Each week a professional investor tells MoneyWeek where he’d put his money now. This week: David Reid, analyst for the Blackrock Eastern European Trust.
In fund management we try to uncover ugly ducklings that have the potential to grow into beautiful swans. Or that, at the very least, might grow a little bit less ugly over time.
Covering emerging Europe over the past few years has felt a little bit like looking after a whole flock of ugly ducklings, compared to its more glamorous peer regions in global emerging markets. From trading at similar valuation levels to emerging markets, the region de-rated during the financial crisis and today still trades at a valuation discount of around 25%. But here lies the opportunity for investors able to look past market fashions and dispassionately evaluate the underlying market fundamentals.
It may surprise some investors that, over the last decade, emerging European companies have actually grown earnings more quickly – at an average of 22% per year – than emerging markets (at 19%). A common fallacy of emerging markets investors is to prioritise rapid GDP growth over the growth of earnings per share. The latter is a far more important yardstick for investing as it is profit that fundamentally underpins the value of a share. The overall profits outlook remains healthy, with analyst estimates indicating that 2011 growth is likely to again exceed 20%. So emerging European companies have an enviable combination of growth and value that makes for attractive investments. Here are three good bets.
First off, there’s MHP (LSE: MHPC) – one example of a deeply underappreciated company. MHP is the leading Ukrainian poultry producer. It has immense competitive advantages by virtue of being vertically integrated into low-cost grain production, using the famously fertile Ukrainian black earth – so rising input costs hold no fear. It is on course to grow production 60% over the next three years by building yet more cutting-edge capacity. Yet despite these qualities it trades at a bargain price/earnings ratio (p/e) of less than eight. That’s under half the average for emerging-markets meat producers.
Another company worth examining is KMG E&P (LSE: KMGA), the Kazakh national oil-production company. Even recent surging oil prices have failed to help the shares take flight, with investors worried about changes to oil taxation and the presidential elections. But both issues have now been settled and the market is ignoring the exceptional value in the stock. The company trades on a p/e as low as five, an even more impressive number when you consider that the company holds almost half its market capitalisation in cash on the balance sheet. For a state company, it also has a surprisingly good record of returning cash to shareholders – the current expected dividend yield is 6%.
Finally, in Russia there is another energy company, Volga Gas (LSE: VGAS), which may be about to spread its wings. The firm was involved in a dispute over an agreement to use the gas-processing facilities of a neighbouring company. This agreement fell through, trapping a large proportion of the company’s reserves in the field unprocessed. The company has now won its case and has agreed to take over the processing unit. Yet Volga Gas is valued at only slightly over $2 per barrel of reserves while other gas-producing companies in the region are on average worth double that. So there is considerable upside potential as the company moves towards production.