BRIC Investors Lose Out as Statists Forgo Earnings
Investors in the biggest state- controlled companies are being punished with the lowest valuations in six years by emerging-market leaders putting public services ahead of shareholder profits as economies slow.
Brazil’s Petroleo Brasileiro SA (PETR3) posted a 52 percent drop in fourth-quarter earnings on Feb. 9 after government-imposed price caps led to losses on fuel sales. Russia’s OAO Gazprom (GAZP) said last month that tax increases will cut 2012 profit by $2 billion, while Coal India Ltd. (COAL) was ordered to sign supply agreements with the nation’s power companies. China’s banks trade near record lows versus net assets on concern local governments may default.
The average valuation of 47 state-owned firms in the so- called BRIC countries sank below that of the MSCI Emerging Markets Index (MXEF) in December for the first time since 2005, data compiled by Bloomberg show. The four biggest developing nations are growing at the slowest pace since 2009 just as Russian Prime Minister Vladimir Putin seeks to reclaim the presidency on March 4 and China hands power to new leaders later this year.
“You’re seeing more companies acting as facilitators for the rest of the economy,” said John-Paul Smith, the London- based strategist at Deutsche Bank AG who has “underweight” recommendations on Brazilian, Russian and Chinese shares partly because of the governments’ influence on businesses. “State- owned companies a lot of the time have different objectives than the objectives investors imagine they have.”
Brazil’s price caps on fuel have helped the government reduce inflation from the fastest in six years in September, giving the central bank room to cut interest rates to an 18- month low. Higher taxes on Gazprom (GAZP) provide revenue for Putin’s campaign pledges, which Capital Economics Ltd. estimates may boost government spending by $164 billion. China cut banks’ reserve requirements last month to boost lending, even as UBS AG analysts estimate as much as $476 billion of local-government debt may go bad.
The 47 state-owned companies tracked by Bloomberg and Trusted Sources, a London-based emerging markets consulting firm, are valued at an average 1.7 times net assets, a 1 percent discount versus the MSCI gauge, monthly data compiled by Bloomberg show. The average price-to-book ratio for the BRIC firms slipped below the MSCI gauge in December for the first time since December 2005, after trading at a premium of about 25 percent a year ago.
The MSCI index rose 0.2 percent to 1,078.50 at 11:47 a.m. in London. Gazprom depositary receipts in London were unchanged, while Coal India shares lost 0.7 percent in Mumbai.
Policy makers have become more willing to compel state- owned companies to support growth after government-directed lending and investment in China helped the world’s second- largest economy weather the global financial crisis, said Deutsche Bank’s Smith, who correctly predicted that emerging- market stocks would trail advanced-country equities last year.
President Hu Jintao’s administration maintained economic expansion of at least 6.2 percent during the crisis as Chinese (HSCEI) banks lent record amounts of money to fund infrastructure projects and real-estate development. In the U.S., gross domestic product shrank by as much as 5 percent.
“The Chinese model isn’t necessarily good for everybody,” said Gabriel Wallach, who manages $2.5 billion in emerging- market equities at BNP Paribas Investment Partners in Boston and is avoiding Chinese bank stocks partially because of the loans they issued during the financial crisis. “At the end of the day, they were misallocating capital in an attempt to grow at 9 percent or 10 percent.”
Earnings at the government-controlled firms averaged 5.4 percent during the past three years, versus 17 percent for the MSCI Emerging Markets Index. Their mean return on equity was 17 percent during the latest fiscal year, compared with 20 percent for stocks on the MSCI gauge and 25 percent for the world’s 20 biggest companies by market value, data compiled by Bloomberg show. The BRIC companies’ average revenue per 1,000 workers was $449,000, or about 40 percent less than in the MSCI index.
Shares of government-owned companies may outperform benchmark indexes should the global economic slowdown worsen.
A market-capitalization weighted gauge of state-owned companies in the BRICs compiled by Bloomberg and Trusted Sources beat the MSCI emerging-market measure by seven percentage points in the three months after Lehman Brothers Holdings Inc.’s bankruptcy in September 2008, as investors bet government backing would prevent the companies from collapsing. The government-owned index has since trailed by 40 percentage points.
Equity valuations for companies including Gazprom (GAZP) have already discounted the impact of state control and the stocks will rally when corporate governance improves, according to Aivaras Abromavicius, a money manager at East Capital, which oversees about $4.6 billion. The Stockholm-based firm owns Gazprom shares in part because they’re “cheap” and the company may return more cash to investors by raising its dividend, Abromavicius said.
Russia’s gas-export monopoly trades for 3.6 times reported profit, the third-lowest ratio among oil and gas companies in global MSCI indexes and 84 percent less than the industry average, according to data compiled by Bloomberg. Gazprom said in December it plans to distribute about $6.2 billion of dividends linked to its 2011 earnings, a payout that would amount to 4.3 percent of yesterday’s share price. The average dividend yield for global energy companies is 2.1 percent, data compiled by Bloomberg show.
‘Things Are Changing’
“Every asset has its price and Gazprom will only remain cheap as long as it has a low level of disclosure and corporate governance,” said Abromavicius. “It does appear that things are changing. A good, stable dividend policy is the first sign of good corporate governance.”
Ian Hague, who manages Russian equities as a partner at Firebird Management LLC in New York, said he’s avoiding shares of government-controlled companies such as Gazprom.
The Russian government, which has a controlling stake of more than 50 percent in Gazprom, is boosting taxes on the company to help fund an increase in social spending. The Finance Ministry raised the mineral-extraction tax for gas producers by 61 percent last year and the rate for Gazprom will more than double this year, according to the Kremlin website. The company said on Feb. 6 that higher extraction taxes will cut profit by $2 billion this year.
Gazprom, whose $150 billion of revenue during the past 12 months amounts to about 10 percent of Russian GDP, recorded more than $11 billion of income-tax expenses during the period, according to data compiled by Bloomberg. That’s almost four times as much as state-owned oil producer OAO Rosneft (ROSN), which had tax expenses of $3.3 billion, the second-biggest bill among listed Russian firms tracked by Bloomberg.
Putin, who served as president from 2000 to 2008 and oversaw the government’s seizure and liquidation of Yukos Oil Co. in 2004, is seeking to return to the office in an election on March 4. Spending pledges made during his campaign may raise government outlays by $164 billion, or as much as 5 percent of economic output, through 2018, according to Capital Economics, an economics consulting firm in London.
“There are people who subscribe to the view that the Kremlin’s relationships are positive for the stocks they control,” said Hague, who founded Firebird in 1994 to buy shares in Russian companies that privatized after the collapse of the Soviet Union. “We don’t take that view.”
Sergei Kupriyanov, a spokesman at Gazprom in Moscow, didn’t return a voice message seeking comment.
A proposal by Putin for VTB Group (VTBR), Russia’s second-largest lender, to buy back shares from investors who lost money in the bank’s 2007 initial public offering has been denounced as a political maneuver by stockholders Charlemagne Capital Ltd. and Van Eck Associates. The buyback, which is capped at a level that would exclude most institutional investors, is a ploy that will dilute the value of their holdings, the firms said.
Common shares of Petrobras, the world’s fifth-largest oil producer by market value, plunged 8.3 percent on Feb. 10 after fourth-quarter earnings trailed analysts’ estimates because of higher costs for imported fuel.
The Brazilian government, which controls at least 51 percent of Petrobras’s voting shares, has allowed the company to increase domestic gasoline prices by about 15 percent since September 2005, compared with an 80 percent surge in U.S. prices, data compiled by Bloomberg show. Petrobras imported about 30,000 barrels of gasoline a day last year because its refineries can’t process enough of the fuel to meet demand. The company lost about $14 for every barrel of imported gas and diesel fuel sold in 2011, according to JPMorgan Chase & Co.
“Refining is one of the worst businesses in the world,” said Kevin Shacknofsky, who manages the Alpine Dynamic Dividend Fund in New York and sold holdings of Petrobras at the end of 2010 because the company invested in its refining units instead of more profitable projects.
Brazilian President Dilma Rousseff prefers low inflation to “fantastic” earnings at Petrobras, Energy Minister Edison Lobao told O Estado de S.Paulo, a Brazilian newspaper, in an interview after the company’s earnings report.
Petrobras is valued at 9.2 times estimated profit, down from 11 times a year ago and less than the current multiple of 11 for Irving, Texas-based Exxon Mobil Corp., the world’s largest oil company by market value.
Petrobras “has strategic goals which need to balance the company’s remunerative endeavors with a social agenda,” John Herrlin, a Societe Generale SA analyst who cut his recommendation on Petrobras shares to “hold” from “buy” on Feb. 16, wrote in a report. “These goals on a short-term basis can be at cross purposes.”
Paula Almada, a spokeswoman for Petrobras in Rio de Janeiro, said in an e-mail that the company didn’t want to comment.
Rousseff, a former energy minister who took office in January 2011, has sought to boost mining taxes, a move that may erode profits at Rio de Janeiro-based Vale SA. (VALE) The iron-ore mining company ousted Chief Executive Officer Roger Agnelli last year after the government, which holds direct and indirect stakes in Vale, criticized management for not generating enough jobs.
China’s government has helped its banks grow earnings through interest-rate policy. The one-year deposit rate of 3.5 percent is less than the 6.56 percent lending rate and the gap has been at least three percentage points for most of the past decade, allowing banks to profit from the difference.
Industrial & Commercial Bank of China Ltd. and China Construction Bank Corp. (939), both government-controlled, are the world’s most-profitable lenders, with combined 12-month earnings of about $55 billion, according to data compiled by Bloomberg.
Even as Chinese banks posted record profits, their shares retreated during the past 12 months on concern that loans extended to local governments and developers won’t be repaid. More than $4.3 trillion of new loans by Chinese banks since November 2008 have helped support growth as President Hu prepares to hand over leadership of the Communist Party to Vice President Xi Jinping, expected later this year.
As much as 30 percent of loans to local governments may eventually turn sour, according to estimates last month by UBS, Switzerland’s biggest bank. Economic growth in China dropped to 8.9 percent in the fourth quarter from 9.8 percent a year earlier.
ICBC Valuation Drops
ICBC (1398) trades for 7.9 times reported earnings, compared with 11 times a year ago, according to data compiled by Bloomberg. The government owns at least 67 percent of the Beijing-based bank’s shares through Central Huijin Investment Ltd., a unit of the nation’s sovereign wealth fund operator, and the Finance Ministry, according to ICBC’s semi-annual report.
The price-to-earnings multiple for Construction Bank, China’s second-largest lender by market value, has dropped to 8.1 from 11 a year ago. Huijin owned at least 57 percent of Beijing-based Construction Bank as of June 2011, according to the company’s semi-annual report.
Chinese borrowers are “going to have to defer repayments of lots of loans,” Jim Chanos, the president and founder of New York-based hedge fund Kynikos Associates Ltd., said in a Bloomberg Television interview. Chanos said he’s betting shares of Chinese banks will fall.
Construction Bank has high standards of risk control on loans to local governments and stock valuations don’t necessarily reflect the lender’s fundamentals, said Yu Baoyue, a Beijing-based press officer. Wang Zhenning, a press officer at ICBC also based in Beijing, declined to comment.
Government-controlled companies may become a long-term drag on China’s economic growth, the World Bank said in a report last month titled “China 2030.” More than 25 percent of the country’s state-owned enterprises are unprofitable and their productivity growth has trailed that of private firms by about 66 percent during the past three decades, the World Bank said.
Coal India shares plunged 5.8 percent on Feb. 16 after Prime Minister Manmohan Singh’s administration ordered the company to sign supply agreements with utilities and import the fuel to overcome local production bottlenecks caused in part by heavy rains. The world’s largest coal producer will pay a fine should supplies fall short of commitments, the government said.
Bigger State Role
India, which owns about 90 percent of Coal India, is stepping up pressure on the company after a dearth of domestic fuel prompted power companies to halt plans to increase the electricity capacity needed to spur economic growth. Indian economic expansion decelerated to 6.1 percent in the fourth quarter from 6.9 percent in the previous three months.
Coal India shares trade for 14 times estimated profits, compared with 16 times for the benchmark BSE India Sensitive Index, according to data compiled by Bloomberg. Zohra Chatterji, the company’s chairman, didn’t return two calls and a text message seeking comment.
“It’s the nature of emerging markets, the state plays a bigger role,” said Sam Vecht, an emerging-market money manager in London at BlackRock Inc., which oversees about $3.5 trillion worldwide. “Whether they do better or worse over time depends on who’s running them and what are the interests of the state.”