IC Market Espresso 28 Mar 2019

Croatia Is Back to Investment Class, Eurobonds Yields Bottom Out
After being in ‘junk’ for six years, Croatia is once again among investment class as S&P Global Ratings decided to lift its rating to ‘BBB-‘. Looking at the bond market, Croatia was investment grade for some time as spread tightened significantly, so agency’s move looks way overdue from that perspective. Nevertheless, spreads could continue going south due to large funds that have limit to invest only in investment grade instruments. What was the driver and what to expect next read in this short article.

Exactly twenty two years ago all three credit rating agencies set Croatian credit rating at ‘BBB-‘ (lowest investment grade) with stable outlook and since then Croatia managed to climb only to BBB few years before GFC. However, crisis took its toll and Croatian GDP fell significantly, government’s debt climbed to above 85% in the beginning of 2015, entering EDP, while unemployment skyrocketed to above 17%. In 2013 Croatia fell to ‘non-investment’ class by all three major credit rating houses and back then it seemed like things could get even worse (i.e. lower than BB, two notches below investment). However, exports exploded due to EU membership and tourism sector, wages finally started to rise, fiscal deficits were limited to below 3.0% and after double dip recession Croatian economy finally started to revive in 2015.

Source: Eurostat, Bloomberg, InterCapital

Fast forward to March 2019: “The upgrade reflects Croatia’s fiscal metrics, underpinned by its recent economic recovery thanks to tax-rich domestic demand, but also fiscal consolidation measures implemented by the authorities. The general government has run primary fiscal surpluses since 2015, including of 3% of GDP on average in 2017-2018, with public debt as a share of GDP declining by 10 percentage points between 2015 and 2018.”

To sum-up, despite many challenges that Croatia witnessed in the last few years (several political disorders, Agrokor, shipyards etc.) it managed to consolidate its finances, post fiscal surpluses in both 2017 and 2018 and put debt on a strong downward path. Just to put things into perspective, Croatian debt as a percentage of GDP fell from 86.2% in 2015 to below 74% in the end of 2018. Also, external debt significantly decreased as current account surpluses were driven by EU funds withdrawals, tourism revenues and sound exports. Meanwhile, CNB managed to increase its FX reserves meaningfully, as a result of its intentions to curb overly aggressive appreciation of Croatian kuna. Furthermore, S&P’s analysts mentioned Croatian intentions to join ERM II in 2020 which would decrease its risk premia further.   

Source: Eurostat, Bloomberg, InterCapital

Last but not least, S&P praised some important structural reforms that Croatian government implemented, such as third round of taxation reform, pension reform and finally educational reform that “could help address labor market bottlenecks in the longer term”.

S&P said that they could raise rating in the next few years in case Croatia’s economic growth proves resilient on European deceleration as that would ensure wages in Croatia to converge towards EU’s averages. However, we doubt that could be the case as Croatia becomes more and more included into European supply chains meaning that it would suffer from deceleration of its main trading partners, especially as exports became large part of its GDP.

How did the market react to S&P’s decision? Well, looking at Croatian Eurobonds, it seems like Croatia was in investment grade class for quite some time now as risk premia was falling throughout 2019. Looking at the Chart 3. submitted below, it’s evident that all premia fell besides Romanian as a result of dovish central banks and never-ending hunt for yield that pushes investors on the edge of Europe. However, Croatian risk premium decrease was the strongest.

What to expect further? As we mentioned above, there are some subjects on the market that are limited in investing only to investment grade instruments, so we wouldn’t be surprised in case pressure on Croatian Eurobonds continue although we do not expect yields to reach Hungarian levels in the short-term ceteris paribus. Nevertheless, one should mention that with every roll of debt, Croatian interest expenses decreased, and this could be the case for many more years, backing up further fiscal consolidation and decreasing debt. On the other hand, European economy clearly shifted into lower gear and some analysts are expecting mild recession in the next 12-18 months which should be a real test for Croatia.

Source: Eurostat, Bloomberg, InterCapital
Arena Hospitality’s Parent Company 22% Shareholding Successfully Sold for GBP 149m Through Accelerated Bookbuilding
Several shareholders of Arena Hospitality’s parent, the PPHE Hotel Group, successfully sold a total of 9,300,000 existing ordinary for GBP 16 per share yesterday. In relative terms such a transaction translates into 17.8x P/E and 11.15x EV/EBITDA.  

The PPHE Hotel Group released a statement yesterday in which they stated that several of their investors successfully sold a total of 9,300,000 existing ordinary shares via an accelerated bookbuilding at a price of GBP 16 per share. In total this gives a secondary placement worth GBP 149m for approximately 22% of PPHE’s share capital (excluding treasury shares). In relative terms such a transaction translates into 17.8x P/E and 11.2x EV/EBITDA. Note that the placing is expected to settle today and that the sellers have agreed with their bookrunners not to sell any further ordinary shares for a period of 180 days.

According to the statement, the sale of shares was done in order to boost the company’s free float which would in turn make it eligible for inclusion in the FTSE UK series of indices. We strongly support such efforts as we believe that the entrance into one of FTSE UK indices would certainly attract more investors, increase liqudity and raise the general awareness of the company. One could also expect these positive effects to spill over to the local market as PPHE’s Croatian subsidiary Arena Hospitality would become the only regional company whose parent is a part of this exclusive group of companies listed on the London Stock Exchange.     

When looking at Arena Hospitality more closely, the company’s share price rose 3% in yesterday’s trading session (to HRK 342), making it one of the day’s best performers. As a result, Arena is currently traded at 19.8x P/E and 8.9x EV/EBITDA.

The results and further details of the transaction can be found on the following LINK.

Romanian Update – Government Proposes Regulation Amendments
The Ministry of Finance published a draft Ordinance which amends some of the current GEO 114/2018 provisions and eases the tax burden set on the companies enveloped by it.
Energy Sector

In the energy sector, the Romanian government intends to keep the turnover tax at 2% for energy producers, however an exemption is proposed for thermal and coal-fired power plants. Meanwhile the cap on electricity prices remains until the end February 2022.

Meanwhile, the energy regulator (ANRE) decided that the return on capital invested for electricity and gas transmission companies will be increased from 5.66% to 6.9%. The newly set rate will be valid for the regulatory period 2019-2024 and is expressed in real terms.

Banking Sector

According to the draft Ordinance for the amendment of the so-called greed tax, the Government plans to lower the bank tax to 0.2%-0.4% a year based on market share. Banks which hold a market share of less than 1% will have to pay tax at a rate of 0.2%, while companies holding a market share of above 1% will have a tax levied at a 0.4% rate. The tax would be due twice a year, despite the banks’ request for the procedure to be an annual one.

An important change in regulation will be that the tax will not be imposed on banks which record a net loss, and in case of profitable banks, the tax will not exceed the profit level. According to media writings, banks demanded that the tax be capped at 16% (the same as profit tax), which would virtually mean a doubling of the profit tax to a 32% share.

Note that banks will be able to cut the tax in half if they achieve government targets which will be set annually. For 2019, the credit growth target is 8% (similar to credit growth last year), while the decrease of net margin is set at 8% (e.g. decrease from 5% to 4.6%). If the prescribed credit increase is not achieved, then the tax rate decreases according to the formula:

R1 = [(increase in credits / credits growth target) * 50%]

*R1 = % by which the initial tax rate is decreased

For example, a 6% credit increase would lead to a 37.5% decrease in the tax rate, which would then amount to 0.25%. The same half-tax reduction applies for the interest margin. Therefore, banks may end up paying no fees if they simultaneously meet all the conditions set by the Government.

The government also plans to replace the ROBOR index, used as a reference in calculating variable interest rates on household loans, with a reference to be calculated by the NBR based on transaction averages (quarterly). Note that the new index will be used for new loans and would not replace the ROBOR index for ongoing loans.

Financial assets which are excluded from the bank tax:
  • Cash
  • Net cash amounts in central banks, excluding non-performing exposures
  • Non-performing net exposures
  • Debt bonds issued by public administrations, excluding non-performing exposures
  • Loans and advances issued to public administrations, excluding non-performing exposures
  • Loans given out to the non-governmental sector that hold guarantees from the central public administration, excluding non-performing exposures
  • Loans given out to credit institutions, attached debts and amortised amounts, excluding non-performing exposures; correspondent accounts at credit institutions; reverse repo operations and borrowed bonds, excluding non-performing exposures.

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