IC Market Espresso 31 Jan 2022

Spare 5 Minutes of Your Time and Read How Reputable International Portfolio Managers See Croatian & Slovenian Stock Markets

InterCapital has been the broker of choice for international funds which invest in Croatian & Slovenian equities for years. We often say that we believe in our region and we are relentlessly promoting it globally and locally. Still it is always good to hear unbiased opinions from abroad.

At the beginning of the year, we decided to interview three portfolio managers who are veterans of investing in our markets and who can give valuable feedback on the way they see our markets. In this article they reveal to us what it is that they look for in investment target, their expectations for 2022 and their ideas on how to improve the markets going forward. Of course, these are general views and they are not to be used as an investment advice in any way.

We will let you to read carefully through Portfolio Managers’ views, while the main point can be summarized as following: “Local markets are (too) small but offer few quality stocks & sectors for patient investors.”

Can you briefly introduce your fund(s) which invest in Croatia & Slovenia in more detail and why do you invest here?

Mehis Raud (Trigon Asset Management): Trigon is Estonian based independent asset manager focusing on Central and Eastern Europe. In Croatia and Slovenia, we are active since 2002. Today we manage close to 700 mn EUR of assets in the region through funds and dedicated regional mandates. Our competence lies within Eastern Europe region as the countries have many similarities in their macro convergence story and many companies tend to offer superior growth dynamics to their Western European peers. Capital markets in Eastern Europe are much less developed compared to Western markets, therefore offering plenty of opportunities for active managers like Trigon Asset Management.

Tamas Cser (Hold Asset Management): Our flagship fund is HOLD Equity Fund, which focuses on the Emerging European equity markets with roughly 120 million EUR assets. It is an active, benchmark agnostic fund and has been investing in Croatia & Slovenia since 2011. We also manage several absolute return funds, which are also taking positions in the Croatian or Slovenian markets, when we find a particularly undervalued company there. Our current largest position is ADRIS in this region. We are focusing on Emerging Europe as these are the markets, we understand the most due to historical heritage. We believe in the saying that the competence of a portfolio manager decreases as he or she moves away from the home ground. Also, we think that these markets are less efficient, therefore offering higher opportunities to capitalize from mispricing.

Valdur Jaht (Avaron Asset Management): Avaron is an Emerging Europe-listed equity-focused asset management house. We currently run around €350mil AUM comprising mostly institutional client portfolios but also publicly available Avaron Emerging Europe Fund (€40mil). We launched Avaron back in 2007 but the experience in regional stock markets of senior team members dates back to the early 2000s. I personally started to cover select Balkan markets including Croatia and Slovenia back in 2003. In regard to our current positioning in Emerging Europe, the exposure is rather diversified across different countries. It has to be said that we are value-oriented pure bottom-up stock pickers and do not make any geographical or sector allocation decision. All the companies in the portfolios are there because we see sizable stock price divergences from our internally estimated fair values of these businesses.

Can you share your outlook for 2022 for Croatian and Slovenian equity markets? What positive or negative effects could shape the market in your opinion? What are your top picks or top sectors you like?

Mehis: We remain constructive on both markets as we see very good value and growth combinations offered by many companies across different sectors.  We continue to like financials in Slovenia that enjoy good earnings dynamics and have extremely strong balance sheets. We have been long-term investors in KRKA which we continue to like for its high cash-flow generation capability. We also see long-term value in Luka Koper and Telekom Slovenije where we hope to see improving corporate governance and in the latter case possible trigger through share buy-backs and privatization.  In Croatia we continue to like food producers Atlantik Grupa and Podravka, in both cases we entered at the time of Agrokor triggered a meltdown in the markets. We are also long-term believers in Croatian tourism sector which offered good entry levels in 2020.

Tamas: We think that this year will be about continued normalization from the COVID situation. Probably the virus will remain with us, but it will be more and more the normal part of our life. This will help the tourism sector to continue its normalization.  Pay-outs from the EU recovery fund will gather speed, which will support the economic recovery in this region. Finally, one very important question of this year, whether the recent surge in global inflation is to what extent transitory. Probably, there will be some normalisation (decrease) due to the improving supply situation and high base effects. But if it turns out stickier than expected, it can cause central banks to turn more hawkish, leading to significantly higher rates, which would be negative for the markets. Financial sector is the part of the economy, which can relatively perform better in this environment as it would further boost its earnings (until rates note becoming overly restrictive to the economy).

Valdur: With the pandemic and inflation issues one thing that has not caught a lot of attention, at least internationally, is Croatia’s euro adoption. Although the switch shall be potentially made in the beginning of 2023, the risk premia adjustments in the company valuations shall be made in 2022. Being an open and relatively small economy, at least in European context, the positives strongly outweigh the negatives for Croatia. As the pandemic is transforming into an endemic the outlook for the upcoming tourism season outlook is favourable. Relatively low vaccination rate though is the main risk factor as Croatia’s “safe destination” status could be questioned.  In case of Slovenia, we have to note that several right steps have been made over the past years to increase its external-sector competitiveness (e.g., labour market reform). On the flipside due to being in better shape and among the counties with the highest GDP per capita, the mid-term growth potential is not higher than Croatia’s. In Slovenia our core holding over the past years has been generics producer Krka. It has a solid and proven business model with good execution, although the capital allocation from the point of view of balance sheet structure is hardly optimal. Also, we are constructive on NLB, especially after their acquisition in Serbia, which has opened up higher growth potential.

Since you are a seasoned investor in our markets and comparable markets around Eastern Europe (and even World), what are your ideas or suggestions how to improve local markets and make them more attractive to international institutional investors?

Mehis: I think stock-exchanges together with the leading brokerage houses are doing a reasonably good job with organizing regular investor days which helps to introduce and keep track on regional companies. That said, not all “blue-chips” are always present, for some reason, and especially this goes for some state-owned companies. I hope this will become a more common practice to participate in such locally organized events and in the future also in some regional conferences. Increasing visibility would be the first step to attract foreign investor interest. From the broker`s side, more analyst coverage and company reports would be welcome. Corporate governance remains the main issue for select state-owned companies in both Slovenia and Croatia. Having a tax environment that suddenly changes, or unreasonable or poorly communicated capex plans, are never good for attracting foreign interest. Well established dividend policy is also something that many investors highly appreciate. The best example where all these improvements have taken place and which I would bring as a role model for others is pharmaceutical company KRKA. Looking at their past 4-year stock chart proves my point quite well.

Tamas: The problem of the local markets is the lack of liquidity and lack of enough sizeable investment candidates per market. Increasing integration of these fragmented markets could help somewhat. Also, 2020/21 has shown globally, that retail investor activity can change significantly, helping the stock markets. So, it totally makes sense to think through, what further retail investor supporting measures can be taken. They can be easy reach to the market, TAX advantages etc.

Valdur: The main issue with Croatian and Slovenian stock markets is the lack of depth and liquidity, especially from an institutional investor point of view. As we cater to large global asset owners, liquidity of the portfolios is important. From our perspective in Slovenia there is only 8 and in Croatia another 5-6 that are investable for us but for a larger foreign asset manager maybe there’s only 2-3 altogether. However, this is an issue that other regional frontier markets also face. And the only way to improve this is to attract larger or high growth issuers on the market. This is not an easy thing to do in an environment where debt financing is so cheap and easily accessible even for companies that some 7-8 years ago would have had to raise equity capital. The way to improve the situation is on one hand help and incentivize the local capital base (institutional as well as retail) to grow and increase its presence in the local equity market. And attract new IPOs to the market.

Free float of CROBEX Constituents

Today, we decided to present you with a brief overview of CROBEX constituents’ free float.

In our analysis we considered free float to equal all individual shareholdings lower than 5%, while pension funds and UCITS funds were considered as free float regardless of their shareholding percentage.

Free Float of CROBEX Constituents (%)

Among the 24 CROBEX constituents just a third of them have a free float higher than 50%, indicating that two-thirds of CROBEX constituents are still held by a small group of majority shareholders. Of the constituents, there are two companies that have free float over 90% – Ingra with a free float of 93.61% and Adris (preferred) with 91.69% of free float.

On the other hand, ZABA, Kraš and Petrokemija have less than 10% of free float. ZABA has free float of 3.80% and is almost completely owned by Unicredit 84.48% and Allianz 11.72%, while Kraš has free float of 8.1% with Mesna Industrija Braća Pivac holding the majority share of 54.96%.

Prime market is the most demanding market on the Zagreb Stock Exchange regarding the requirements set before the issuer. It is worth noting that it requires the issuer to have a free float of at least 35%. If we were to compare CROBEX to that parameter, a few of the constituents would not meet the criteria (Petrokemija, ZABA, Kraš, Saponia, Brodogradilište Viktor Lenac and HPB).

If we were to calculate free float of CROBEX constituents while excluding pension funds, the results would be slightly different for some, but significantly different for other companies. Namely, Croatian pension funds hold HRK 15.9bn of the total market capitalization of ZSE, meaning a considerable part of free float of some constituents is technically “locked in”.

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