Our interview with analyst Ori Licht, the head of sell-side research at IBI Israel Brokerage & Investments, took place in the shadow of the ruble’s collapse and the crisis in Russia, together with the uncertainty regarding shares in Israeli energy shares after antitrust commissioners threatened to break up the local gas monopoly.
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Regarding Russia, Licht sees three possible scenarios. “The least pessimistic scenario is that [Vladimir] Putin will convey a message of reconciliation to the world – in other words, that he will withdraw Russian troops from the Crimean Peninsula, and by so doing obtain a partial lifting of the economic sanctions. In the apocalyptic scenario, the Russians can stop the export of natural gas to Europe .... if that happens, all of Europe will be headed in a very bad direction. A more moderate scenario sees the Russian government supporting the currency by buying rubles with help from the country’s foreign currency reserves.”
If the government provides funding to the banks that enabled them to roll over loans to the country’s biggest businesses, that might enable Putin to put a stop to the crisis, Licht says. “Putin is a strong leader who has never blinked first, and his decisiveness could resolve the crisis,” he believes.
Are there investment opportunities here?
“I don’t have one recommendation for all types of investors. An investor who can risk money, who is aware of the risk, and realizes that the level is one of the highest in recent years, can make a great deal of money. I would suggest everyone else steer clear of Russia.”
We’ve seen that institutional investors who were exposed to the Russian market via investment in companies controlled by Eliezer Fishman and Lev Leviev did not hedge against the currency. What does that say about their risk management?
“Some of their risk-management strategy involved diversifying their currency risk. The institutions’ ruble exposure is fairly limited, because they have spread their investments across developing and developed markets. That means they diversified their currency risk, which should provide a natural hedge for the investment portfolios.”
The Russian crisis will take its toll on other markets, Licht warns. “Russia isn’t functioning. It’s collapsing. Money is leaving,” he says. “The sharp decline in the price of oil will weaken the currencies of countries like Brazil and other emerging markets. As a result, money will leave emerging markets, and the dollar will grow stronger. The money that leaves will search for yields. Some of it will go to U.S. government bonds, despite the low yield. Some of it will look for countries on the border between developed and emerging markets, like Israel.”
Safe and secure
You think the Israeli stock market doesn’t face any serious security risks right now. Correct?
“Yes .... I think Iran is weak. In addition, the Saudis are on the Americans’ side; Hamas was weakened quite a bit because of Operation Protective Edge; and Syria is falling apart. Israel’s security situation is not a bad one. It would be a big mistake if the election focused on security instead of well-being and social justice. It’s not true that Israel is standing on the verge of a security abyss.”
Aren’t you being a bit too optimistic?
“No. In my opinion, the election will be good for the economy because it may set the foundation for a stable coalition, which the market likes. Still, there are threats.”
“The TA-25 Index rose by about 11% in 2014. The TA-75 index sank by 4%, and the Mid-Cap 50 by 8%. There have not been gaps like that between the indices anytime in the past decade. Teva Pharmaceuticals, Frutarom Industries and NICE Systems led the gains of the TA-25 index. In other words, the leaders were exporters, who will continue to do well in 2015. In the TA-100, there are 40 companies whose sales are mostly abroad, and their weight in the index is 40%. The risk is in the companies that are focused on the local market, particularly food, communications and banking.”
“It’s likely that the election will focus on the high cost of living, which could hurt those companies. Regulation of the communications industry will focus on landlines – which is Bezeq’s most profitable segment. Sales of the food companies will continue to decline in the near term because of the [social-justice] protests, competition and regulation – for example, the Food Law, which goes into effect in early 2015.
“The banks are going into 2015 with the overarching goal of becoming more efficient. Very painful moves must be made by the banks so that can happen. On the one hand, the banks’ shares are not expensive. They trade at just 70% of their book value. The banks should benefit from an influx of foreign investment into Israel. On the other hand, it’s hard for banks to be profitable when interest rates are low, so their focus will be on undertaking efficiency measures.”
Let’s start in reverse. Which sector should we avoid?
“There’s no industry that you should never invest in. But there are sectors where investing should be selective, such as food. In the food industry, we’re less optimistic about Rami Levi, Osem and Shufersal (aka Supersol), which have underperformed in the market. In the food industry, we recommend concentrating on the small companies, such as Neto.
“The gaps in telecommunications, for example, have only gotten bigger. To ensure competition, communications groups have to have equally strong ownership. In 2014, Bezeq moved far ahead of the others in the industry. Despite the measures that the Communications Ministry took, competition grew weaker. Regulators will have to focus on landline communications in 2015, so that competition will gradually reach the consumer’s home.”
What sectors do you recommend?
“The year 2015 will be interesting for natural gas stocks. [Antitrust Commissioner David] Gilo’s decision to void the agreement in which Delek and Noble were exempted from antitrust scrutiny has raised the level of uncertainty in the industry. If investing in companies that own the proven reserves was considered relatively safe so far, it now needs to be seen as much riskier.
“Another industry in which regulators changed the rules of the game is food. The year 2014 was a watershed for that industry. It included competition, price wars, leading players that turned into followers, and small players dictating new rules for the game – as well as new laws and reforms.
“In 2014, for the first time in a decade, sales in shekel terms fell ... The supermarket chains lowered prices and discounting was the fiercest in the food industry since the 2011 protests. The Food Law going into effect at the beginning of 2015 could hurt the corporate profits. Among other things, the law requires the supermarket chains to post online prices at all their stores, which will allow consumers to compare prices.
“If Shufersal and Mega can come up with a solution in the price arena, they may bring shoppers back to their stores. The smaller supermarket chains will work hard to justify their image as affordable places to shop. We may well see the first half of the year as a challenging time with eroding profits. We believe that in the second half the industry will begin showing signs of recovery, even if it does not reach its old level of profitability.”
Property at a crossroads
How do you feel about real estate companies?
“The real estate industry is at a crossroad. On the one hand, people fear a glut of commercial and office space, and a slowdown in consumer spending. On the other, low interest rates are reducing companies’ financing expenses and boosting demand for real estate shares from investors looking for better yields.
“A real estate company’s major goal is to create cash flow for the shareholders derived from the difference between the income created by its property portfolio and its financing costs. That differential is very large in Israel [compared] to what it is abroad, and it could grow larger still because of falling financing costs. So we predict a good year for the real estate companies. It’s not likely that real estate shares will show the phenomenal growth they did over the past year or two, but they are still a good investment in a low-interest environment.”
The plans for large-scale reforms in the communications industry ended with little, apart from Gilad Erdan creating the framework for wholesaling – that is, allowing independent operators to piggyback on established networks, creating more competition. What do you see happening in 2015?
“We see three significant changes in 2015 that could have an effect on competition in the landline segment. The first is the establishment of a wholesale market and the entry of Cellcom Israel and Partner Communications into the Internet and landline telephone industries. The second is that Cellcom will be rolling out multichannel television. The third is the ViaEuropa consortium’s building of its fast-Internet infrastructure. This is why we believe it’s a good idea to reduce exposure to Bezeq and in favor of the cellular companies.”
What about bank shares?
“We can see how pessimistic the market is about the bank by their share prices. The slowdown in the domestic economy, the interest rate environment and the continued uncertainty regarding the trend toward change in the Consumer Price Index, the risk that stems from the initiatives of ambitious Knesset members who believe they have a cure for the high cost of living in Israel – they all make it hard for the banks to show the same level of profitability and return on equity that they were accustomed to in the past, even though the economy and banks are coping fairly well with the challenges. At the current price levels, we prefer the small banks. First International Bank of Israel, Israel Discount Bank and Mizrahi-Tefahot are somewhat more attractive investments in relation to the risk.”
“The positive atmosphere in the global capital markets led quite a few Israeli companies to make initial public offerings. Unfortunately, they chose to list outside Israel this year, too, mainly on Nasdaq. We believe that as 2015 begins, the Israeli tech companies will do fairly well as they benefit from the weak shekel and the recovery in the U.S. economy. Still, we recommend those who like tech shares to look overseas, where the number of opportunities is huge.”