Eastern Europe Back in Black

10/27/2010 2:09 pm EST


Andrew McHattie

Editor, Investment Trust Newsletter

Emerging European equities are cheap, as is a UK-listed fund whose manager sees tremendous value in the region, writes Andrew McHattie in Investment Trust Newsletter.

Eastern European Trust (London: EST) [manager] Sam Vecht argues that emerging Europe can double in value. He points to its earnings growth record, which easily beats both world equities and global emerging markets over the last 10 years, its return on equity, which has the same boast, and the price/earnings ratio, which is much lower. Vecht expects 50% earnings growth in the next couple of years and thinks that a re-rating is possible. “There are risks”, he says, “but it could double.”

Running through some of the positives for the region, profitable companies come top of the list. Gazprom (OTC: OGZPY, London: OGZD)—an 11% holding in the trust—is the most profitable company in the world in absolute terms. The area also has plenty of growth companies, including what Vecht describes as Europe’s fastest-growing airline (Turkish Airlines (Istanbul: THYAO), and a massive commodity resource, not just in terms of oil. At a time as well when many countries around the globe would love to see their currencies devalued to make their economies more competitive, Vecht reckons that the currencies of Russia, Estonia, Poland, Lithuania, Latvia, Hungary, and the Czech Republic are all undervalued. This makes their exports competitive, and Sam points out that the region is already a manufacturing hub. Eastern Europe benefits from low labor costs and a proximity to core markets in western Europe.

Budgetary problems are not too bad for Eastern European governments, which are not facing the same elevated levels of public debt as the UK, US or Japan. As a result there is little pressure on these governments to increase their low tax rates, unlike those developed economies where tax rises are a necessity and a certainty. With cheap currencies, skilled labor, competitive costs, good tax rates, and lower leverage in their economies, the Eastern European nations have plenty of reasons to consider themselves well placed at present.

Vecht is very positive then, and still puzzling over why Eastern Europe is so cheap. He sees four key risks to growth in the region though, namely (i) another world recession, which would inevitably sink growth plans; (ii) a general move towards risk aversion from investors, which would see funds withdrawn from these perceived ‘risky’ markets; (iii) a collapse in commodity prices, which would hurt Russia disproportionately; and (iv) a growth in what Vecht calls “internal political noise.” He accepts that the politics of the region are a barrier to investment, although in the long-term he sees China’s politics as a far larger problem.

To conclude, the case for the trust sounds pretty compelling at 297.5 pence—as long as global growth stays on track.

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