CEO Equita Group & Equita SIM
by Andrea Vismara, CEO Equita Group & Equita SIM;
Nowadays, investors perceive Italy to be more a source of risk than an opportunity owing to its chronic problems of sluggish GDP growth, high public debt, low productivity and a banking system that is beleaguered by a high NPE burden. However, if we take a closer look at the Italian scenario from the perspective of mid-sized companies, the overall picture is much rosier and full of attractive investment opportunities.
From a macro standpoint, we could highlight the country best-in-class primary, bolstered by a positive trade balance, or the limited level of private debt. What is more, as far as the financial system is concerned, although the level of non-performing loans in Italy (11%) is twice as high as the EU average (roughly 5%), we should not underestimate the efforts that have been made over the last two years to reduce the exposure (the NPE ratio was at 19% in the third quarter of 2015). Neither should we underestimate the in-depth sector restructuring that has been undertaken over the last 10 years, which has reduced the number of branches by 35% (-11k) and the headcount by 23% (‑89k). All of this was achieved using limited public resources, i.e. around €14 billion.
Instead, from a financial markets perspective, the Italian equity market is underperforming international benchmarks to a significant extent. It is still underdeveloped in proportion to the Italian economy (total market capitalization at the end of September was €622 billion, 40% less than Apple alone) and the main index (FTSE MIB), which comprises the biggest 40 listed companies, had a market capitalization of roughly a third of the German index (39%) and the French market (31%), and was 20% smaller than the Spanish market (despite having a GDP almost twice the size).
Yet what if we exclude the struggling financial sector? The performances of Italian companies operating in other areas (e.g. industrial, consumer and utility sectors), especially if they are mid-cap companies, are in line with or above the top international benchmarks.
In our view, it is by looking at things from a different perspective that we can understand how it has been possible for many Italian sectors (and, most of all, for many mid-caps) to record similar absolute performances to the top international benchmarks while the main index posted a shocking underperformance.
Italy has plenty of world-class companies to offer, particularly amongst the mid-caps, which are just as capable of generating value as the most successful international business cases.
If we consider the characteristics of what we call “Italian Champions”, i.e. the 10 best-performing stocks (with annualized returns between 20% and 30% on average per year) over the last 10 years with market caps above €1 billion (De Longhi, Reply, Brembo, Amplifon, Recordati, IMA, Diasorin, MARR, Banca Generali and Campari), we discover something very interesting.
These companies have market capitalizations between €1.5 billion and €9 billion (averaging around €4 billion) and most are not yet listed on the main Italian Stock Market index. They operate in diversified sectors (and not in the stereotypical mechanical industry or fashion sectors) and are firmly in the hands of one reference shareholder (often family-owned, providing empirical evidence at a global level of the outperformance of the family-owned companies). These “Italian Champions” are, on average, highly exposed to export (over 50% of sales), they have a strong propensity for M&A activities and they have essentially doubled their sales and increased their earnings four-fold in the 10 years between 2008 and 2017.
…yet more needs to be done to improve the Italian financial market conditions…
Despite the success in performance terms over the last 10 years and a growing propensity of the reference shareholders to increase the free float, thanks in part to the recent introduction in Italy of multiple voting shares, the liquidity ratios of the “Italian Champions” are still fairly low (average daily trading volume of €7.9 million, ranging from under €2 million to €22 million), and they tend to use few financing alternatives to the traditional banking channel.
The limits of the Italian market need to be overcome if new “Italian Champions” are to emerge. For instance, the limited number of issuers (partly due to the low propensity of mid-cap companies to access capital markets) and the low level of liquidity are key issues to be addressed.
The success of initiatives such as PIRs (Piani Individuali di Risparmio, or Personal Savings Plans, which were introduced in 2017 and which attracted investments of €14.2 billion in just 18 months up to June 2018, thanks to tax incentives for mid-term investments) and SPACs (Special Purpose Acquisition Company vehicles) is not enough. The government should stimulate access to the markets by taking action on both the supply front (e.g. by streamlining the listing process) and in terms of demand (e.g. by offering new instruments dedicated to micro caps and private equity/private debt channels).
Our prudent approach on the financial markets has proved correct over the last few months: the risks of a macro slowdown due to the uncertainty brought about by politics, aggressive trade policies and cost inflation, in addition to the approaching end of QE, have created the conditions for a market correction. We think it is still too early to become more constructive on the broader markets, but we believe that recent corrections are starting to offer opportunities to re-discover high-quality companies with solid business models that are able to weather tough markets at very reasonable valuations (Italian Mid-Small caps are currently trading below 14x PE 2019 vs. 16x PE 2019 two months ago, with 5% discount on European peers), thus creating increasingly attractive conditions for investors.