Greece: An Attractive Dislocation Opportunity

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About: Global X MSCI Greece ETF (GREK), Includes: ALBKY, EGFEY
by: Our Man In NYC
Summary

Greece provides an excellent dislocation opportunity for investors.

After suffering a 'Great Depression' and 90% stock market losses, both the economy and the market have bottomed.

Valuations are very attractive and the economic fundamentals are improving driven by reforms.

The 2019 election offers an opportunity for a change in narrative that will draw investors back in.

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The Investment Opportunity

I believe that the public markets reward contrarianism, especially when it is tied to common sense, and my playbook for a dislocation is:

  1. An investment that has had abysmal performance. Ideally, investors will have been burned badly and/or are fatigued by the situation, which means it is likely overlooked.
  2. Valuations are cheap and the fundamentals are turning, yet very few people care. Stocks should at least suggest that they have found a bottom.
  3. A change in narrative that provides an excuse or all-clear sign for investors to consider the area as investable once more. This creates a ~24-month window for a sharp re-rating, after the narrative has changed.

Today, the conditions in Greece are setting it up to be a textbook dislocation opportunity for contrarian investors.

Background: It All Goes Wrong For Greece

For Greece, the Global Financial Crisis was followed by a starring role in the European sovereign debt crisis. While most people are largely aware of the Greek debt problems and the associated economic problems, the severity isn’t fully appreciated. The crisis saw a 45% decline in GDP and unemployment top 27% in Greece – similar to the Great Depression in the US!

Greek GDP Source: Tradingeconomics.com

Unsurprisingly, this saw Greek equity markets get decimated; down over 90% from their 2007 peak, over 80% from their post-08 highs, and over 70% from their 2014-highs. The fall from 2014 is particularly important as ‘sophisticated’ investors helped recapitalize the Greek banks in 2013 and 2015, with the expectation that the crisis was largely over. It was not!!

Greek Stock Market Source: Koyfin

Well for Greece, the opportunity is pretty clear; economic disaster and collapsing equity prices, over a prolonged period means that even ‘sophisticated’ money has been scared off.

Valuations Become Attractive, And Things Turn Around

However, take another look at that chart of economic growth – things have turned around, and stabilized over the last couple of years. Those aren’t the only signs of progress. Greece passed over 450 reforms under the conditions of its IMF/European Central Bank/European Commission (the “Troika”) bailout deals and under those deals it is financed through 2033, when its debt amortizations start. In exchange for this financing to help build a cash buffer, Greece had to agree to remain in a post-program surveillance program. This helps guarantee the Greek government continues to deliver on its already enacted reforms.

Additionally, for a country with a reputation for people not paying their taxes and historically reckless spending, times are changing! Greece has had one of the largest turnaround in public finances in history; it has posted a budget surplus for each of the last three years and is committed to running one for years to come!

Greek Government Deficit Source: Tradingeconomics.com

The same is true in equity markets, which bottomed back in 2016 and held well above those lows in 2018. To give a sense of the broad value in Greek equities, consider the CAPE ratio in Greece – an inflation adjusted 10-year price-earnings ratio – it is negative!

With regards to the value in the banks, Alpha Bank (OTCPK:ALBKY) and Eurobank Ergasias (OTCPK:EGFEY) ended 2018 trading at ~0.25x their estimated 2019 book value compared to European peers that traded at just under 1.0x. Now, investors are rightly skeptical – after all there have been three bank recapitalizations this decade (2010, 2013 and 2015) that have seen investors lose almost all of their money. However, at this point regulators have been insiders on Greek banks for a decade so book value really should be the actual book value, the ECB also passed the Greek banks when it vetted capital levels in continent-wide stress tests last year, and finally Alpha and Eurobank both have 15%+ Tier 1 capital and are profitable!

Fundamentally, the banks continue to improve their non-performing exposures (NPEs) which have fallen 20% from the 2016 peak, with the ECB monitoring and acting as ‘big brother’ to help ensure this. Last November, saw reasonable new NPE targets set by the ECB, working in conjunction with the Greek banks. The ECB, the Bank and the Greek government all know that the banks must continue to reduce NPEs in order to be able to lend again, and help the economy grow. This is why you’re seeing NPE sales by individual banks and various government plans being floated by the Central Bank and Ministry of Finance to help speed up the process. These combined with the recent Katseli law that makes it harder for people to strategically default, and the banks’ self-help (cost-cutting, etc.) are all positive signs, and give the banks substantial operating leverage to improved conditions.

Changing The Narrative And Drawing Investors back In

This all brings us to the change in narrative!

Last year saw some steps in this direction, with Greece exiting its official bail-out program and raising money from the bond markets. Those bond markets, seem pretty sanguine on Greek risk.

The Greek government further took advantage of these low yields, to raise money and prepay $4bn+ of higher-interest IMF loans. Further steps like this, and the banks continuing to fix themselves, will help but they won’t draw most investors back in. That will require political change, and Greece is having elections in 2019!

SYRIZA and their leader Alex Tsipras, who came to power in 2015, are broadly viewed as crazy leftists. Yes, it’s in their name… SYRIZA being the syllabic abbreviation for The Coalition of the Radical Left. Despite this, SYRIZA agreed to the Troika’s demands, passed bankruptcy laws, generated budget surpluses and helped the economy start to climb out of the abyss. Irrespective, they are not a government that investors (especially US-ones) feel comfortable investing alongside. However, 2019 is an election year in Greece and what if the country elected a leader that comes out of Western investors’ central casting?

You know, the kind that went to Stanford and Harvard, had spent time working for well-known US banks and consultancy firms before becoming a PE/VC investor, was pro-markets and business and came across as more efficient technocrat than ideologue. Well, that’s the resume of Kyriakos Mitsotakis, the leader of the New Democracy party that’s currently comfortably ahead in the polls. Should they seem likely to win as the election approaches, and eventually do so, I think it will remove a key obstacle for investors – Greece will no longer be scary, nobody will be fired for looking at it again, and it might even become the latest ‘unique idea’ for hedge funds. This isn't to underplay all the good that Mr. Mitzotakis and a new government could do, just a reflection on what investors respond to.

Some Risks To The Thesis

While the above all suggest how Greece is setting up to be very attractive, under no circumstances should anyone think that it is even close to a risk-free investment. As such, here are some of the key risks:

  • An important risk to the thesis is if global, and especially European, growth materially slowed down or became recessionary. The most immediate impacts to the thesis would be to weaken the economic fundamentals in Greece and to increase the stress on the banks. Additionally, stock markets and risk appetite would likely be weak in such a recessionary environment. That wouldn’t spur anyone to invest in Greece and should lead to both a smaller position and reassessment of the thesis.
  • An obvious risk is that SYRIZA returns to power, hamstringing the change in narrative and remaining an impediment to investor interest rekindling. A SYRIZA victory would also remove the optionality that a more business-friendly government could increase economic growth. The Troika would still continue to monitor Greece’s compliance to its economic agreements and the fundamentals likely wouldn’t change substantially. In this case, while a position would still be warranted it should be smaller given the elongated time frame and increased uncertainty.
  • A final important risk is that the position, especially in the Banks, is dependent on regulatory forbearance. The ECB has worked with the banks as a ‘big brother’ to set NPE reduction targets, and those most recently agreed for the period 2018 to 2021 were firm but fair. Should the ECB change its approach it would likely mean further write-downs and recapitalization for the banks that would negatively impact both investor and economic confidence. While the ECB’s current plan is working well and the ECB is an independent central bank, the President is appointed by the leaders of the countries that have adopted the euro. ECB President Draghi’s term ends in late 2019, and a new President (and team) may choose to take a different approach to Greek banks for their own political reasons. This is something to continue to monitor, and much like investors the ECB decisions may be tied to the election result.

How To Invest And Conclusion

There are limited ways for US investors to get exposure to Greece. The easiest way is through GREK, the ETF, which makes up the core of my position. The ETF offers investors broad exposure across the Greek market, and the ability to participate in what I expect to be a broad rally in Greek stocks. The industry breakdown of the ETF is below but core holdings are in the Banks, the major telecom company (Hellenic Telecom), the lottery company (OPAP) and shipping (Gaslog).

GREK Holdings Source: Global X Funds

There are only a limited number of other options for US investors. While there are 20 Greek ADRs, almost all of them are in Shipping. For those more comfortable with increased risk then additional positions in the banks, especially Alpha Bank and Eurobank Ergasias that both trade on the OTC market, make attractive smaller positions around a GREK core.

Greece is currently my largest position, reflecting my belief that it offers an outstanding dislocation opportunity; historical performance has been terrible, it's largely ignored, but valuation is very cheap and fundamentals and price have turned the corner. The Greek elections in 2019 offer a high probability opportunity to change the narrative that will persuade investors to give Greek investments another look.

Disclosure: I am/we are long GREK, EGFEY, ALBKY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.