Bank Stocks Lure Investors to Colombia

Bogota is a high-altitude capital

The bombings in the northeast city of Barranquilla at the end of January are a savage reminder of the evolving political setting in Colombia. Despite the government’s signature agreement with the Revolutionary Armed Forces of Colombia, commonly called FARC, other terrorist groups continue to operate. In this most recent incident, the National Liberation Army, known as ELN, claimed responsibility for the series of attacks, killing seven police officers and wounding dozens. Cross-border investors are unnerved by these headlines.

Isolated terrorist incidents, albeit tragic, will not derail a strong economic story. In Colombia, GDP growth could reach 2.9% this year, well above the 2.0% or so expected on average in Latin America. Recovering commodity prices are a huge boost, so too are outsized infrastructure outlays. As a testimony to this growth outlook, the Colombian central bank announced that its 25 basis point interest-rate cut at the end of January would be the last for this easing cycle.

Global investors tend to focus on headline political developments in emerging markets in ways that local investors do not. Politically-motivated violence has been a recurring backdrop in Colombia for at least two generations. FARC, for instance, was formed in 1964. The stock market was volatile after the recent Barranquilla bombings, but that actually reflected oil-related trading patterns in Ecopetrol, the largest single stock by capitalization on the Colombia Stock Exchange. The broad-based Colcap Index is otherwise up a dollar-based 11% in the year-to-date period through February 2.

Ecopetrol is the local blue-chip benchmark. Colombia ranks as a top 20 oil exporter; its capacity is similar to the United Kingdom or Azerbaijan. Ecopetrol controls a dominant portion of the domestic business, although it is not a strict monopoly. Among cross-border investors, Ecopetrol is considered a more conservative portfolio holding than Pemex and Petrobras, the Mexican and Brazilian oil giants. If the oil price continues to improve, Ecopetrol’s stock price should also be buoyant.

The real gem in Colombia, however, may be the financial services sector, representing the largest component of the domestic economy at about 20% of GDP. One reason for that largess is that the country runs a mandatory pension-contribution system. The combined market capitalization of the major bank stocks is near one-third of the total stock market, or about twice the size of Ecopetrol.

Global investors should be encouraged by the fundamental story among Colombia banks, the largest of which is Bancolombia. You can scratch the classic emerging-market stereotype of slow-to-innovate financial institutions that are dogged by government regulation. As a group, these banks are altogether different. We see two trends worth watching, both of which should propel bank stocks over time:

Asset Growth. Financial inclusion rates are low. According to the World Bank, only 39% of the Colombian population over 15 years old has a bank account. Compare that to 68% in Brazil and 63% in Chile. As the volume of bank accounts grow, the role of credit in the economy should also expand.

Financial Technology. The major Colombian banks are highly profitable, empowering them to go on a startup acquisition binge, especially among local fintech players. Average return-on-equity among the major banks is close to 15%, compared to about 10% among US banks. The ratio is lower in Europe.

The fintech angle deserves attention. Colombia has the third largest number of fintech companies in the region at 124 firms, compared to 230 in Brazil and 238 in Mexico, according to Finnovista, a venture-development consultant. Take-over expectations may be one reason why valuation levels among some Colombian startup companies are so lofty, in our view. Acquisitions by traditional banks of fintech companies could have a further impact on enterprise innovation.

The dark shadow lingering over the investment story is the May presidential election; there is also a March parliamentary vote. President Santos is constitutionally barred from running again. He is also deeply unpopular. One reason is that many feel the FARC deal is overly generous. Another is ongoing corruption scandals. A prominent case involves bribes paid by the Brazilian construction giant Odebrecht to Colombian officials.

Santos’ weak approval rating opens the door to emerging national politicians. The front runner is Sergio Fajardo, a recent governor of economically-powerful Antioquia Province, where the city of Medellin is located. Yet Fajardo is vulnerable. Provincial debt levels ballooned enormously under his leadership. The opposition is likely to paint him as a fiscal profligate. Adding texture to the race, the former FARC guerilla commander Timochenko is now set to run in the May election.

The political setting could upend interest in the stock market over the next few months, but we are still drawn to the opportunity because of the underlying growth potential. A primary focus is the robust banking sector. We are prepared to look beyond sporadic violence. Local companies can probably manage that risk better than distant analysts.

Our Vantage Point: Global investors may be surprised at the upside potential in Colombian equities in 2018. We expect to see most of those prospective gains in the second half of the year, after investors are more comfortable with now-uncertain election results.

Learn more at The New York Times.

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Image: The capital city of Bogota has a population of about 8 million. Credit: Ostill at Can Stock Photo Inc.

Riyadh Probes Interest in Mega-Sized Bank Loan

Saudi Arabian currency is called the riyal

While borrowing for investment purposes is hardly controversial, it can quickly become so when the bank loan represents a lien on state assets. And the borrower is Saudi Arabia. News leaked over recent days that the Kingdom’s Public Investment Fund may draw down as much as $5 billion in a bank loan to accelerate the nation’s steps toward economic diversification.

This approach to building an asset portfolio is aggressive for a sovereign fund based in an emerging market. We see three potential problems:

Investment Risk. The Public Investment Fund is an established institutional investor with deep experience in venture investing. But return expectations can shift suddenly and deals go sour quickly. There is a material difference between borrowing for open-pool allocation decisions and, say, issuing a bond to cover a project outlay, starting with transparency in the use of proceeds.

Market Risk. Saudi Arabia is undergoing a dramatic economic transformation. The outcome is unknown, although officials are unwavering in enthusiasm over catapulting the nation beyond the oil era. Mix that reality with regional political unrest—especially in the volatility of the feud between Riyadh and Tehran—and you could see international confidence in the region falter rapidly.

Political Risk. While Saudi Arabia does not have a strict Shariah-compliant financial system, many institutions embrace tenets of Islamic finance. In this context, simply stated, borrowing for investment purposes is prohibited. Fundamentalist religious leaders could bundle this leveraging activity and other transactions with still-controversial social reforms to paint a picture of a reckless government.

To be fair, details of the bank loan are scant. It lingers in the concept stage. The government, although not the sovereign fund, has borrowed from financial institutions in the past without much controversy. In the current setting, Riyadh may guide a syndicate of players to participate in the arrangement as a type of milestone to affirm market-access privileges in the future.

A bank loan at $5 billion is chunky, but it has context. The still-unconfirmed Saudi borrowing represents a small proportion of the crudely-estimated $230 billion in assets now held by the Public Investment Fund. Importantly, the sovereign fund could be a prime beneficiary of the forthcoming initial public offering of Saudi Aramco, boosting its asset base significantly.

Our Vantage Point: Despite domestic confidence in the economic trajectory, outsized financing activity telegraphs country-risk issues. International investors will likely remain circumspect about Saudi opportunities.

Learn more at Bloomberg.

© 2018 Cranganore Inc. All rights reserved.
Unauthorized use and/or duplication of any material on this site without written permission is prohibited.

Image: Saudi Arabia introduced sweeping economic reforms in April 2016. Credit: Trafawma at Can Stock Photo Inc.

Investors Find Comfort in Turkish Equities

Battle of Manzikert paved the way for Muslim control of Anatolia

Populism may sustain stock prices on the Istanbul stock exchange, despite the 45% gain in US dollar terms since the beginning of the year. Our logic is tethered to the view that President Erdogan is looking for a decisive victory in the November 2019 election. That vote seems like a distant prospect. The campaign, however, will inform ongoing fiscal stimulus, regardless of any attendant economic imbalances. Skeptics should take a closer look at Erdogan’s speech this week in the eastern Turkish city of Mus, commemorating the anniversary of the Battle of Manzikert. The victory of the Seljuks over the Byzantines in 1071 paved the way for Muslim control over Anatolia. The speech was both populist fodder and a dramatic reminder of Erdogan’s nationalist agenda. Granted, economists may fret over domestic inflation figures, which in turn could lead to tighter monetary policy. But investors are likely to overlook those fundamentals in favor of a measured growth trajectory. One reason for that stance is the lackluster setting on other regional bourses, including the UAE, Egypt, and Saudi Arabia.

Our Vantage Point: We acknowledge that Turkish equities appear to be overbought. But our worst-case scenario calls for consolidation, rather than outright correction.

Learn more at A News.

© 2017 Cranganore Inc. All rights reserved.

Image: Diorama at the Istanbul Military Museum depicts the Manzikert battlefield. Credit: O. Mustafin at Wikimedia Commons.

Pakistan Lures Bargain Hunters

Agriculture is about 20% of Pakistani GDP

Currency-depreciation rumors are playing out in Pakistan, with the rupee tumbling over 3.0% in mid-week trading. The realignment is provoked, at least fundamentally, by a deteriorating external account. But it is exacerbated by faltering confidence in the government. Prime Minister Sharif is under investigation for money-laundering allegations. There is good news behind the veil of volatility. Prior to this week, the IMF targeted economic growth at 5.0% in 2017 and 5.2% in 2018. A weaker rupee could bolster that momentum, given a lively export sector, although the impact of higher local interest rates is unclear. We suggest that cross-border investors actually sharpen their focus on Pakistan. Foreign-exchange shocks often depress private- and public-sector valuations; they can lead to outsized discounts. We acknowledge that a perpetual obstacle to deal-making here is ad hoc headline analysis. A cover story from The Atlantic in December 2011 lingers vividly: “The Ally From Hell: What to Do About Pakistan.” There are other examples. In this market, the risk tolerant are best served by maneuvering to the front of the economic cycle, rather than centering attention on international affairs.

Our Vantage Point: In Pakistan, like other emerging markets, asset volatility can be unnerving. But that skittishness may cultivate widespread opportunity.

Learn more at Bloomberg.

© 2017 Cranganore Inc. All rights reserved.

Image: Pakistan is a major player in agricultural exports, ranking eighth globally in farm output.. Credit: Paop at Can Stock Photo Inc.