Grant’s: Four Unloved Emerging Market Stocks And One Bond

Looking for international bargains? Grant's Interest Rate Observer has your back. In the August 7 issue, Grant's takes a look at four, unloved emerging market stocks, and a Brazilian corporate bond.

"Each is cheap, each has merit–each had merit even before its price was sawed in half in sympathy with the goings-on in Turkey, Greece, Brazil, Russia, South Africa, Argentina, Colombia, China etc…" — Grant's

In each case, macroeconomic problems have overwhelmed business fundamentals. But as Grant's points out, cheap businesses are a rare commodity. If it weren't for the macroeconomic dislocation, the value wouldn't be there for shrewd investors to profit from.

What's caused the macroeconomic trouble remains a topic of debate. A strong dollar, capital outflows, high levels of leverage and falling commodity prices are all contributing factors. Trying to trade on macroeconomic fundamentals alone can be a risky, and costly endeavor for investors. So, a bottom-up stock picking approach is often the best way to go.

And Grant's has selected unloved emerging market stocks in three emerging markets that are cheap at present levels. Avianca Holdings SA, the Colombian airline; Grupo Nutresa SA, a Colombia-based food distributor; senior debt of General Shopping Brazil S.A. an operator of Brazilian shopping malls; Sberbank of Russia; and the Moscow Stock Exchange itself.

Unloved emerging market stocks: Russian growth

At the end of last year, Grant's speculated that the tensions between Russia and the West would subside during 2015, leading to a recovery in Russian equities. Unfortunately, this scenario has not played out. The value of the ruble remains depressed, and the price of oil has not recovered. Sberbank, Russia's largest bank has seen its share price decline by 41% in dollar terms. The Moscow Exchange has fallen 31% in dollar terms, although in ruble terms the value of the exchange's equity has rallied 21%.

According to Grant's, the Moscow Exchange and Sberbank are two "options on normalcy" in Russia. Sberbank's fortunes are tied to the state of the Russian economy. The bank's net income slumped 58% during the first quarter, non-performing loans increased by 70bps and the net interest margins are contracting. During the first quarter, the bank reported a 12.5% ROE, down from the level of 20% as reported during 2012 and 2013 but still more than the likes of J.P. Morgan, which reported ROE of 10.2% during the first quarter. Sberbank is priced at 75% of book value and 6.2 times trailing earnings. Sberbank preferred stock is priced at 53% of book, 4.5 times earnings and yields 0.9%. What's really interesting about Sberbank is the group's seeming unrivaled ability to compound shareholder equity through thick and thin. From 1997 to 2014, Sberbank's book value has grown at a compound annual rate of 17%. Over the same period, the ruble has lost 90% of its value against the dollar.

Moscow Exchange has also been able to produce impressive growth during times of stress. The exchange's second quarter results were published after Grant's went to press last week. First-half net income increased 73% and the firm posted the second-highest fee and commission income in the company's history. Management has laid out a five-year plan to boost growth through derivate trading. The stock currently trades at 9.8 times historic earnings, yields 5.5% and some analysts are projecting a 60% dividend payout hike next year.

Unloved Emerging Market Stocks – Brazilian perpetual

In Brazil, Grant's likes the look of the perpetual 10% senior dollar-dominated debt of General Shopping. When Grant's went to press, the debt was quoted at 48 cents on the dollar and yielded 20%.

General Shopping owns and operates 16 shopping malls in Southeast Brazil. The founding family, the Veronezis, own 60% of the company, and the rest is freely traded on the Brazilian market.

General Shopping's big problem is the depreciation of the Brazilian real. The cost of the company's dollar dominated debt is rising while income remains constant — not an ideal situation. But there are several key reasons why General Shopping's debt could appeal to distressed debt investors. Firstly, at year-end 2014 the value of all of General Shopping's assets stood at $880 million, the total value of liabilities amounted to $570 million.

The market value of General Shopping's debt is less than half the value of the company's total real estate value. Secondly, General Shopping is not distressed. Indeed, the company has a high level of cash liquidity with cash of 1.5 times earnings before interest, taxes, depreciation and amortization — enough to pay interest, even if the company receives no new bank finance or funding for the next two years. Alongside the senior debt, General Shopping has a lump of subordinated debt, on which it has the opportunity to defer interest payments — great news for holders of the senior.

Unloved Emerging Market Stocks – Look to Colombia

Avianca Holdings S.A. is Colombia's foremost airline. Also, the group owns regional airlines in South and Central America with subsidiaries in Ecuador, El Salvador, Costa Rica, Peru, Nicaragua, and Honduras. Avianca is somewhat of an asset play. The stock trades at 4.5 times earnings and recently sold 30% of its LifeMiles B.V. subsidiary (a consumer loyalty program) for $344 million, valuing the whole of the LifeMiles subsidiary at $1 billion. Avianca Holdings' current market capitalization is only around $1 billion, implying that you can buy LifeMiles B.V. with an airline tacked on for free. Just like the American carriers, Avianca will also benefit from lower oil prices. Margins are expected to increase by 30% to 70% next year.

Grant's other play on Colombia is Grupo Nutresa SA, a $4.1 billion food distributor and processor, "The Nestle of Colombia."

Nutreasa processes and distributes cold cuts, biscuits, chocolate, coffee, tea, juice, ice cream and pasta. Additionally, the company is Starbucks' Colombian coffee vendor. Overall, the group has a 61% market share with 100,000 individual partners and over one million points of sale. Nutreasa's shares trade at 17.6 time forward earnings but a 37% discount to comparable worldwide food companies.