Conflict zones sometimes mean investment opportunities
September 22, 2008 on 8:13 pm | In Money | No Comments
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Cynthia Steer, chief research strategist at the pensions consulting firm Rogerscasey, has returned to her office in Darien, Connecticut, “galvanized” from a two-week intelligence-gathering trip to sub-Saharan Africa. One of the first calls she received after landing back in the United States was from a client who wanted to know about the political unrest in Kenya. “He asked if it was a good time to invest in Nairobi's stock exchange,” she said. “In all honesty, I could not say no.”
It is easy to dismiss war zones as no-go areas for investment purposes, but judging by the experiences of many fund managers, the perception of risk is often at odds with reality.
“Given the choice between investing in Africa - conflict or no conflict - and a basket of Western banks, Africa would win every time,” Steer said. “As an investor, you know exactly what you are getting in the region: No artifice, just superior growth at inexpensive prices.”
According to the International Monetary fund, economic growth in sub-Saharan Africa will top 7 percent in 2008, with oil-rich markets like Nigeria set to grow much faster. An estimated $5 billion of private equity is looking for a home in the region, along with hedge fund money and mutual fund flows.
Jamie Allsopp, the manager of New Star Heart of Africa fund, has made significant investments in Kenya and Nigeria, two markets with which he feels comfortable despite their recent troubles.
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“The blowup in Kenya was particularly startling because no one saw it coming,” Allsopp said. “The incumbent government had made progress in improving the country's economy and international observers had initially praised the presidential election as generally smooth and fair. But provided negotiations between the two political factions reach a favorable conclusion further progress can be made.”
Short-term political unrest is understandably negative for the Kenyan economy and stock market, but the long-term investment potential for this and other sub-Saharan markets, is promising, Allsopp said. “We have not diluted out holdings in Kenya,” he said. “In fact we are adding to positions that look cheap.”
One of Allsopp's preferred stocks is Access Kenya Group, the only provider of broad band in Nairobi. The company has increased its earnings threefold in the past 12 months and is a favorite pick with Africa analysts.
Although the Nairobi stock market was down 5 percent since the start of the year, many stocks in Kenya have proved remarkably resilient since the crisis erupted in December 2007. Examples include East Africa Breweries and BAT Kenya, which have both risen in value this year. Companies involved in Kenya's tourist trade have fared less well. The share price of Kenya West, the country's main airline, has dropped 30 percent in the past three months.
Many analysts are understandably concerned about the investment outlook in Kenya because it is the economic hub of sub-Saharan Africa. Stuart Culverhouse, a research analyst at the broker Exotix in London, said that he had not seen many international investors pull out or dispose of assets in Kenya but that he had advised clients to delay new buying.
“The macroeconomics outlook for Kenya in the near term, and possibly further out, is challenging,” he said, “and I do not believe investors have really factored that in just yet.”
If Kenya - which has the region's second-biggest exchange, after South Africa - is out of the running for a while, then other markets, like Nigeria, might benefit. As one of the main exporters of oil in the region, Nigeria, along with its economic landscape, has undergone a transformation in recent years. Money gained from exporting oil has enriched consumers and resulted in increased sales for domestic companies, like brewers, mobile phone providers, banks and food companies.
Dangote Sugar Refinery is a good example of a Nigerian success story, Allsopp said.
“After one of the biggest stock market flotations in Nigeria's history, the share price doubled from its March 2007 launch price, making Dangote the country's largest company by market value,” he said. Zambeef Products, the largest meat supplier in Zambia, made similar gains, with its share price rising 150 percent in 2007.
The strength of Nigeria is not just based on its considerable natural resources.
“Successive governments have embraced market orientated reforms and proved good fiscal managers,” Culverhouse said. “Inflation is low and the currency has been allowed to appreciate gradually.”
His stock picks included Flour Mills of Nigeria, a major diversified conglomerate with interests in flour and consumer goods, as well as cement manufacturing and trading. Culverhouse suggested that the company could benefit from spending on infrastructure in Nigeria and a strong growth outlook for food related goods.
Allure fades for shares of drug makers their shine
September 22, 2008 on 8:13 pm | In Money | No Comments
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Shares of drug makers are usually in demand when the economic outlook is cloudy and investors are avoiding risk. The companies' stable earnings may be less appealing this time because the sector has some risks of its own that were not there in the past.
Widespread calls by political leaders to overhaul the U.S. health-care system have hit the stocks, as has consternation over the feeble state of industry leaders' pipelines - the inventory of drugs at various stages of development - which suggests that researchers have hit a dry spell in creating blockbusters.
This is an especially critical issue today because manufacturers of generic drugs are more aggressive, bringing their products to market sooner. When companies do develop new drugs, regulators are far more sensitive to potential risks and less inclined to approve their use.
Some investment advisers believe the sector is worth buying despite all the problems, or because of them. The stocks have been underrated for so long that their valuations may account for all of the bad news and very few positive developments.
“Most of these companies are trading at very low multiples of earnings,” said Damien Conover, an analyst at Morningstar. “They only need a couple of blockbusters to move the needle on earnings and get some multiple expansion.”
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Some anticipated blockbusters seem to be just plain busts. The stocks of Merck and Schering-Plough sank in January, taking much of the sector with them. The drop came after a study found that their joint cholesterol treatment, Vytorin, formed by blending two other drugs, was not significantly more effective than Zocor, one of the components, which is available in generic form.
That provides a buying opportunity in Schering-Plough, whose sellers have ignored several promising events, Conover said. He highlighted its recent acquisition of Organon BioSciences, a European biotechnology company that should expand the parent's pipeline and research efforts.
Another appeal of Schering is Sugammadex, which Conover described as “one of the first breakthroughs in anesthesia in 20 years.” The drug allows patients to awaken sooner from surgery, which will hasten their departure from the hospital, reducing costs.
His other selections include Novartis and Pfizer, which trades at less than 10 times estimated 2008 earnings and has a 5 percent dividend yield and $20 billion of cash on its books.
Barry Ogden, manager of the Ivy Capital Appreciation fund, likes the other Vytorin casualty. Merck is valued at just 12 times earnings, which he said underestimates its strength in cardiovascular and diabetes treatments and ignores efforts to cut costs by such measures as trimming its sales force. His other favorites include Abbott Laboratories, which produces diagnostic and nutritional products in addition to prescription drugs, and Gilead Sciences, a global leader in drugs to fight the virus that causes AIDS. Some investors have shifted to midsize biotechs like Gilead that have products on the market or in advanced stages of development.
These companies could continue as standalone operations or as acquisition candidates for big drug makers with more money than ideas.
Conover's biotech of choice is Biogen Idec. It has a strong portfolio of treatments for cancer and multiple sclerosis, and he thinks that Pfizer could do worse than to use some of its stockpile of dollars to take over Biogen and “buy some growth.”
One reason there is so much growth in biotech companies is their focus on large, complex molecules called biologics. They are hard to make, so companies can charge more for treatments based on them, and their complexity makes it more difficult to produce generic versions, Conover said.
He finds the threat from generics the biggest impediment facing the industry and its shareholders. For Ogden, the main source of low price/earnings multiples is politics, not commerce or science.
Concern that a Democratic president and Congress would try to require drug makers to lower prices has depressed the sector. Whether or not it happens, Ogden said, the anxiety about it is overdone.
“Even if reimbursement rates don't change and there is no restructuring of the system, fear of it could pressure multiples further,” he said, “but at these valuations, you've got to be predisposed to build positions in some of these names.”
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Japan is not too bothered by falling stocks
September 22, 2008 on 8:13 pm | In Money | No Comments
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The Nikkei average of Japanese stocks sank below 13,000 this week, sending its loss over the preceding 12 months past 20 percent.
You can blame the weak dollar and a weak U.S. economy, which curtail demand for Japanese goods. Another culprit, no mere cyclical phenomenon, is the lingering inability of Japanese businesses to operate as productively as their counterparts elsewhere.
This condition persists in part because Japanese investors, consumers, workers and political leaders do not seem too bothered by it.
After nearly two decades in which the Japanese economy was seldom far from recession and the stock market lost two-thirds of its value, few in Japan are calling for radical change in economic and corporate management.
Contrast the fatalism there with the mood in the United States, where a drop of 5 percent in the Standard & Poor's 500-stock index in the past year has been enough to raise heated rhetoric over what has gone wrong and what can be done to fix it.
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“Japan's a consensus society,” said John Maxwell, a Japan analyst and portfolio manager of the Ivy International Core Fund.
“Companies historically have looked at themselves as trying to win a global battle for market share and employ Japanese people. They never really thought of themselves as having to be good stewards of capital.”
And most are not. Investors can find more cheap stocks in Japan than almost anywhere else, he said, but with executives feeling little pressure to operate more efficiently or to make moves like share buybacks or special dividends that return money to shareholders, there is every reason to expect them to stay cheap.
“Japan is one of the very few countries where you can find companies with tangible assets that are worth more than the price of the stock,” Maxwell said. “The reason is, people don't believe the companies will do anything with them.”
Charles de Lardemelle, chief investment officer at International Value Advisers, does not expect a catalyst to emerge any time soon, either, but he is happy to own Japanese stocks while he waits. The cash that Japanese companies hoard, rather than putting it to work in some useful activity, limits the bang that shareholders get for their buck, but it helps guard against corporate blowups, too, he pointed out.
If you put the cash to one side, he added, valuations are much lower and profit margins higher. Meanwhile, the cash adds an element of safety in unsafe times, and shareholders continue to collect healthy dividend payments.
De Lardemelle prefers domestically focused business like the phone company NTT DoCoMo; Cosel, which makes electronic components; Nissin Healthcare, a provider of catering services to hospitals, and Shoei, a real estate company that holds a large stake in Canon, offering bargain-priced access to the camera maker's stock.
Maxwell concentrates his Japanese holdings among exporters, especially to emerging markets, where growth remains strong. That way, he limits the impact of the weak dollar and soft economic conditions in the West. And because shares of exporters have fallen heavily in the past week or so, anyone buying now may pay prices that fully, or even excessively, factor in the challenging conditions.
He also likes exporters because they have to compete with the world's best, which offers an incentive to improve efficiency and behave less like typical Japanese companies. The tough operating environment may even persuade manufacturers in certain industries to arrange mergers to unlock value.
Maxwell's selections include Nintendo, a worldwide leader in game consoles; the carmaker Suzuki, and Nissin Kogyo, a supplier of auto parts that derives 60 percent of its profits from emerging markets. Maxwell also favors heavy engineering companies like JGC and Chiyoda, which he thinks can more than hold their own against Western rivals like Saipem, Foster Wheeler and Fluor.
The businesses he prefers are “globally competitive companies that have good margins for their industries, good cash flow and strong balance sheets,” Maxwell said. But he finds such companies to be the exception, not the rule, and his portfolio is fairly light on Japanese stocks. “I'm not buying the walking dead that don't have great businesses, just good balance sheets,” he said.
De Lardemelle, with his greater patience and faith that his purchase of undervalued assets will pay off, is somewhat overweight in Japan. He advised investors not to underestimate the gains that can accrue to companies that have more capital than they know what to do with, especially now.
“The worst-case scenario is that Japanese companies keep cash on their balance sheets,” he said. “There are much worse worst-case scenarios in the United States.”
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Global Financial Warriors
September 22, 2008 on 8:13 pm | In Money | No Comments
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Global Financial Warriors The Untold Story of International Finance in the Post-9/11 World By John B. Taylor W.W. Norton. 320 pages. Beneath the White House lies a small, wood-paneled chamber where black, high-backed chairs crowd around a conference table. One end is dominated by a wide video conference screen, the other by the president.
This is the Situation Room, where top officials of the U.S. government plan their responses to major threats, foreign and domestic. John Taylor went there about 400 times from 2001 to 2005 while he was undersecretary for international affairs for the U.S. Treasury, starting a few months before the terror attacks on New York and Washington on Sept. 11, 2001, and leaving after voters handed a second term to President George W. Bush.
During that time, Taylor's job was to disrupt the financing of suspected terrorist organizations; provide a sound financial infrastructure for Afghanistan and, later, Iraq; and change the way the International Monetary Fund and the World Bank operated.
Some say Taylor helped orchestrate the biggest overhaul of international financial institutions since Bretton Woods. Whatever your opinion of the Bush presidency, there is little doubt that his administration presided over unprecedented changes in international finance, and Taylor led the charge.
One of his goals, focusing on terrorism, was transparency. We see the side effects of these policies today, as the German and British authorities are assailing the legal barriers that have made Liechtenstein a notorious tax haven and demanding greater honesty on the part of states and taxpayers. “Global Financial Warriors,” published last year and recently released in paperback, tells the story of how some of this came about.
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In finance, battles of ideas translate into what Taylor aptly calls battles of arithmetic, with numbers as the foot soldiers. Whether he was urging collective-action clauses for the bonds of emerging market countries, causing more World Bank money to be given in grants instead of loans, or negotiating with Turkey over the price of collaboration during the invasion of Iraq, Taylor was building his own models.
He is the kind of man who can do that. A specialist in monetary economics, a fellow at the Hoover Institution, now a professor at Stanford, Taylor is not reading textbooks anymore, he is writing them. And when he is not writing them, he is putting their ideas to work in the field.
But what Taylor doesn't say in “Global Financial Warriors” could fill a book. The holes in the narrative are gaping and much of the action is classified. What the reader finds, in its place, are atmospherics.
And it is in these atmospherics that we find Taylor the man, a garrulous technocrat who, by his tone, seems to be writing about the Eisenhower-era America of the 1950s rather than today. A connoisseur of euphemism, his characterizations move from strength to strength: Most efforts, though challenging, are crowned by success; all troops are hard-working and loyal; most decisions, untinged by realpolitik, are well-intentioned. What could have resembled a piece of detective fiction ends up reading like the chronicle of a Boy Scout jamboree.
The title itself conveys the heroism he sees in his task, and that same glowing prose applies to all Bush efforts and all U.S. troops, for Taylor's work and theirs are just multiple fronts of one wide-ranging war.
But the conqueror is worried, and even Taylor strikes notes of discontent. In the years after Sept. 11, 2001, we were reminded by the folks who are paid to have opinions that the world would never be the same. They pegged the turning point as the day the attacks occurred. So it may seem strange that Taylor looks back on the immediate aftermath of the attacks with something like nostalgia, and views later events with disappointment.
But then again, maybe the turning point came later. Because if America lost a sense of invincibility when the World Trade Center fell, it has lost much else since. As Taylor says, there was initially a “unique spirit of cooperation.” By 2004, Taylor believes, that cooperation was gone.
Iraq takes up four of the last five chapters of “Global Financial Warriors,” before the government lost this book's very capable author to academia. It makes you wonder what Taylor could have accomplished for the world economy if he had been able to stay just a little longer.
Chris Nicholson is an editor at the International Herald Tribune.
Chris Nicholson is an editor at the International Herald Tribune.
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More pain from bank stocks
September 22, 2008 on 8:13 pm | In Money | No Comments
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Bank stocks hit fresh multiyear lows this month, and unlike what happened in earlier routs the damage was not confined to institutions thought to be most heavily exposed to bad mortgages.
Banks that had seemed to come through the crisis with reputations and capital intact because of better judgment or maybe better luck, played catch-up in the latest leg of the race to the bottom.
The sector has been under continual pressure because the mortgage securities at the heart of the crisis trade infrequently and are hard to value. When investors are unsure about where they stand, they tend to fear the worst.
As the picture becomes clearer, it looks as if their fears were justified: Two firms that had pledged mortgage securities for loans said recently that they could not meet calls for extra collateral. The cash-strapped debtors or their creditors may be forced to sell the securities at depressed prices.
That is bad news for them, but also bad news for all the banks and investment firms that are exposed to the mortgage securities market, said David Ellison, a manager of financial-service stock portfolios for FBR Fund Advisers.
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There is no liquid market in the securities, he explained, so the few sales that are made are used to set the price for similar instruments on the books of banks around the world.
With billions of dollars in such paper out there, and with the leverage inherent in banking - a big bank's capital may amount to just 5 percent of its assets - every penny on the dollar by which the value is reduced can wipe huge amounts off the banking industry's net worth.
With shares of big-name banks like Citigroup, Merrill Lynch, Morgan Stanley, Goldman Sachs and JPMorgan trading anywhere from one-third to two-thirds of their highs of last summer, it may be tempting to step in and buy.
Given the pressure the industry is under, Ellison's advice is to resist the urge.
The stocks may rally from here, he said, but with so many doubts remaining about the industry's prospects, they will have to rally without him.
“Is this a $300 billion problem, or is it a $1 trillion problem?” Ellison wondered.
“Do we have enough capital in the system to get through it?
“I'm worried that the system is not functioning properly,” Ellison said. “If it's going to get worse before it gets better, I'll step away now.”
Ryan Caldwell, a fund manager at Waddell & Reed and a specialist in banking stocks, said he was also maintaining a discreet distance from the sector.
“What we've got to get our arms around is what the losses are going to be,” he said. “To date it has been exceptionally hard to analyze.”
Until the numbers become crunchable and the effects on earnings and book value are understood, he added, “the stocks are in trouble.”
But some are in trouble even when the banks they represent are not.
Both fund managers made a distinction between banks that rely on so-called nondepository liabilities, like mortgage securities and other mercurial sources of funding, and those that rely on old-fashioned deposits.
Institutions with large deposit bases are far more secure than others because depositors are not prone to yanking their money out, yet that has not prevented their stocks from being sold heavily.
Bank of America and Wachovia are examples that Caldwell cites. He said that he would not buy them yet but that he expected them to lead the way up whenever a recovery begins.
One sign of the low regard that Caldwell has for the sector generally is that the few banks he likes - ones that have “lots of capital and little leverage” - are halfway around the world from him: HDFC, a retail bank in Mumbai with branches across India, and China Merchants Bank, headquartered in Shenzhen.
Ellison likes some small lenders closer to his home base, including two New York-area thrifts, Hudson City and Astoria Financial, and two small but diversified institutions, Comerica and Marshall & Isley.
As for the big banks that have been sold the most, Ellison would rather miss the start of the next rally than be stuck in them for the end of the present decline.
“This business isn't about being a hero,” Ellison said. “There's going to be an opportunity in the next two years to make significant money, but this is not the time.”
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