Banks are cyclical. Cyclical stocks are stocks whose earnings increase and decrease with the business cycle. The apparent predictability in the fluctuation of these stock's prices results in many investors trying to time the market by buying these stocks at the bottom point in the business cycle, when the economy looks its worst, and selling them at the high point when the economy looks its best. Most of the bullish investors in the National Bank of Greece (NYSE:NBG) see the stock trading at prices well below historic highs, see the Greek economy contracted after five years of recession, and believe that with the backstop of the European community, the lows have been reached and the worst is behind us. My investment thesis for NBG, however, is bearish. I recommend waiting for early signs of a recovery before accumulating shares.
It isn't hard to see how investors calling for a bottom are wondering: How much worse can it really get? The Greek economy has already contracted over 12% from its 2008 peak, the stock market is down about 85% from its 2007 highs, and unemployment is around 24%. Despite these alarming conditions, my opinion is that we still haven't seen the bottom yet and that we have another leg to drop.
To start with, the Greek economy is currently contracting at an alarming rate. Economists think the economy could be in for another 7% decrease in 2012. Also, the problems in Greece are structural, which means that there aren't quick fixes that currency devaluation or debt forgiveness can fix. Public sector wages in Greece increased 50% from 1999 to 2007. Tax evasion is rampant. The economy doesn't have to be efficient before it bottoms out, but the social mood and progress made so far indicate that constructive reforms will be a challenging long-term process. Finally, leading economic indicators and economic drivers like real estate continue to be burdened with problems.
As is true domestically, real estate was and continues to be extremely important to Greek GDP. In fact, real estate in Greece has historically represented over 10% of GDP. In 2007, the construction sector employed over 300,000 people. Most investors know that Greek real estate has been hit, but it's helpful to quantify just how much it's contracted. As was stated previously, the real estate market in Greece, which was historically over 10% of GDP, is now closer to 7%-8% of GDP. Building permits are at one-third of their 2005 peak levels.
Part of the problem is that during the 2007 bubble a lot of the construction was conducted by private individuals who no longer have access to capital. With the banking sector in Greece in critical condition, funding and risk appetite for new building activity is limited. Another problem is that the inventory of Greek real estate for sale is extremely high relative to the buying activity. Some analysts believe it will take at least three years or more to clear the 150,000-200,000 homes that are on the market, assuming transaction activity of around 50,000 properties a year. In 2011, 42,000 properties were transacted. Unless marketing companies can tickle the interest of foreign buyers, many analysts believe the property for sale in Greece will continue to be a GDP drag.
However, a lot of that information is already known, and investors are interested in the future. After digging into the condition of the real estate market, my outlook for the Greek economy continues to be muted. We took a look at the second-quarter earnings of Athens-based Titan Cement (OTC:TITCF) to see if we could gain some insights into the condition of the Greek real estate market. Titan Cement has a vested interest in the housing sectors in the markets it serves and is a decent proxy for the state of the Greek real estate sector (despite that it has somewhat limited direct exposure to Greece, as explained below).
Just looking at the share price performance of Titan Cement it would seem that the outlook for the Greek real estate market could be somewhat bullish. Titan's share price is pretty much flat against a domestic market down over 20%. The stock is also trading at over 7 times EV/EBITDA, which is in line with its comparable European counterparts (HeidelbergCement, Lafarge, etc.). But digging deeper, reality tells a different story. Despite being based in Greece, Titan really only has about 15% EBTIDA exposure to the Greek market and generates a lot of its profitability from exports. Most of its exports are to the Egyptian and U.S. markets. Titan Cement's relative outperformance is therefore not necessarily suggestive of a Greek recovery. The eye-opening statements made by management about the state of the construction market in Greece are what really caught our attention.
Titan Cement's management explicitly stated that it sees a "continuing decline in the Greek market," and that demand for its products in Greece is continuing to decline at an alarming "annual rate of roughly 40%." Management continued, stating that "cement consumption for the year is expected to be approximately 75% lower than the levels recorded five years ago. The last time consumption stood at such levels was in the first half of the 1960s." Management also said that "in the context of the economic depression witnessed in Greece, a reversal of the decline in private building activity is not possible. Moreover, the much hoped for benefits arising from a restart of stalled public works projects will not affect demand for building materials in the course of 2012." It seems that even against dire expectations, the market surprised to the downside. Management noted that "in Southeastern Europe, demand for building materials did not recover to the extent expected in the second quarter."
Titan Cement management was also generally cautious on Egypt and the United States. Significant currency devaluations in Egypt, coupled with civil unrest in the region and a sluggish recovery in the United States, suggest its key markets will remain challenged. As an aside, given all of these negative factors, we wonder whether Titan Cement should be trading at such a premium to the Greek market. (The full press release can be read here.)
In conclusion, we think that there are continued headwinds for the Greek economy, especially after looking at the housing market. That is bearish for NBG. Real estate could lag for another three years at least. Without a housing recovery, it will take significant help from Europe to take the Greek economy off of life support, and without a healthy real estate sector my outlook is for continued challenges for the nation's largest bank. We think that it would be best to wait a couple quarters until companies like Titan start suggesting that things have started flattening out at the very least. In our opinion, investors are better off missing out on catching the absolute bottom and making an entry when things look more stable. Don't get caught calling for a bottom given that things look so bad now, because, unfortunately, things could get worse before they get better.