“Can You Get Hurt Jumping Out Of A Basement Window?”Guest Post
An Interview With Richard Rooney:
Burgundy’s investing approach takes time and patience. And, perhaps most importantly, it takes some original thinking, intensive research, and a willingness to go anywhere in search of high-quality companies trading at reasonable prices. A case study that demonstrates how this approach has worked to our advantage can be found in Burgundy’s entry into Japan. Our first trip to Japan occurred in 1998. Back then, there was little for investors to get excited about with a poorly regulated financial system and management teams with inefficient capital allocation and corporate governance practices. It was truly a neglected market. But we saw value. We wrote about this trip and presented our initial case for investment in a View from Burgundy called “The Sun Also Rises.” It was a research trip that ultimately generated very healthy returns for our clients.
Ten years ago, the collapse of Lehman Brothers signaled the magnitude of the financial crisis. Global markets have staged a significant rebound since the depths of that crisis with the MSCI World Index up almost 180% in Canadian dollars. While it has been a great period for investors in almost all regions, there is a market that remains down about 90% from its peak: Greece.1 It would be easy to rationalize investor disinterest in Greece, considering the ongoing economic, political, and social challenges in the country. But as value managers, we are used to questioning the consensus and doing research on businesses that others have neglected. In June of this year, Richard Rooney, President and CIO, and Anne Mette de Place Filippini, Deputy CIO and Portfolio Manager of Burgundy’s Emerging Markets strategy, did just that. Over five days in Greece, they met with the management teams of 15 companies and several former senior government officials. To discover what they learned, my colleague, Elizabeth Andrews, and I sat down with Richard Rooney for a conversation.
Q: When most people think of Greece, they think of a beautiful vacation paradise with delicious Mediterranean cuisine. What do you think of first when you think of Greece?
A: I probably think about the same kinds of things. Herodotus, the famous Greek historian, said that every society has its peculiar genius. He said for the Persians it was government, for the Egyptians it was mathematics, and he said for the Greeks it was their weather, which I thought was a modest claim considering their legacy. It is incredibly moving to be sitting in your hotel, looking across Athens and seeing the Acropolis. It really is so basic to your idea of our whole civilization. And the weather, they’re not exaggerating, it’s spectacular.
Q: What were your preconceptions from an investment perspective?
A: This was a “Can you get hurt jumping out of a basement window?” kind of idea. It’s difficult to overstate how awful things have been in Greece over the last decade. The extent of the deflationary adjustment the Greek economy has faced is about 20% or 30% more than the American society faced during the Great Depression. It’s been the most brutal deflation in the history of deflations. And, of course, a stock market that is off 90% kind of catches your eye. It just seemed that it would be worth checking into.
We are value and quality people. We knew there was value there. We just didn’t know if there was quality. That’s what we were going to find out. If there are management teams that have managed to maneuver their way through this god-awful situation with a degree of competence, if there are businesses that have survived, then presumably they are inherently strong.
Q: A lot has happened in Greece over the past decade. Could you summarize this period?
A: It’s been a period of almost uninterrupted misery for Greece: sky-high unemployment, underemployment, political upsets, and scandals. You can see why a lot of Greek citizens might think the whole system is rigged against them. In order to get into the European Union, the government of the day lied through its teeth about what Greece’s finances were like.2 In 2009, they announced the budget deficit was actually three times larger than previously claimed. It was 15% of GDP. You’ve got a lot of desperate people. There is a huge youth emigration. Anyone with any prospects has left. That kind of backdrop is peculiarly toxic.
It’s very sad and disturbing in a lot of ways that such a lovely place with such great people should have undergone so much pain, and you’re not really sure what for. Essentially, the government borrowed vast amounts of money, the upper class stole it and put it in Switzerland, and everything collapsed. They still have almost 180% of GDP in government debt. The economy is 27% smaller than it was in 2008. The Syriza government, a left-wing government, has been reducing pensions by as much as 50%. This is a traumatized country.
In terms of the financial system, the Greek banks are in dire condition. There were 30 banks in 2008. There are four today. The system’s not really functioning. You don’t make new loans when the old ones are all bad. We are talking about 40%-50% of the loans on the bank balance sheet being non-performing. Nobody’s paying interest or principal on them. As we saw with Japan, which was in the same position in the 1990s, it’s extremely hard for an economy to extricate itself from this deflationary spiral if nobody’s lending. It’s a vicious cycle, one that Greece has been in for a long, long time.
Being part of the EU and, therefore, in a currency union, has been Greece’s curse. If they still had the drachma, they would have defaulted on their debts – something they’ve done five times since independence. In that situation, the economy would collapse; the debts would all be written off; the drachma would collapse; and therefore, Greece would become competitive and would not have deflated away.
Q: What did you find during your trip?
A: The bullish story is employment. The unemployment rate has started to fall as the labour market has priced itself into jobs. If a government were able to make some sensible labour-market reforms then that would help. It would get the system starting to flow. As people start getting jobs, they start spending.
There is also a replacement story. We went to see the Ikea distributor in Greece. In a normal developed economy, expenditures on furniture and household goods run to about 1.5-2% of GDP. In Greece, they’ve been running at 0.4% of GDP for about 10 years. There were 6,000 housing starts in the entire country last year.3 Cement consumption in Greece is at one third of its 50-year average. You really can’t go a lot lower. At some point, things will need to be replaced and people will be needed. Eventually, things will normalize. It’s kind of a mean reversion story.
One of the reasons the debt at 180% of GDP looks so awful is because it’s on a denominator that’s down 27% from 10 years ago. You can do the math. If they can get the economy back to where it was 10 years ago, then that number comes to around 130% and perhaps that starts looking sustainable. Maybe you start attracting back your youth. Greeks are a pretty patriotic bunch. They want to go back.
Q: You said you knew there was value in Greece but weren’t sure about the quality. Did you find quality?
A: To have survived and perhaps done a little better in a deflation like this is probably an indication that management are pretty good capital allocators. We found a couple of good companies that were export-oriented, as you might expect.
One of the better companies we saw was Fourlis Holding, which was the Ikea distributor. In a country like Greece, businesses like to operate through a local family that knows the score. In 2008, Fourlis had two locations selling €200mn worth of product. Today they have five locations and 15 distribution centers, selling about €250mn worth of product, all while household expenditures remain at depressed levels.
Another highlight was Jumbo S.A., a low-end, family-oriented retailer that has grown their store count and their revenues during this time. They’ve done very well in Romania and Bulgaria. They seem to really have their act together.
The good companies tend to be family owned. A lot of the issues with emerging markets are around legitimacy of governments. You aren’t necessarily protected by the rule of law. If the family controls the business, it presumably reduces your agency risk.4 The family is not going to do something stupid that risks the business over the long term. They’re also going to have the relationships that are required to function in those markets. That’s pretty common in any emerging market and it’s certainly the way Greece works – very much an insider network.
Q: What’s next for Burgundy in Greece?
A: It was an enlightening trip. There are challenges left, and they are probably ones that the prime minister isn’t going to be in a position to answer. Greece is not at safe harbour yet.
There were some good businesses there. It was difficult to come up with the idea that you could take a big ownership position in any one of them. I think Anne Mette and I both came away thinking a small basket of them might be an interesting way to approach it. I guess that’s a way of saying Greece companies appear to offer more value than quality. If you’re buying value, you want to get diversification if you can.
We take pride in our willingness to go anywhere in search of quality assets that have been neglected by the market. But as value investors, we can be too early. And perhaps that is the case today with Greece. But as was noted by Richard in 1998 after his return from Japan, it is often darkest before dawn.
Value appears when things look bleak. It is the prospect of improvement that ultimately drives equity markets and generates better returns. With business activity and spending at such depressed levels in Greece today, it wouldn’t take much to get their economy going again. We will be patiently watching.
- FTSE/Athens Large Cap Index
- Countries were required to comply with the 1992 Maastricht Treaty guidelines in order to be accepted into the European Union. The treaty limited government deficits to 3% of GDP and public debt to 60% of GDP.
- For comparison, Canada’s population is about 3.3x larger than Greece. Housing starts in 2018 are projected to be ~200,000 in Canada, or over 33x higher than Greece.
- Agency risk can occur in investing when the goals of management are not properly aligned with those of shareholders.
Article by Rachel Davies, Burgundy Asset Management