Check out this emerging European gem
The Czech Republic is roaring ahead, yet on a price-earnings ratio of nine, it’s the cheapest stockmarket in the world after Russia, says Frederic Guirinec.
The Czech Republic is roaring ahead, yet on a price-earnings ratio of nine, it's the cheapest stockmarket in the world after Russia, says Frederic Guirinec.
The country that is today the Czech Republic lies at the heart of Europe, at the crossing of many historical trade routes. Various groups have encountered each other in this region, resulting in both commerce and war. Remarkable castles, the thriving city of Prague and the picturesque town of Cesky Krumlov in the south of Bohemia are testimony to the variety of these past encounters.
Over this time, the country has been prosperous, creative and entrepreneurial across sectors large and small. The city of Plzen created Pilsner Urquell, the first pale lager and the influence for many major beer brands today. Skoda and Tatra are among the oldest vehicle manufacturers in the world, alongside European peers such as Peugeot, Opel and Mercedes-Benz.
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Before producing cars, Skoda was one of the largest European industrial conglomerates, producing heavy guns, tanks, aircrafts, ships and locomotives for what was then the Austro-Hungarian empire. Crystal and lead crystal manufacturers such as Moser are widely renowned. Lastly, during the cold war, while we in the West watched Warner Bros cartoons, children of the Eastern bloc watched the adventures of Krtek, the little mole, and his woodland friends, created by Zdenek Miler, a Czech animator.
A success after communism
With that history, it may be no surprise that the Czech Republic is the ex-communist country that has recorded the strongest growth since the end of the Iron Curtain in 1989, and has become a relatively economically successfully country. With a GDP of $193.5bn and a population of 10.5 million inhabitants, the Czech Republic is similar in size to Greece or even Portugal. Yet in purchasing power parity (PPP) terms, its GDP stands at $35,014 per capita well above Greece ($26,793), Poland ($27,567), Portugal ($30,061) and close to the European Union average of $38,918. It has the second-lowest poverty rate among OECD economies and was ranked 31st by the World Economic Forum's Global Competitiveness Report.
The economy is growing at a steady and robust pace of 2.5% per annum. Unemployment stands at 3.2%, the lowest in the EU. The public finances are healthy: public debt stands at 41% GDP, as a result of limited public spending (40% of GDP, compared with an average of 49% for the EU) and the country generated a budget surplus in 2016. The trade balance is generally a comfortable surplus, driven by the robust German economy: a third of the Czech Republic's trade relates to Germany.
However, this of course points to one potential vulnerability: as a small economy, its fortunes are dependant on the economic health of Germany and the eurozone.
The Czech Republic has attracted €100bn of foreign direct investment since 1993, according to the Czech National Bank. Large firms such as Continental, Danone, Ford, Honeywell, Hyundai, IBM, Nestl, PSA, Procter & Gamble, Siemens and Volkswagen (through its ownership of Skoda) have significant subsidiaries in the Czech Republic.
Car manufacturing is a notable export success: the industry accounts for 20% of exports and 10% of GDP, with 1.34 million cars manufactured in 2016. Metallurgy, glass, defence and other sectors also play a role (even dairy products much of the Prsident Emmental brand cheese sold in the UK is produced in the Czech Republic, not in France).
However, this is not simply an industrial economy: services contribute to over 59% of the GDP. The tourism sector in particular flourishes, thanks to the city of Prague and the country's 2,000 castles.
There are some weaknesses. The labour market is not particularly flexible. Innovation is also a weak point and the country faces difficulties retaining or attracting talent. The end of the Iron Curtain and the transition to a capitalist system created golden opportunities for opportunists and the nomenklatura (Communist party members who held key administrative positions in the bureaucracy) to build sizeable wealth.
Hence corruption was rife in the 1990s, and this in part led to a financial crisis at the end of the decade. Corruption remains an issue today, despite some noticeable progress and efforts to curb it. Transparency International, an anti-corruption non-governmental organisation, ranked the country as 47th out of 176 worldwide on corruption. One main weakness remains the power of some lobbies to affect the legislative process.
Still, the financial sector today is sound and well-regulated as a consequence of that financial crisis. And unlike many households in neighbouring countries, Czechs have not taken out mortgages in Swiss francs in pursuit of lower interest rates.
A tiny but attractive market
Overall, the label "emerging Europe", frequently applied to the former communist economies of Eastern Europe, is misleading. The Czech Republic is not emerging it is roaring. Yet on a cyclically adjusted price/earnings ratio of nine, it is the cheapest stockmarket in the world after Russia.
Foreign investors can also expect gains from currency appreciation. Last April, the Czech central bank ended a longstanding policy of keeping the koruna weak against the euro (in the form of a 27 koruna per euro cap on the exchange rate) and the currency now trades at around 26.5 koruna per euro. The cap was abandoned due to rising food inflation, which had raised expectations of an increase in interest rates, and while the currency has remained stable since, it should increase over the medium term versus the euro.
The snag is that the stockmarket is extremely small: the Prague stock exchange has under 20 listed companies. Some are subsidiaries of multinationals such as Komercni Banka, which is partially owned by Socit Gnrale. However, most large companies are unlisted subsidiaries of multinationals, such as Skoda and Pilsner Urquell (now owned by Japanese brewery group Asahi). Other key firms are privately owned, many by those individuals who made their fortune by acquiring state-owned companies in the early 1990s as the economy turned to capitalism.
Consequently, it's difficult to find a fund that has any significant exposure to the Czech Republic. However, it is possible to invest directly into Prague-listed stocks: Saxo Capital Markets offers access to the exchange. So for private investors who are willing to invest abroad, this is not an insurmountable obstacle. We look at a few local stocks in the box below.
Six ways to invest in the Czech Republic
General Electric, the US conglomerate,spun off Moneta Money Bank (Prague:MONET), its Czech financial servicesdivision in 2016. The bank, which focuseson retail banking and small businesses,recorded a strong first quarter this year,and beat analysts' expectations. It offersa 12% dividend yield.
Unipetrol (Prague: UNIPE) is a large oildistributor partially owned by the Polishcompany PKN. With a price/earnings(p/e) ratio of six, the valuation is veryattractive. As a distributor rather thana producer the company benefits fromlower oil price, since this boosts demand.Bookmaker Fortuna Entertainment(Prague: FOREG) had a difficult year in2016, but should benefit from the footballWorld Cup to be held in Russia next year.
However, with a p/e ratio of 22 and ashare price that has increased by 33% thisyear, it looks less compelling than it did.London-listed Stock Spirit (LSE: STCK)generates 25% of its revenues in theCzech Republic (and 50% in Poland)following the acquisition of the Prazshavodka, Nordic Ice and Dynbyl gin brands.Despite a difficult year in 2015, operationshave improved under the helm of the newchief executive Miroslaw Stachowicz.
The company has a near-20% earningsbefore interest, tax, depreciation andamortisation (Ebitda) margin and healthyfree cash flows. It trades on a p/e of 14.Real estate in Czech Republic looksextremely good value in comparison toWestern Europe. One way to invest isthrough Arcona Property (Amsterdam:ARCPF), a fund that mainly focuses onthe Czech Republic and Germany. Itspecialises in offices and retail spaces.
A larger player is CPI Group (Frankfurt:O5G), which manages property worth€5.6bn and is the largest retail spaceowner in the Czech Republic. It hasrecently acquired 11 retail centres fromCBRE for €700m. Outside Central Europe,it owns the Palais Maeterlinck in Nice,among other assets. The fund is 75%owned by founder Radovan Vitek, a Czechbillionaire real-estate developer.
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Frederic is an investment analyst. He started his career at JP Morgan in Paris. He has more than ten years of experience investing in private equity and also worked with the 3i debt management team investing in private debt. He is an ACCA member and a CFA charterholder. He graduated from Edhec Business School.