A Lethal Cocktail
By Don Quijones, Spain & Mexico, editor at WOLF STREET.
After years of uninterrupted domination, the old guard at Spain’s Ibex 35 stock index – two mega-banks Banco Santander and BBVA, oil giant Repsol, telecommunications behemoth Telefonica, and utility Iberdrola – is beginning to lose it.
Today the big-five’s combined capitalization represents 45% of the ibex 35’s total capitalization. This may seem like a ridiculously high percentage for five companies compared to most other stock markets, but it is actually its lowest share in decades. Over the last 15 years, the big five’s combined share has averaged 60% and at times even reached as high as 65%.
There are many reasons for this change, including the rise of relative newcomers. Of particular note is the spectacular growth of Spain’s clothing giant Inditex, whose brands include the world’s biggest fashion retailer, Zara, and whose owner, Amancio Ortega, is now the world’s second richest man. Inditex has a market capitalization of €92.7 billion, compared to Santander’s €59.5 billion!
The other main reason for the big five’s shrinking market share is their sinking share prices. Telefonicá and BBVA’s shares are at their lowest point since 2013. Santander’s shares, which have suffered the debilitating effects of countless capital expansions, haven’t been this low since 2012. As for Repsol, the last time its shares plumbed their current depths was in the 1990s. The only member of the big five to escape this rout is Iberdrola.
One thing that all of these companies have in common is their massive exposure to emerging markets — in particular Latin America, whose commodity-rich economies are now suffering the fallout from dwindling Chinese demand. In the aftermath of Spain’s real estate collapse, when opportunities at home were almost non-existent, Latin America’s fast-growing economies were a godsend to many of Spain’s biggest companies. But they are fast becoming a curse.
The profit forecast for 2016 and 2017 for firms listed on Latin America’s four biggest stock markets — Brazil’s Bovespa, Mexico’s IPC, Argentina’s Merval and Chile’s IPSA — had dropped 26% from the previous estimate. By far the worst pain is being felt in Latin America’s biggest economy, Brazil, which is facing its deepest and longest recession in decades.
Brazil’s enduring travails could be particularly bad news for Spain’s biggest bank, Santander, for which the Latin American economy was once the biggest source of profits but in October was relegated to second place behind the UK. That said, Brazil’s contribution to Santander’s profits (19%) still dwarfs that of Spain (13%). And instead of reducing its exposure to Brazil’s increasingly fragile economy, Santander recently doubled down on its bet, forking out €4.7 billion on the acquisition of the remaining 25% of its Brazilian unit [read: Is Brazil About to Drag Down Spain’s Biggest Bank?].
For Telefonica, meanwhile, Brazil provides (or provided) 23% of its gross earnings. Respol is also deeply involved in Brazil, with operations in the Campos basin. It was among a number of firms to discover deep offshore deposits in Sapinhoá last year. To drill there, however, the company has a break-even price of $50 per barrel, $16 above the current price of Brent crude. And that’s after divesting €6 billion of its assets.
Iberdrola also has its share of Brazilian headaches, most notably the Belo Monte hydroelectric mega-project. Its partners in the project include the Spanish company Abengoa, which is on the verge of becoming Spain’s biggest ever corporate insolvency and stopped paying its invoices in Mexico and Brazil weeks ago, leaving Iberdrola (and hundreds of other companies) high and dry.
The emerging market risks of Spain’s second biggest bank, BBVA, lie elsewhere — primarily in Turkey and Mexico. In the case of Turkey, a country that is undergoing social, political and economic upheaval, BBVA began its operations there in 2011 when it spent €5 billion to acquire 25% of the country’s biggest listed lender, Turkiye Garanti Bankasi AS (GARAN), from the Turkish group Dogus and General Electric.
Since then, the Turkish Lira has lost close to 50% of its value. That didn’t stop BBVA from forking out an additional €1.99 billion in July 2015 to acquire an extra 15% of Garanti — just when fear over emerging market risks and Turkish political instability was reaching fever pitch!
BBVA’s other key emerging market, Mexico, has been its biggest source of profits for well over a year now. The country’s macro conditions are significantly more favorable than Brazil’s or Turkey’s, especially given its much smaller exposure to the Chinese economy. But enormous risks still persist. U.S.-denominated corporate debt in Mexico is at its highest point ever, while the Mexican peso is at its lowest point ever against the dollar, making it very difficult to service this debt. Meanwhile, falling oil prices are creating huge fiscal pressures for a government long-accustomed to living off tax revenues provided by the country’s formerly publicly owned but now semi-privatized oil company, Pemex.
This week saw the price of Mexican oil plumb new depths while the peso suffered its worst opening week of the year since 1995, the year of Mexico’s Tequila Crisis, a long-forgotten event that at one point almost put paid to some of Wall Street’s biggest investment banks. They were eventually bailed out indirectly by the U.S. Treasury, the IMF, and the Bank of International Settlements.
Whether a similar fate could await some of Spain’s biggest banks and corporations today, it’s too early to say. What is clear, however, is that the global economy is far more interconnected and interdependent now than it was in 1995. It is also swimming — drowning? — in a much larger sea of debt. As such, the risk of contagion is significantly larger.
And with at least half of Spain’s corporate sector dependent for a large chunk of its revenues and profits on markets that face a very dangerous cocktail of economic conditions, Spanish investors would be well advised to pay close attention to what happens across the pond. By Don Quijones, Raging Bull-Shit.
After weeks of false promises, rampant speculation, and furious denials, Mexico’s biggest construction company, ICA, finally admitted that it will not pay the interest outstanding on $700 million of bonds. The company’s shares plunged 24% on the news. Read… Dollar-Debt Blows up in Mexico, Pushes Biggest Construction Firm toward Abyss