Despite short-term volatility caused by the pandemic in 1H 2020, the Balkan region could be one of the relative winners globally in the post-COVID era. Equity investors should acknowledge that the region is on course to receive one of the largest stimulus packages globally (equivalent to 17% to 35% of GDP) through the facilities of the EU Recovery Fund and budget, while it is also set to benefit from the key post-COVID economic and business trends. At the same time, regional markets offer some of the most attractive valuations globally, trading at only 6-10x P/E for 2021e, significantly lower than the13x for MSCI Emerging Markets and 15x for Euro Stoxx 50.
EU funding — supporting strong economic growth in Southeastern Europe
Facing the largest economic drop in post-WWII times, European governments agreed to implement an extraordinary set of measures, including the establishment of the EU Recovery Fund, with a size of €750bn, aiming to facilitate economic recovery across the European Union. The fund will include €390bn in grants (the rest is in the form of low interest rate long-term loans) targeting broad infrastructure and “green energy” projects, and will be implemented through the mutualisation of debt: it will be first time in history that the EU borrows money as a supranational entity and then uses these funds for common European purposes. As a result, Southeastern Europe (Greece, the Western Balkans) will be the key beneficiary of the EU Recovery Fund and the EU 2021-2027 budget over all, due to the size of funds’ allocation, its timing and strong multiplier effects on the economy.
Figure 1. Preliminary allocation of the EU Recovery fund and the EU Cohesion Funds in 2021-2027
Source: EU Commission, Bloomberg
In terms of size, as seen in Figure 1, the combined EU Recovery Fund and previously-communicated EU Cohesion Funds for 2021 – 2027 are massive. Bulgaria and Croatia will receive funding equivalent to 35% of their 2019 GDP, while Greece, Romania and Slovenia will get support amounting to 27%, 26% and 17% of their 2019 GDP respectively. This means an additional 2.5% to 5% of GDP annually, a number that will be extremely supportive for the mid-term economic outlook. Our conversations with policy makers in Slovenia and Greece suggest governments will not waste any time in preparing the projects to be able to draw the majority of funding available.
As the funding will be targeting multiple broad infrastructure projects and will be focusing on green transformation and improvements in structural efficiency, we expect sizeable multiplier effects in economic growth for Southeastern Europe. In Greece, for example, the mid-term potential growth rate of GDP can increase by 2-2.5pps compared to previous estimates. We believe most of the countries in the region will be able to grow at a pace of 5%, an environment that should be supportive for local businesses and their earnings.
Timing is yet another very positive factor, as approximately 70% of the EU Recovery Fund is aimed to be committed by 2023 and fully disbursed by 2026, to facilitate economic recovery earlier in the cycle.
Post-COVID trends benefitting the Balkans
In the current environment, political and corporate ambitions are realigning by putting greater emphasis on local production, thereby reversing long-standing trends to push manufacturing overseas. It is reasonable to expect that a large portion of European companies will try to bring production chains within the EU and neighbouring countries. The Balkans and Turkey could be the regions of choice, given their high level of education and professional skills, combined with still substantially lower average salary levels compared to Western Europe (average salary in Romania in 1Q 2020 amounted to €1082/month, compared to €4035/month for Germany)
Emigrants flocking back home is yet another trend that should be structurally positive for the growth in the region, as the shortage in the labour force declines. According to official statistics (for example Romanian Ministry of Diaspora), ca. 5.6 million Romanians and 0.8 million Greeks were living abroad at the end of 2019. The return of at least part of the diaspora will cause a sizeable boost in the potential GDP growth level.
Many countries in Southeastern Europe are highly dependent on tourism sectors, and while the initial shock was negative, long-haul tourism is expected to be affected the most by travel restrictions and health regulations, while short-haul should benefit. The higher chance of Europeans travelling to Greece, Croatia, Turkey and Bulgaria instead of vacationing in far-away countries benefits the Balkans in terms of redistribution of tourists flows.
Responsive fiscal and monetary stimulus, combined with lower energy prices
As a response to the negative economic impact of the COVID-19 outbreak, all countries in the region implemented a set of monetary and fiscal measures to support a faster recovery in economic activity.
Euro zone countries (such as Greece and Slovenia) are clearly benefitting from the accommodative monetary policy of the European Central Bank, while non-Euro zone countries also proceeded with cuts in key rates and local QE programs. Since the beginning of the year, Turkey has cut the rate by 3.75pps (to 8.25%), Romania by 1pps (to 1.5%) and Serbia by 1pps (to 1.25%). In fact, there is plenty of cheap liquidity available for companies and a credit crunch does not seem even remotely possible ; a huge difference from the global financial crisis, when corporates were scrambling for liquidity. Being in dialogue with the CEOs of both public and private banks, we believe the banking sector is in good shape and willing to lend, and we are convinced that we are not entering a deleveraging cycle this time around. Substantially lower rates are obviously also supportive for equity valuations.
On the fiscal side, all of the countries in the region announced a set of measures in an attempt to smooth the decline in GDP in 2020 and relaunch economic activity faster in 2021. Greece managed to allocate 13.3% of GDP, while Croatia, Serbia and Austria allocated 11.6%, 11.1% and 9% respectively.
Last but not least, being net energy importers, all countries in the region are expected to get substantial support for their economies and bottom lines from the lower energy prices. According to our numbers for Turkey, every USD5/bbl difference in crude oil prices makes ca. USD3bn positive impact on the Turkish balance of payments (Brent is currently trading at USD45.5/bbl vs. USD64/bbl on average in 2019).
Local pension funds support equity markets
The base of local money invested into regional equity markets has continued to expand, and is now a significant market driver. In recent years, on the back of the increasing employment rate and growing disposable income, domestic pension funds have surged and stable inflows of long-term money are channelled to the local equity markets.
In Romania, for example, the AUM of pension funds increased from RON25bn (€5bn) at the end of 2015 to RON60bn (€12.5bn) by the end of 2019. Equity allocations are clearly expected to rise given significantly lower bond yields. The lower interest rates also imply that shares with high dividend yields become a more interesting proposition for such funds.
Equity markets in the region have experienced different patterns in 2020, with the declines ranging from 9% in Slovenia to as much as 33% in Greece. Romania and Turkey ranked in between, with 16% and 20% declines, respectively. But in most of the markets it has mainly been local investors picking up shares. We think the positive economic outlook and low valuations will eventually lure back foreign investors as well.
Despite sizeable supportive economic measures announced and a much better-managed control of the COVID outbreak (vs. the US and Western Europe), Balkan equity markets are trading at very low multiples. For long-term investors, the 2021e P/E for Turkey (6x), Romania (8.5x), Slovenia (8x), Austria (10x), and Greece (13x) clearly offer a very attractive starting point, especially having in mind the positive tailwinds the region should enjoy in the mid term. So far, we have been impressed with how our portfolio companies have handled the crisis. We have not experienced a single capital increase so far, highlighting the robustness of the business models. We participated in person in AGMs of Slovenian companies and were engaged in very constructive dialogues about the dividends. We are happy to say that all Slovenian companies now understand the importance of dividends. The ones in non-financial sectors (Petrol, Krka) upheld their dividend policies and paid the highest dividends in their histories, a rather unique example in the wave of dividend cancellations across Europe and wider, while those in the financial sector confirmed they will pay dividends immediately after regulatory dividend bans are lifted. An example of a company that we like through different time horizons is Purcari Wineries. In the short run, the Romanian company remains resilient, as the wine sector has not been affected by the crisis. In the mid term, its combination of quality and price should enable the company to grab additional market share. In the long run, it remains on track to become the wine champion of Eastern Europe. The company trades at 2021E 8.7x P/E and a 6% dividend yield.