Argentina is mainly known as a nation being in perpetual crisis mode. Besides beef, wine and tango, among the first thoughts that likely come to one’s mind are debt, economic hardship and hyperinflation. Needless to say that in such an environment you won’t find a booming economy. However, many Argentine stocks or those with a vast exposure to this market, have been rising over the last months. Is a (massive) turnaround in sight?
Summary and key takeaways from today’s Weekly
– There’s a fairly good chance that Argentina experiences a massive shift from left to market friendly with the next elections.
– Only the perception of a change from bad to less bad can be enough to ignite a fire.
– YPF seems to be an obvious choice, but I pass on this one. I think, I found a better stock.
The core of this Weekly spins around the soon to be held primary and then presidential elections (in August and October / November) in Argentina.
An event-driven investment opportunity, if you want to put it this way. But you should look BEFORE the event hits (or not) and not wait until it materializes.
That’s what we are going to do today.
As it seems, there is likely not going to be just “another round of elections”, only confirming the status quo. What’s on the table this time isn’t a continuation of decades of evil mismanagement and running the economy head-first against a hard wall, wondering where the headache comes from.
It seems that a massive political shift is coming in Argentina.
(though, it will be interesting to see whether the people voted “hard enough”, after the results will be published…).
After the visibly failed socialist experiments of the past and the ever more tasting of the same medicine that does not want to work (and taste), finally the people seem to be fed up with the promises of la la land and paradise on earth.
The reality is simply different.
I am not the first to write about this topic.
Also, not about the opportunity to at least have a look at Argentine stocks. Many of them seem to have hit their bottom already late last year, only to turn into overdrive mode and multiply (!). I wanted to show you my perspective and summarize the key facts and figures to point out this potentially interesting investment opportunity.
If certain things materialize – the chances are there – then a structural shift could come, possible leading to a boom in Argentina’s economy and the related stocks.
This is especially interesting, as there are many stocks listed on the NYSE in the USA.
After telling you what you need to know from a bird’s eye view, I am checking YPF (ISIN: US9842451000, Ticker: YPF), the biggest public Argentine company by market cap and sales – and for many likely the prime target when it is about buying “something in Argentina”. However, it did not make it into my next research report for several reasons.
My members know that I am demanding, looking for high quality.
Next Saturday, 29 July 2023, my Premium PLUS members will receive my next exclusive research report about a company offering a pure-play investment opportunity in a strategically important sector for Argentina. The recent developments are simply too important to be ignored and likely life-changing for Argentina, i.e. there’s lots of money to be made.
And yes, the valuation of this founder-led business is still dirt-cheap.
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Is Argentina (finally) turning around?
What you should absolutely know is that Argentina has had many changing government regimes in its history. I am not referring to simple changes from one party or political group to another, both more or less doing the same.
(if you’re interested in more than I sum up today, just click here)
Argentina had it all, even if it is tough to believe today: conservative, radical, military dictatorship and socialism.
The latter, also known as “Perón” or “Peronism” is key and what you typically know as having its origins in an entanglement of some sort of a labor party, unionized groups, social protests, “unfairness”, state welfare, controlled prices, extra taxes, left-leaning views and promises as well as – of course – the megalomania of pretending to know how to centrally steer an economy with interventions.
To be fair, this “philosophy” is not limited to South American countries.
The Perón movement started secretly during and openly shortly after the end of WWII with Juan Perón campaigning for presidency. He won and first the post-war economy of neutral Argentina went well, until it experienced high inflation that made imports more expensive, decreasing the standard of living.
In 1955, Perón was ousted by the military which took over until 1973.
The anti-Perón movement dissolved Perón’s labor party and focussed on bringing back dried up foreign investments (sounds familiar?). Argentina for decades had a strong relationship with Britain which was its biggest investor already prior to WWII.
Britain’s capital helped building Argentina’s infrastructure while Argentina had a strong market it could export different goods to.
However, the country did not come to a rest as economic challenges proved to be permanent. It experienced riots, the killing of a former president, inflation and currency devaluations along the way.
In 1973 a Peronist coalition came to power, again. Perón’s economic policies included price controls and dictated wages to limit the profits of agrarian exporters.
Everyone able to count his or her fingers should know just by pure logic that any sort of limitation always first decreases supply and then leads to higher prices, often also fueling black markets. Exactly those prices that should be limited. If it gets extreme, supply dries up completely.
But this is something that socialists either don’t know or ignore maliciously only to blame someone else, then.
This graph above is somewhat confusing. The first 30 years until the 70s look quite calm, but please have a deeper look at the axis on the right. It is only due to the explosion in the early 1990s. I even had to cut this chart, otherwise the first 5o years would have looked completely flat.
In 1976, the military took over again, after a massive currency devaluation and inflation of several hundred percent (this should sound familiar, too, see the chart above for the massive first spike).
From 1983 to 1989, the radical party took over. After implementing a new currency, the Austral (keep this in mind), devaluations, price controls, etc. first allowed to bring down inflation somewhat and restructure foreign debt (restructure, not pay down!).
But it didn’t last for long as the second huge inflationary wave hit the struggling country, until in 1989 again the Peróns took over – with promises to take care of the working class, however, with a moderate and more free market approach as it seemed. Initially, the problems of a crumbling economy persisted, but in 1991 and a new economy minister, a stabilization finally came.
The inflation at the height rose to more than 20,000%, according to Trading Economics. This is 15x higher compared to where the chart above and 150x where the chart below ends.
Again, a new currency was put in place – this time the Argentine Peso that is still around today. You see that inflation for a few years really came down, even dancing around zero.
The peso initially was pegged (fixed) 1–1 to the USD.
Inflation fell to a nearly 20-year low and many state-owned enterprises were privatized. The economy appeared to have stabilized, however, debt was high. What came were an overvalued currency due to the peg, first a milder than a severe recession, fiscal deficits and in 2001 the default on foreign debt.
From 2003 on the Kirchner’s (from the Perón camp) took over.
First Néstor Kirchner, then in 2007 his wife for two four-year terms. They pushed left-leaning policies with the known issues as a result. Argentina’s economy was continuously plagued by one the world’s highest inflation rates and more and more state intervention.
Needless to mention what the currency did over the last more than 20 years, although the government for a long tome refused to face the truth and let the currency float freely. This was allowed only after the government change in late 2015 – that’s where the USD / ARS took off (in a negative sense).
Nearly a 300-bagger. A massive devaluation.
The following years after the Kirchner’s are quickly summed up.
First, a new rather liberal president, Mauricio Macri, came to power, bringing big expectations for a change. After his win was announced, Argentine stocks rallied heavily. Among others, he lifted price and capital controls, cut subventions and let the currency float freely to seek its market price.
But this was to be a short joy, before reality set in again. He was blocked in the Kirchner-led parliament on many fronts, leaving him with dull weapons and the initial relief prompted to only be relatively short-lived.
Hopes for a sustainable change vanished. Stocks dived again.
But please notice the following as this pattern could repeat again, soon. In the fall of 2015, presidential elections took place and market friendly Macri took office in late 2015 until late 2019 when a Peronian came to power again.
For a better illustration of what I want you to understand: The first chart in light blue is the Merval, i.e. the Argentine main index in Argentine pesos. Below in dark blue is the Merval, expressed in USD which I created by dividing the Merval in pesos by the official exchange rate of USD / ARS (last yellow chart).
You see that after the victory of the liberal Macri, a phenomenal bull market set in even in USD, despite a heavily depreciating currency. The Merval index more or less tripled until 2018.
This means that capital was flowing into the country, lifting equity values.
After it was clear that Macri’s hands were tied, hope started to vanish and capital fled again. The peso’s depreciation accelerated meaningfully and the Merval dropped to even lower levels than where it came from – measured in USD.
Since 2019, the Kirchner-backed socialist Fernandez is president. Especially since then, the economy went into a waterfall – you know, the same medicine…. The peso massively lost by some 75% (4x the pesos needed for one USD).
It is important to measure such developments in a strong currency as gains in pesos are nice, but useless when converted back to USD or EUR.
And this where we are today.
You can see below on the full chart until today, 27 July 2023, that the low in USD was already in 2020. Since then the Argentine market has had a bull run. It currently is only slightly below the “Macri-high”.
The bottom seems to be in – I think this is safe to say.
Is the party now over or close to? Unlikely, because a real bull market ends when everyone is in. But as the currency is depreciating this cannot be said. Only if the market rises WITH the currency, i.e. an appreciating peso, I would become defensive.
Think of Japan in the 1980s. The Nikkei rose together with the yen as the world outside of Japan wanted to be part of the bull market and subsequent bubble.
It cannot be said that everyone is already sucked into Argentina, far from it.
Should what I write below come to fruition, then there should be more to come.
In mid August, i.e. in c. two weeks from when I publish this weekly, the next primary elections will be held. Then in October the first round of the presidential election will take place. If no candidate achieves 45%, then there’ll be a face-off in November between the two with the best results.
So far, so good. Now comes the interesting stuff.
Remember when I wrote a few lines above that Macri was a market friendly guy and the hope for a turn-around plus some market friendly measures propelled stocks – measured by the broad market index – up 3x in USD?
As hedge fund manager Kuppy described the whole situation in an own blog post, here’s only my summary (see here, if you’re interested in this Argentina situation, please take the 5 mins to read it):
The candidates this time are: hardcore-radical free market, still-heavy free market and a Macri-type, centre-liberal guy. And as forth, a Peronist. This means that on an equal basis (as they like “equality”), 75% of the candidates are either Macri-style or more extreme towards free markets.
And all have good chances!
Notice that the socialists seem to have finally lost confidence in big parts of society? The current president won’t run again. More and more people seem to be fed up with the economic misery, especially of the last decade.
The majority are non-socialists. Why is this important?
If you have a situation that is so dire it can hardly get worse (and it is worse than 2015), just a glimmer of hope and some positive news are enough to turn it from worst to worse. Only this seemingly minor shift can be enough for a dramatically change that is good enough for some multi-baggers.
It does not have to become superb.
It is not only a hedge fund manager like Kuppy who expresses his desire for a quick buck with his post. This is also what I read from other sources and what younger people wrote on Twitter.
This is insofar interesting and strange at the same time, as usually young people tend to be more socialistic as they don’t understand the consequences and are more easily brain-washable by “equality” or “fairness” slogans of leftist politicians.
It is rather the more experienced and elderly that turn conservative as they see what the left create (or destroy).
The Economist is also making such a headline:
The currently leading candidate, Javier Milei, wants to completely turn around Argentina. By the way, so wants the second-placed female candidate Bullrich, however, at a lower pace.
But there are many ideas pointing in the same direction.
Besides many subsidy cuts, Milei want to abolish capital and price controls, privatize unprofitable state-owned enterprises and especially the heavyweight YPF (though it seems to have got the corner, I’ll discuss it in the next section), privatize the healthcare system, abolish the central bank and dollarize the economy.
The last point means that the USD would be the official currency in Argentina.
For example, Ecuador after a massive crisis also adopted the USD as its national currency in 2000. Other smaller countries like Panama, El Salvador or Costa Rica also frequently use the USD. I am not sure as to whether this is possible to implement so easily and whether it is needed anyhow.
What I am sure is that the country needs external confidence and capital.
Chances are good that this happens as three of the four main candidates have the potential to bring back the trust. Here is a current poll simulation as to who could win in several different scenarios (see here).
Keep this in mind. It only needs to get from worst to worse to ignite a fire.
Argentina seems to be doing a 180-degree turnaround.
This is what Argentine stocks seem to slowly price in. Despite some of them having gone up by 3x, 5x or even 10x from their bottoms late last years, the valuations are still ridiculous – ridiculously low, to be more precise. And don’t forget that doing business is still aggravated due to different limitations.
An opening up of the Argentine economy would completely enable new economic activity that currently is not possible. I don’t know whether it happens or how it would be applied. But at this stage it could be enough that the perception will be that Argentina is going to turn around. From bad to less bad.
By the way, Argentina has vast amounts of many strategically important commodities. Did you know that Argentina has the world’s second highest lithium resources (c. 20%), only slightly behind Bolivia?
But there’s also and maybe even a higher potential in the oil and gas sector.
With this, let’s turn to YPF – Argentina’s biggest company by sales and market cap.
YPF as an obvious choice to play the recovery…
I personally think that Argentina’s oil and gas sector will be in a huge bull market for years to come – in the case the above applies. Yes, even if oil prices don’t move much (which I don’t think will happen). This has the potential to turn Argentina into an energy net exporter again, instead of having to import LNG expensively.
The country has everything it needs: own refineries, pipelines to neighboring countries (either there or being built) and access to the Atlantic Ocean.
As Argentina has a better debt to GDP ratio than the US, the UK and most countries of the EU, I think chances are good that it can meaningfully delever during this decade through turning to an energy powerhouse by exporting oil, gas (LNG) and lithium – besides already being a food exporter.
First, I warted to write my research report about YPF, the national energy company as it is so much hated.
By the way, this is also Kuppy’s biggest bet, according to his article. One can argue that if the perception comes up that there’s much to gain in Argentine stocks, then many will buy the household names and blue chips, i.e. among others YPF.
But after I did my analysis, I didn’t feel comfortable enough.
Sure, with the argumentation above, this could be an understandable bet. However, I didn’t want to present my members just a bet, but a strong business that passes my strict quality filter.
Here’s my analysis of YPF and later I explain why it didn’t make it into my next report.
In short, YPF the 51%-state-owned enterprise is the countries biggest company by sales and market cap. It has been listed on the NYSE already for around 30 years. In between it was bought and majority-owned by Repsol (ISIN: ES0173516115, Ticker: REP), the Spanish energy company.
However, in 2012 the Argentine government under Ms. Kirchner decided to re-nationalize YPF again. It “acquired” 51% of the company and gave itself a majority.
This move was self-explanatory against laws, as it was an expropriation without adequate compensation and a full takeover offer would have had to be made which didn’t happen. This issue is still in courts with results expected soon.
What is clear up until here is that the state of Argentina will have to pay a compensation and that YPF itself is free of any guilt.
As to the business, the future plans are built on three pillars, namely to massively increase operations in the Vaca Muerta (dead cow) field – the world’s second best shale energy (mainly oil) field, after the Permian Basin in the US.
It is located in the West of the country and still massively underdeveloped, but key to the whole story of making Argentina an energy net exporter.
YPF owns around half of Vaca Muerta.
It is also building pipelines in order to be able to export its shale oil to neighboring countries like Bolivia or Chile.
Next come gas exports, as LNG plants are also being constructed, with a likely finish around 2026 / 2027. Later on, YPF also wants to take part in the export of hydrogen, lithium and other resources, but let’s leave it with that. It also has a big equity stake in “renewable” energy operations.
You see, it is THE energy company of Argentina.
Despite all the trouble in the country itself, recently YPF managed to achieve a multi-year high in production and operating results, here adj. EBITDA. Operating cash flow was also strong.
You will likely also notice that investments / CAPEX have risen to multi-year highs – there is definitely more to come. Management expects to keep investments high in order to increase production and thus sales while simultaneously building out the infrastructure.
Plus, debt was decreased meaningfully – but the company was short to bankruptcy in 2020. And during the next years rather not small sums will have to be refinanced.
This is more or less the basic story.
An already slowly turning company should benefit enormously in the case of a more open economy and a foreign capital influx. It is not only the urgently needed capital, but also access to better technology to increase efficiencies and develop the field quicker.
The current 5 year plan of the company foresees a doubling of total oil production (shale even 4x) and an increase of 30% in gas production. With time, exports shall increase after the local market is supplied.
However, at least until 2025 there’ll be no free cash flow.
Yes, they are investing for the future. But why pick a company without free cash flow when there are so many other, better choices? I prefer safety here.
On the next chart, you can see a longer term overview of oil and gas production in Argentina. It shows that both are below the highs of 20–25 years ago.
However, both are also rising. The lows seem in place.
It is expected that – even under the current government (!) – production shall increase to new highs over the next three years.
Imagine what could happen under a market friendly government…
The current valuation also looks interesting, leaving enough room for a big upside (despite the stock being up 5x since the low last year) with a
- price to book value of around 0.6x (you need to value the “hard assets”)
- an expected PE of 4x
- an expected double of operations and thus hopefully business results
I also like that YPF changed its accounting currency to USD last year.
However, this is a bit to short-sighted, plus I’m having several other problems with this case, despite the overall background story sounding really great:
- due to the massive investments there is no free cash flow left currently
- it is also hard to tell when and how much free cash flow can be expected in the future, despite the 2025 goal; investments can become more expensive and a slightly above zero number would not appease me
- no dividends or even buybacks – especially the latter would make sense at such still low levels, but there’s not enough cash flow
- the debt load is still too high for me – despite the reduction
- the debt load brings other problems, as Argentine companies are currently forced to keep a certain amounts of local debt and constantly need to refinance / roll it over
- although management said that YPF is financed for this year, the next round is already around the corner
- it is still a state-owned enterprise – not efficient and with a constantly changing management
- YPF is forced to first supply the local market – however, at currently state-dictated and limited prices – the majority goes local first
- YPF has a legacy conventional energy business which has higher production costs, but still needs investments
- all in all, it is a too big and fat organization for me
As said above, I can totally understand if one plays this potential Argentina revival via YPF as the biggest company. Its stock likely would increase.
But I am investing first and foremost based on fundamentals and in businesses, not lottery tickets. That’s why I am passing on this one.
However, I wanted to mention that it could be worth it to think about some bonds of YPF, if the goal is cash flow for your investment. The only thing to be sure about is whether YPF survives.
There’s a USD-bond with an 8.5% coupon, trading around 95%, due in July 2025.
Unfortunately, the price has risen over the last weeks. Assuming you buy the bond for 95%, the yearly return would be 11% – not unattractive. The ISIN is USP989MJBE04. But check liquidity!
No recommendation, just a mention.
It could also make sense – due to the volatile nature of Argentina and especially volatility to be expected around the election rounds – to pick up some bonds, should they come under pressure, assuming that the business of YPF does well (in any case, check it!). For example, still in May this year, this particular bond traded around 80%!
In the energy sector – besides the offshore energy revival I wrote about a month ago – I find the Vaca Muerta story fascinating.
This is the second sub-sector where I see a big chance for a year-long bull market, because many companies operating in the Vaca Muerta field are massively growing.
I researched and found another company that checks my required boxes. It is the topic of my latest research report, exclusively for my Premium PLUS Members.
There’s a fairly good chance that Argentina experiences a massive shift from left to market friendly with the next elections.
Only the perception of a change from bad to less bad can be enough to ignite a fire.
YPF seems to be an obvious choice, but I pass on this one. I think, I found a better stock.
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