plans is an enormous cost that citizens pay in taxes and excessive tariffs, and an “eviction effect” on companies, which need to close or leave to other countries because costs soar and the system penalizes start-ups. And now politicians ask for more of the same. Nothing like repeating a formula that has failed.

“Government’s view of the economy can be summed up in a few sentences: If it moves, tax it. If it keeps moving, Regulate it.And if it stops moving, subsidize it. ” Ronald Reagan

Blaming China or India, cursing globalization and promoting protectionism lead us to where we are. Stagnation and praying that next year “will be better.”

Governments have a role in the economic transformation of a country, of course. But their mission is not to  maintain low-productivity sectors at all costs. Governments’ job is to understand globalization and facilitate the transition to high productivity economic models, encourage innovation, not subsidize it, and promote high education.The problem is that politicians do not like it, because it does not give photo opportunities inaugurating bridges.

The current model of “intervention-subsidy-fail-debt-impoverishment-subsidy” leads Europe, and peripheral countries in particular, to compete only through internal devaluation . This is our great success. We can produce cheap cars for another. Wow.

When the economic model is the policy of the ostrich of burying one’s head and wait for 2005 to return, hoping that the world will recognize our acquired privileges -that we refuse to other countries, the outcome is only recession and devaluation. Impoverishment.

No, exports of low value-added products and the destruction of domestic demand are not economic successes. They are the result of maintaining GDP through excessive government expenditure, uneconomic investment and overtaking China in unnecessary infrastructure and ghost towns. China may be able to afford it. We don’t.

Producing low added-value products for others, focusing on construction and concessions, leads to seeking competitiveness through lower wages. It’s a patch, but it impoverishes. There will always be a country willing to produce the same good at a lower price. The point is that the production of such good must not only have an adequate cost, but a technological and logistical advantage. Growth through margin expansion. Europe must change a rapidly decaying model and let change and innovation thrive, not try to go back to 1977.

The solution is not to make low cost components for other European countries, which in turn will impoverish to compete for the same factory. The race to zero always ends in nothing.

The industrial plans promoted by the European Union have been characterized by:

– A huge cost to the taxpayer. Industrial plans have always been promoted through spending, more debt, not through tax incentives and deductions. Now most of Europe has public debt above 90% of GDP.

– Capricious and non-economic political decisions to pick “winning sectors”, only to let them fall after a fake price and demand signal created by subsidies. Supporting non-competitive industries.

– Defending decadent sectors to “sustain employment” and keep alive zombie companies through subsidies, only to remove them, achieving neither a strengthened “national champion” nor wealth and employment. This creates a problem of  managers that are “private-sector civil servants” and cronyism.

– When the money flows, states spend in low-productivity sectors and forget to invest in R & D. When the fund flow stops, they also forget. See the chart. Better not to subsidize, just give tax incentives.

All this would not be a serious issue if it wasn’t financed with debt, or if the tax policy and costs for businesses were bearable. However, when countries spend amounts exceeding 5-10% of Europe’s GDP per annum in subsidies and wasteful spending, the tax burden and costs escalate.

“Growth Plans” do not create jobs, they subsidize them for a very short period of time… leaving behind a load of debt. Remember the Plan E, the green initiative, the 20-20-20 plan… For every euro spent, according to our estimates, 1.25 euros of debt since 2006 virtually no net job creation. “It would have been worse otherwise”, we hear. No, when we have created such a debt problem. Not at all.

A system that in recession increases the tax burden by five percentage points and makes energy tariffs (Germany, Spain) rocket 30% above any commodity, is unacceptable for a company, especially small and medium enterprises, which account for 70% of value added in the periphery. They close or emigrate.

A parasitic European Union where there are too many “supervisors” and too little “doers” … makes the “silent Depardieu” happen more and more, as the assault on the entrepreneur deepens. Think of the recent examples of threats to nationalize Arcelor-Mittal’s operations in France, or how public administrations don’t pay suppliers but demand them to pay VAT of the unpaid bills in time!.

It’s not just just the money spent on maintaining declining sectors, is the accumulated debt and the cost of losing the opportunity to pursue innovation.

That is why they have to lower taxes, ensure legal certainty and reduce the size of the public sector . These three problems are engulfing any real recovery option and long-term productive investment.

This has repeatedly been alerted by the IFO institute and the Natixis report “The Vicious Cycle for Europe”.

We have proven for decades that “stimulating”-giving the State a check-book with debt- does not work. We now know that the “internal devaluation” only brings more taxes, less disposable income, less consumption, debt is not reduced, which leads to structural unemployment.

And, of course, due to the reducing number of companies and additional debt … lower of tax revenue, new adjustments and start again. Five steps back to take a step forward. It is no coincidence that the vicious circle is monopolized by peripheral countries, the most stubbornly committed to support declining sectors and promoting non-competitive industries through subsidies.

The solution is, and always has been, to attract capital, not reject it.

The new production model is not going to be created in a committee or a summit. Private investors will doi it. The State should facilitate the transition not through intervention, but by investing in education, lowering taxes for entrepreneurs, reducing bureaucratic obstacles and, above all, not subsidizing the expensive and inefficient sectors.

At the end of my talk in London, a student asked me, “Why does Spain not create a Spotify, or a Core Labs?” He is an Engineering Technology student and is preparing a start-up.

I asked: “Where are you opening your business, here or in Spain?”

He said: “In Westminster they have told me that I might not pay taxes during the first three years, so probably here … Why?”.

“You’ve just answered yourself”.

Ideas for 2012: Look out, Helter Skelter!

Europe, Global Economy, On the cover

(Published in Cotizalia on 24th December 2011)

First of all, i wish you all a fantastic 2012, full of peace.

Like every year, I venture to give you my ideas for the year that is approaching.

My bet for 2012 is a combination of corporate bonds, anti-recession stocks  ​​and a very neutral strategy in commodities, covering with short positions in semi-state-owned companies and indexes in France, China and Brazil.

All my bets are relative, ie I do not expect the stock market to rise, in fact I see a fall potential of almost 20% in the Eurostoxx , so I expect a neutral strategy to deliver positive returns through the outperformance of longs versus shorts.

The reason why I look for long positions in Southern Europe, and particularly in Spain in 2012 is as follows. On the one hand, efforts to keep the corpse of the Euro will probably lead to the Germany and Eurozone countries to accept successive injections of liquidity by the ECB. That, as in 2011, creates the best short opportunities in the Eurostoxx as it is a transfer of wealth from Germany, Finland and the Netherlands to the south of Europe of nearly €150 billion, which added to the effect of a more aggressive policy to reduce debt by Monti in Italy and Rajoy in Spain could lead to the stocks in southern Europe to perform better than European indices. It is a gift from Northern Europe to the risk premium of Southern Europe stocks, and therefore lowers cost of capital.

Consensus of analysts still expects a growth in Europe of earnings per share of +10% a year 2012-2013 . This is falling gradually, and once adjusted for more realistic growth, the PE of the Eurostoxx, according to Kepler, is actually 11.2x 2012, not cheap. In a report with which I agree fully, and I’ve said before in this column, this investment bank believes that corporate earnings still have to be revised downward by 50% to reflect a realistic drop of 5-10% for 2012-2013.

Those who follow me regularly know that nobody can accuse me of being optimistic in my estimates, but Spain can be a surprise in the European market, but investors should be very selective because without subsidies or the debt expansion party, constructors, concessions, renewables, banks and other subsidized firms will continue to suffer a prolonged stock market Via Crucis . I would stick to the companies with strong LatAm and Emerging Market exposure and low gearing.

Dividend cuts in the rest of Europe are still to come. I expect a fall in the dividend yield of 4.6% of the Eurostoxx to a more reasonable 2.8%. Beware of German industrial companies, and the companies with unusually high expected dividend, which is likely to be cut.

I look for long positions also in the UK, where businesses are openly for sale, and mergers and acquisitions will likely accelerate in 2012. The benefit of the UK is to be an open market with its own currency, which has its own stimulus plan, and added to inflation makes it more attractive. British energy companies, except BP, remain at the top of my bets.

Avoid debt-dependent sectors and subsidies because the deleveraging process will continue in 2012 and will probably be much harder than in 2011. As an example, we have seen four solar companies go bankrupt in 2011, two consecutive profit warnings from Vestas in wind, and the list will continue. Putting money in these companies is not an investment, is a donation.

European banks have to seek capital for at least €115,000 million, and is not going to be easy. The risks of capital increases and dividend cuts are obvious.

Beware of “cheap for a reason” mega-caps and conglomerates. Do not bet on expansion of multiples when there has been none in 2009-2010 and 2011, years of expansion and growth thanks to the post-stimulus effect.
More Debt. More Debt.
No, unfortunately in 2012 I do not expect Europe to reduce debt as it should. Packaging more debt into the ECB balance sheet is simply masking reality. And the war of the conscious destruction of currencies by governments will continue … Let’s see who will be printing more and worse.France is the biggest problem, since it will probably have to rescue two of its banks with public money while industrial production falls by 0.5% and public debt reaches 110% of GDP. Countrywise, France, along with China, which is a huge bubble of debt, build up my bearish bets in 2012.

The bad news will continue to come from the OECD. The estimates of GDP growth in Europe and USA still seems too optimistic. With over $2 trillion cuts in public spending, $5.9 trillion debt to refinance only in Europe and elections in key countries like the United States and France, it will be hard to see the economy take off . I expect a GDP contraction of 0.5% in Europe and in Spain of 0.6%. In the U.S., estimates have been revised upwards after the latest macroeconomic data, regardless of the enormous amount of downward revisions of data from previous exercises we have seen. Very Orwellian, to review the past really helps to give good data today. Seeing all increase in jobs last week coming from couriers is not exactly exciting. I estimate real GDP growth of 1.5% in the U.S., entering a recession in the second half in a year of elections and sequestration of budget (almost the effect of a  “negative QE”).

The problem of stimulus plans and injections of ECB debt in Europe is that it would strengthen the euro, and this makes it harder to recover the competitiveness of companies and European countries. This massive increase of ECB balance sheet to artificially lower CDS and help banks creates a real economy problem. The financial system and public debt eat all the financial resources available to the European economy, creating a “crowding out” effect on real economic growth, jobs and industries. When trying to resolve a problem of liquidity and solvency the true effect is that the European Union is squeezing the real economy out and not helping confidence or credibility in the system. I believe that the euro should go to $1.15 or even back to parity with the dollar.I do not think interventionists will allow it.
 
Emerging Markets
 
China is likely to remain the “Big Short” in 2012. Growth will continue to be manipulated, driven by a housing bubble that has already reached 12% of GDP and non-financial debt already exceeding 200% of GDP, and therefore destructive of value. With growth slowing, the country will pursue an expansionary monetary policy, accelerating debt to sustain a GDP growth above 6%. But this “growth” takes place through the further destruction of value seen in the economic environment, as returns collapse. In my analysis, 70% of Chinese listed companies generate returns below their cost of capital. It should be no surprise. Semi-state companies are usually large destructors of value, and in the MSCI China Index, 48% are semi-government owned. Conclusion: Short. Brazil and Russia will continue the same path, in which inflation and growth is expected to move in the same direction, generating very little value for investors, especially because of its excessive dependence on oil.
Avoid at all costs semi-state-owned entities in an environment of economic slowdown. They end up being the subsidisers of the economy and minority investors in them are simple charitable donors. That is why China, France and to a smaller extent Russia , where the percentage of semi-state companies is higher, is where the minority shareholder is most vulnerable when states seek to reduce inflation and contain costs.
Commodities
 

Unfortunately, consecutive years of printing money, lowering rates and injecting liquidity into the system means expensive commodities despite the expected fall in demand and increased supply.

I estimate growth in global oil demand of 0.7 million barrels a day compared with +1.2 million expected by  consensus and a small increase in production, generating a spare capacity of 5 million barrels/ day, leading to an estimated average of $90/barrel Brent excluding geopolitical pressures. The price premium for geopolitical risk if we see an increased pressure on Iran would move, as usual, between $8-10/barrel.

All indicators I have lead to estimate a stagnant demand for gas and electricity in the OECD, especially in Europe, which will highlight again the installed overcapacity environment.
In a  “La Nina” year, poor harvests and weather challenges would make a great opportunity to see increases in the price of corn and wheat of spectacular magnitude. My bets on commodities are kept in corn, wheat, oil and declining gas (Henry Hub), electricity (Germany and Nordpool) and especially CO2, where the path of death of this fake commodity, and manipulated as well, continues due to the massive selling pressure of debt filled countries, stagnant demand, refining shutdowns and emission free allowances needed to be sold. I see an unattractive environment for coal in 2012 , as China’s demand may not, in my opinion, offset the decline in India, which is spectacular. But my big bearish bet of 2012 is aluminium, where overcapacity is estimated to reach 30% while Chinese smelters continue to produce at lower costs.

Fixed Income

In a year in which states will be looking to refinance 5.9 billion in Europe and all companies have their sights on the bond market , the fixed income opportunities are not be missed because European companies have to refinance almost 1.1 billion in 2012 . No need to go to junk bonds, Single A  corporate bonds, (NOT banks) as in 2008, will be very attractive. Forget Sovereigns as oversupply will likely hurt any performance. As Bridgewater Founder, Ray Dalio said on Europe: “You’ve got insolvent banks supporting insolvent sovereigns and insolvent sovereigns supporting insolvent banks”
Remember in November 2008 flagship single A rated companies with good cash flows had to refinance at 250-350 basis points above the average (benchmark)? This generated one of the most attractive environments for investment in bonds. I think 2012 may again be a similar environment. The credit market will be monopolized by billions of sovereign debt issues and 1.1 billion of corporate debt to refinance, so it will likely be an attractive environment to buy single A corporate bonds at unusually attractive rates.
 In Summary

I see a year to gain much in the short term but very volatile, with a clear negative trend. I hope I’m wrong and in June I will write that all is well.

Volatility is good but does not hide a bearish environment, so I keep buying stocks ahead of Euro summits and stimulus packages and selling once announced. A market neutral strategy seems the most appropriate and of course, long only bets on “everything is already discounted” are the most dangerous.

May I remind you of my traditional sentences. The market does not attack, it defends itself. And in 2012 the market will be attacked again and again by waves of intervention.

I always say this market is a good bet and a bad investment , make good use of that and there is much money to gain. And when you read strategic reports of banks, remember the three phrases to identify a good short position: a) fundamentals have not changed, b) it’s a good company and c) the dividend is still attractive.

European utilities and the value trap

Energy, Europe, Global Economy, On the cover

(This article was published on Cotizalia in Spanish on July 22nd 2010)

“Welcome to the banana republic.” These are words of RWE’s chief financial officer (the second-largest German utility) after learning of the German government’s intention to impose a tax on nuclear power stations of € 2.3bn pa. Nearly 15% of the net profit of the two major companies are to be “seized” by the government. Snip.

The European electricity sector is again the worst performing sector in 2010, down 20%. This already occurred in 2008 and 2009 due to the weight of the five major integrated companies, which have all the features of what is called a “value trap”:

1. The returns of the companies are “seized” when governments need money. Indeed, from Germany to Italy (the cynically called “Robin Hood tax”), power companies are perceived by governments as public service entities, available to tap the capital market to make huge investments in the long term, but not allowed to generate returns above what governments consider “adequate”, which is a paltry 8% ROACE on average. At the end of the day, the governments think, they can always make capital increases (more than € 16bn in 2009) and start all over again. A sector where companies invest hundreds of billions per annum for 25 year projects but where the rules of the game change every four or five.

2. Run To Stand Still. Part of the huge number of mergers and acquisitions that we have seen between 2004 and 2007 came from the objective of these groups, several semi-state owned, seeking to generate returns outside their country because the profits in their home market will always be limited. But then the results end up being as disappointing as the domestic. Look at EDF (France), which has spent €60bn on acquisitions, to generate no added net income whatsoever, or Endesa-Enel, GDF-Suez, a story of additions through acquisitions that have always delivered lower ROCE, or E. On, whose net profit is very similar to that of 2007 after acquiring billions of dollars in assets. Funny that the sector is not cheaper on 2 year forward multiples than it was in 2008, when it’s 40% lower.

3. One sector that is only optically cheap. The sector trades at an average of 6.7x times 2012 EBITDA and dividend yield of 6.7%. It seems very attractive to those seeking an investment in the “long term”, right? Careful. The EBITDA multiple is actually closer to 8.5 times if “clean” estimates, removing the free CO2 permits, are applied. And more importantly, after the wave of M&A and re-gearing, the WACC has increased, something that companies do not acknowledge. And be careful with the estimated dividends. First, because we have already seen cases (Enel, National Grid, SSE, etc.) in which the dividend is paid by the investors themselves through capital increases disguised as “opportunities for growth”. But also remember that such a capital intensive sector needs to maintain a pristine credit rating to access the bond market. With returns confiscated and an average 3x Net Debt/EBITDA, the sector does not generate enough free cash flow to undertake the committed investments, pay dividends and reduce debt.
In addition the sector has delivered the keys to the reserve margin management and investment decisions in new generation capacity to their governments, who are delighted to see overcapacity, and the industry, with the risk of seeing no growth, prefers to invest in the hope that someday they will be remunerated for the investments.

A sector is also a reflection of its managers. Except for honorable exceptions, it’s worth highlighting the low quality of management teams, with a history of investing billions at the peak of the cycle and then selling at the lows, and their poor exposure to the share price (minimal ownership of directors in the shares). At last, after all, how can the investor trust a manager who owns almost no shares in their own company, is incentivised to buy anything that moves to “grow”, and having to invest long term, have a such a poor long term track record?. Additionally, I would highlight the low interest that governmets have in the share price of their own investments, not aligned with the minority holders.

It is interesting to see in this environment that the worst performing stocks are the most recommended by analysts (EDF, E. On, GSZ, EDPR) all over 80% of “buy” recommendations. I always say it: In a bull market you don’t need analysts and in a bear market you don’t want them. The only ones that are doing well are the ones showing financial discipline, focused on return on capital employed (ROCE) and “anti-government rebellion”. And if you like the sector and want value, play short-term securities which are targets for predators or in the process of restructuring, or transmission companies, BUT only those which offer a higher dividend to that of the yield of corporate and government bonds, because if not, you are subject to the risk premium of the equity market without the required returns. The rest is waste of money. We continue to warn about it.