Practical analysis for investment professionals
20 April 2015

The Outlook for Spain and the Eurozone

José Ramón Iturriaga is one of the top fund managers in Spain. He oversees three long-only funds for Abante Asesores, a firm he joined in 2005. Prior to his tenure at Abante Asesores, he was CIO of Gesbankinter. Two of the funds he now manages — Okavango Delta and Spanish Opportunities — are clones of one another, though the latter is domiciled in Luxembourg. The third fund — Kalahari — is a low volatility version of the other two and is based on the same portfolio of equities. Iturriaga applies a top-down approach with a value twist to asset management.

Iturriaga is a regular presence in the mainstream media in Spain. He has recently started to write a weekly column in the newspaper ABC and since 2006 participates in the widely followed radio talk show La Brújula de la Economía on Onda Cero.

For three years, in the midst of the most severe bouts of the eurozone crisis, Iturriaga was notorious for being one of the few believers in the future of the single currency. During those years, he had to defend his macro thesis time and again, until events and data started supporting his investment decisions. His flagship fund, Okavango Delta, delivered a jaw-dropping 74.93% return in 2013, and after a rather flat 2014 (1.16%), it seems to be taking off again this year. It was up 21.21% for the year as of 14 April.

With these developments in mind, it seemed like an ideal time to speak with Iturriaga about his thoughts on the economic situation in Spain and the eurozone as well as his investment strategies more generally.

Gustavo Teruel, CFA: Since the end of 2010, your thesis has been that Germany would yield to the pressure of its EU partners and embrace expansive monetary policy (like the issuance of eurobonds) once the periphery countries complied with some painful reforms. How well has reality conformed to what you foresaw at that time?

José Ramón Iturriaga: The approach to solving the European crisis hasn’t been quite showy, but it’s been very effective. The structural reforms undertaken were unthinkable just a few years ago. In Spain, in particular, the production model has been turned upside down. The competitiveness gains, as a consequence of the reduction in labor costs, have laid the foundations for much healthier growth, with less exposure to cycles and greater potential.

Besides, the fact that the drunk drivers have been removed from the financial system — not all the cajas [Spanish savings and loans] but all of them cajas — constitutes a turning point for the Spanish financial system and economy.

Obviously, we could have gone further with the reforms. But there is no doubt that in structural terms, progress has been greater in the last four years than in the previous 40.

How do you foresee the EU integration process going?

There has also been a quantum leap in the last few years on this matter. The banking union is a giant stride forward for the process of European integration that — maybe because it has succeeded — has not been given the recognition it deserves. With this development, the link between the financial systems and the sovereigns of each country — one of the causes of the euro crisis of recent years — is broken .

Besides, good progress has also been made on a fiscal union. In fact, France had to pass its budget in Brussels before it was approved. So, not overnight but at a steady pace, in the monetary union we have achieved a common monetary policy and banking union and we’re close to a legal fiscal union, although de facto fiscal union has progressed a lot.

A few months ago it seemed that the populist political party Podemos could seriously disrupt the governability of Spain. Have you already dismissed that possibility?

The results of the regional elections in Andalusia have become the first reliable leading indicator (after all the noise in the public opinion surveys of recent months) of what may happen in Spain in the months to come.

The key factors to consider are: the margin of error introduced in the polls by the emergence of new political parties. Yet much more important is the real weight of Pablo Iglesias’s party.

The results that we’ve seen lead to the conclusion that the threat posed by Podemos was way overestimated. International investors can rule out the worst. This being so, if in a region like Andalusia, which provides the largest number of members of congress in the general elections, the vote for Iglesias’s party was a mere 15%, a lot of theories about the governability of Spain are called into question, even more so if we take into account the historic ideological bias of the Andalusian electorate.

Thus, the fact that the major investment funds of Wall Street have been closely following the election results in the south of Spain is nothing if not comical. They can already start to cover their shorts.

In one of your latest columns you’ve stated that Greece will have to accept the terms imposed by the “Troika” because they don’t have any other choice. Some other investors, like Warren Buffett, have said that an exit of Greece from the euro wouldn’t be traumatic for the eurozone. Do you think that an event like that could be handled cleanly?

I don’t think it will happen mainly because the Greeks don’t want it to. Greece in the end is an island surrounded by countries that average a quarter of Greece’s level of wealth (in terms of GDP per capita). Things that have no reason to happen don’t happen. That’s one of the lessons of the recent crisis.

In the end, the euro didn’t break up, Spain didn’t default on its debt, and Berlusconi didn’t drag Italy into the abyss.

The swans are white. The story of the black swan was a wonderful theme for a book, but it’s not a good theme to guide investment decisions.

You said at the end of 2013 that, in soccer terms, the bull market was just in the 20th minute of the first half of the match [In soccer the games are divided into two 45-minute halves]. What minute of the match are we in now?

Definitively in the first half. Maybe in the 30th minute. The best indicator is the evolution of the income statements of the companies that, even though they’ve turned around, are still far off what they would be in a normal year. And that’d be the result of the middle years of the cycle, the best reference point to assess the value of a company.

In the latest monthly letter of your flagship fund Okavango Delta, your allocation to banks was around 25% of the fund’s assets, with another 14.4% of the assets invested in insurance companies. So far these bets have been a sovereign yield play, given their large holding of Spanish sovereign debt. With Spanish bonds trading at historically high levels, what do you expect at this moment from these investments?

The financial industry — banking and insurance — benefits from two of the main themes that I think are going to keep working in the months ahead: normalization of the perception of risk in Europe and a stronger and quicker recovery of the Spanish economy.

First, we have local banks that comprise the biggest weight of the fund. After several years defending the notion that there were neither more bodies in the closet nor a greater need for capital, banks have started discussing their growth strategies and profitability targets.

The qualitative change is huge. Presentations lately have focused on growth plans in the more profitable niches, such as small and medium businesses and consumer credit; the recovery in volumes; and a less uncertain future. The strategies vary from the those of boldest — those that may be a step ahead in international diversification — to those of the ones that have always been arriving late to the ball in recent years but somehow have had the financial wherewithal to survive.

Cost reduction keeps being one of the cruxes of their story, but it’s no longer the only one they can talk about. Regulatory risks still persist, although they’ll probably implement new requirements. They’d better do it. But you can’t expect them to push on a string.

Once the dust has settled, the debate should focus on the potential profitability of the Spanish financial system in the current environment. The forced departure of the drunk drivers and the new practices in capital markets have made it so what’s left of the Spanish financial system may look ahead with optimism.

The wounds have not yet healed and nobody speaks about the potential profitability of Spanish banking, yet it will come. And within local banks, if I had to choose one, the one that I think has lagged behind but has greater potential nowadays is Bankia, which maybe has done worse for reasons that have nothing to do with its fundamental valuation.

On the other hand, insurance would be the other main sector. It’s an industry exposed to the two main investment keys that will keep working in the months ahead. They have very attractive multiples, especially if we take into account where in the cycle these companies are.

With other bets in your portfolio (like the real estate investment trust (REIT) Merlin Properties, the real estate corporation Inmobilaria Colonial, and the infrastructure firm Ferrovial), you seem to be anticipating that other investors will eventually bid up their prices due to the search for yield. How much higher do you think these companies can go in terms of valuation?

They are very attractive companies in terms of valuation. Regarding the real estate industry, it seems that it’s starting to recover after several years of a severe shrinkage. Since the second half of 2013, occupancy levels have started to stabilize and the number of deals has increased, which has led to a compression of the yields and the rents have started to rise.

From 2007 to 2013, the rents and prices went down 40% on average. Taking into account the very attractive entry points  some of the SOCIMIS [a kind of listed REIT with an advantageous tax regime] are getting, once these investment vehicles are fully invested they become a good way to play the recovery in prices as well as in rents. Besides, the improvement in financing conditions will allow these companies to lever their portfolios at 40–50%. For reasons of liquidity as well as for the composition of its portfolio, I believe that, among the alternatives, the best is Merlin Properties.

On the other hand, Colonial offers the possibility of investing in the best Spanish real estate assets, through a company that has left its balance sheet problems behind and is at more or less its book value at this moment of the cycle and in this interest rate environment.

At the end of 2014, you got out of two industrial companies, Tubacex and Tubos Reunidos, whose main clients were in the oil industry. One of your main holdings is Sacyr, which owns, among other real estate and infrastructure businesses, an 8.89% stake in Repsol. Aren’t you afraid of the impact of lower oil prices in this case?

In a sum-of-the-parts valuation of Sacyr, we could say that the influence of Repsol is neutral — it doesn’t add and it doesn’t subtract. The main attraction of Sacyr is its real estate company, Testa, which it is trying to float via a capital increase.

I think that this will be the main evidence of how foreign investors are valuing prime Spanish real estate in, as I say, this moment of the cycle and in this interest rate environment. I think we might be in for a pleasant surprise.

The debate, when we turn the page on the latest black swans — Grexit, Podemos — is going to be at what level interest rates will stabilize — and that will be the new normal — and its implications in the valuation of all asset classes.

Another sector of the market in which your fund has a high allocation is media. When the stocks of the two main television networks were trading at prices half of what they are nowadays, many analysts thought that advertising revenues would never recover due to migration to the Internet or mobile platforms. Do you think that the impact of the new technologies will be significant for these companies or that advertising revenues will return to pre-crisis levels?

I think they will. In spite of the new technological developments, the weight of advertising in free television broadcasters remains high and it keeps growing in markets much more developed than the Spanish one.

In any case, after seven years of correction, the room for recovery from current levels is still ample. And the impact that this foreseeable recovery will have on the income statements of the two listed companies is huge due to the unprecedented operative leverage following the cost cuts that these companies have undertaken and the re-ordering of the whole industry.

Within the media industry you have a sizable position in PRISA, a stock that has enticed several value investors because it was cheap compared to a sum-of-the-parts valuation. However, the stock has fallen in value and the company, on the brink of bankruptcy, had to resort to a line of extremely expensive financing from funds specializing in distressed investing. Besides, its main asset, Digital Plus, never seemed to take off and the CEO responsible for the decline of the group is still there. What makes you think that now is the time to be long on PRISA?

PRISA is the clearest turnaround story within Spanish equities. The milestones that the former CEO, Fernando Abril, proposed two years ago have been achieved without the market recognizing it. I think that the reason behind this lack of recognition is the enormous skepticism that still persists about Spanish equities.

We’re in Saint Thomas mode — people don’t believe anything unless they put their fingers into the wound. Probably when the sale of Digital Plus is finally approved by competition authorities and the market realizes the huge reduction of debt and the restructuring of capital produced, people will take another look at the company. Today PRISA is the stock in my portfolio with the greatest appreciation potential.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

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About the Author(s)
Gustavo Teruel, CFA

Gustavo Teruel is a partner at Exxacon, a Spanish-Chilean company that manages investments in real assets for institutions and high net worth individuals since 1998. Apart from earning the CFA Charter, Mr. Teruel completed a M.Sc. in Civil Engineering at the University of Granada and an MBA at IE Business School.

1 thought on “The Outlook for Spain and the Eurozone”

  1. christian says:

    this is the biggest load of rubbish I have read,please tell me about the millions of unemployed Spaniards,and the millions of unsold properties which your WONDERFUL banking system retains on an “extend and pretend” basis, YOU my friend are living in cuckoo land.

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