Friday, February 24, 2012

Investment strategies for a devaluation

The idea for this post came from a thread on the Corner of Berkshire and Fairfax message board asking about Portuguese investment opportunities, and then a follow on email conversation with a blog reader.  One of the questions the reader asked was what were my thoughts on a devaluation in Portugal.

The question was interesting, and I've been thinking about this for while and wanted to put together some thoughts I have on it.  Mainly this would apply to European periphery countries right now but could really be any country at some point in the future.

If anyone has access to the data I'd be interested in knowing how companies that matched my criteria in Argentina back in 2001 did after the devaluation.

What is a devaluation?

Simply put a devaluation is when some sort of event takes place that makes a countries currency suddenly worth less.  On Monday 100 units of currency are required to buy an item and suddenly on Tuesday 150 units of the same currency are required to buy the same item.  This isn't inflation, it's when the currency is deemed to have less value.  The mechanism for this to happen isn't always the same, in the case of Portugal a devaluation would most likely occur if they left the Euro and began to use the escudo again.  In the case of a Portugal the country would be using the Euro on Monday, and suddenly on Tuesday all Euro deposits would be replaced by some escudo deposits possibly at a reduced rate, or at a much higher conversion rate.

How to invest?

The general idea is to find a company that will be unfairly punished in a devaluation, or a company that might benefit from a devaluation.  Here are a few bullet point thoughts on what might be good to look for.

  • Most important, the company needs to be export driven, most sales should come from out of the devalued country, greater than 75%.
  • The company should have a solid earnings stream, this closely relates to the above bullet.
  • Avoid companies that are cash heavy unless the cash is foreign denominated (and even still be wary).  
  • Avoid companies with large receivables in the new devalued currency.
  • Look for companies with payables in the new currency.
  • High debt isn't always bad if it's in the new currency, is devalued and can be paid off with export sales in a foreign currency.
  • Look for some sort of competitive advantage, or brand.  Will an exporter have a stigma attached because they operate out of a devalued country?  Global recognition should mitigate this risk.
  • Put limited emphasis on assets, these will be worth much less after a devaluation.
  • The exception to the above bullet is if the assets are extremely rare and supply is limited.  A priceless asset might apply as well.  
A devaluation could be a catalyst for a generally marginal business.  If the business has local denominated debt, local labor and exports their suddenly strong earnings stream will be able to quickly reduce debt and margins will increase with their new lower labor costs.

Here are two possible investments in Portugal

A decent business with a good earnings stream likely to be unharmed:
Corticeria Amorim, written about here , here and here.

A marginally profitable exporter that could be helped by a devaluation:

Disclosure: Long COR

7 comments:

  1. Hi Nate,

    I was born in Portugal and lived in the country for 24 years until I moved to Switzerland to work as an Asset Manager in a Swiss Private Bank 1.5 yrs ago. Looking back, leaving the country was probably one of the best decisions I made, although I still love it and plan on going back someday.


    Regarding the devaluation thesis I don’t agree. Maybe this is because I am Portuguese and thus have a strong bias, maybe it is because I am an optimist, but I just don’t see it happening. You have to take into account that Portugal is a Democracy, you will never have the currency of the whole country changing from one day to the other. That is just too extreme.

    When Portugal asked for help from the IMF / EU to solve its problems you already had a very important political event: elections. You had the centre left party coming out and a coalition between the centre right and right (I would compare this right party to you Republican party, but with a much lower % of votes) coming it. And you know the story... blame it on the other party. That’s exactly what they did, they told people, listen we have a big problem to solve, all the yrs the other party was ruling lead to excesses in everything, we have to go into austerity. And so they are starting from scratch, they are pretty much free to implement reforms. And more, they want to do it, they implemented even more austerity than the IMF / EU were asking for. They really want to get things done. Leaving the Euro is just not an option, as the problems are solvable. It will take time and it will be tough, but problems are solvable.

    Things are really tough in Portugal, and I would expect them to remain like this for a couple of yrs, but I see the country emerging in a couple of yrs.


    Portugal's main stock Index is the PSI20, which has 20 stocks:
    - 4 Banks (stay away!)
    - 1 construction company (again stay away)
    - 3 Utility companies (The Chinese recently bought a 20% stake from the state in one of them - EDP)
    - a Highway company (too much leverag for me)
    - Galp, which is an oil & gas company (has a big stake in Brazilian deep water oil reserves)
    - 3 pulp & paper (or related) companies (Altri has too much leverage, Portucel is very interesting, and Semapa, a holding company that holds +/- 80% of portucel and 51% of a cement company)
    - 3 Telecom companies (Portugal Telecom may be interesting, but since they were forced to sell their stake in Vivo, a brazilian company, to Telefonica and overpaid for Oi (another brazilian Telecom) I don't find it much interesting)
    - 2 supermarket companies (Jerónimo Martins and Sonae)

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  2. The 2 companies I find interesting and worth spending time on are Portucel and Jerónimo Martins.

    Portucel is Europe’s largest UWF paper producer, with a 19% market share. The company operates 3 BEKP (pulp) plants in Portugal, with two of them being integrated with paper. The company is vertically integrated, managing 136k ha of forest (self-sufficiency rate of 15%). It also owns a co-generation capacity of 240 MW. For 9M11 Paper represented 79% of sales, pulp & energy represented 10% & 11% respectively. The company is a low cost paper producer: as other paper makers are closing down capacity Portucel is operating at 100%.

    The company has a market cap of EUR 1.5bn and has net debt of EUR 493Mn, which it is in the process of reducing (in 2010 it stood at EUR 687 Mn).

    To your point regarding the Euro, a Strong USD should strengthen Portucel, as it has 25% of its revenues in USD. Also sales are mostly outside Portugal.

    The major share holder is Semapa, holding +/- 80% of the shares. Semapa is known for being a leveraged way to play Portucel, but they also hold a stake in a Cement company which hasn’t been doing very well.

    The other interesting company, Jerónimo Martins (JM) operates supermarkets in Portugal (33% of EBITDA / 21% market share) and Poland (63% of EBITDA / 13% market share), and will start expanding into Colombia (yes Colombia) in the second semester. It is expanding aggressively in Poland, opening +/- 200 stores per yr. Because of the exposure to Poland they are also exposed to the Zloty (Poland’s currency), with a 10% change in the Zloty having a +/- 8% impact in EPS. Debt is low.

    Personally I love going to JM’s stores in Portugal, and the quality of their products is excellent. Actually they have started using their own brand for most of the products (JV with Unilever), which gives them a higher margin and control.

    I never bought shares of JM because they were always pricey... PE in the 20’s for most of 2006-2010. But shares just kept on going higher as they opened new stores in Poland. Every time I enter a JM store I beat myself for not having bought the stock yrs ago ...

    I found your posts on Corticeira Amorim interesting and plan on having a look at the company in the future. In the past the “Amorim” name always put me off having a look at it...

    Wow... I just got ahead of myself... a couple more paragraphs and you would fall asleep.
    Keep up the great blog.

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  3. what a mess Nate, I just realized I posted this thing about 4 or 5 times! It kept giving me a message in German (which I don't speak) ... this is what you get for living in switzerland, things are automatically in german.
    Can you sort it out or do you want me to post it right (again). The post is quite big, so had to split it in 2

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  4. Element,

    Really really awesome comments, thank you! I think I have them cleaned up so there are no duplicates.

    I actually agree with you in that I think Portugal will stay in the Euro. The country seems to have the determination to make it happen.

    Regardless a company with a strong export stream will do well either way like Corticeira Amorim. A company that needs a devaluation like FISPE to work out is a lot riskier.

    I'll look at JM and Portucel, thanks for the tips. I agree with your earlier comment about most of the companies, they're poor quality in general. I'd seen Sonae mentioned before as well. Groceries can be lucrative especially in markets that are still dominated by small local groceries a national chain can come in and steal marketshare like crazy.

    Nate

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  5. Hey Nate, COR just came out with its earnings for 2011. You can use google translate, but it just says that earned 25.3 Mn for the yr, up 8.3% YoY.

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  6. Thanks for the steps on how to invest those are really nice strategy very helpful not only for me for those also who interested in it :)

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