Colombia: a frontier market that might surprise?

Colombia: a frontier market that might surprise?
12:12 p.m. 02/08/2008 By Polya Lesova Provided by MarketWatch

Analysts say lifting of capital controls could provide bounce market needs
NEW YORK (MarketWatch) -- Colombia, a country scarred by violent conflict and the drug trade, could present a nice surprise for foreign equity investors searching for untapped value this year, say analysts who are watching the region.

Colombia is one of Latin America's frontier markets, meaning it is smaller, more undeveloped and riskier even by emerging markets standards. Compared with other countries in the region, Colombia receives only a trickle of foreign investment flows.

From July through December last year, for example, fund flows were positive during five of the six months, according to fund tracker EPFR Global. During the best month, inflows totaled $34 million, while during the worst month outflows were $15 million. In comparison, regional neighbors, like Brazil, receive hundreds of millions of dollars of foreign inflows.

"Sentiment hasn't collapsed, but it has definitely gone on hold," said Cameron Brandt, global markets analysts at EPFR Global.

Colombia "could take another leap forward," Brandt said. "But at the moment why invest more in a country that has capital controls and is somewhat stalled on the reforms and free trade front and is at loggerheads with Venezuela, an important trading partner?"

In May 2007, as the appreciation of the Colombian currency put pressure on some exports, the government imposed a 40% non-remunerated, six-month deposit requirement on all short-term foreign inflows, denting investor sentiment. On the trade front, the U.S. Congress still has not ratified a bilateral free-trade deal signed in 2006. Another potential risk is the diplomatic spat between Colombian President Alvaro Uribe, a staunch U.S. ally, and Venezuelan President Hugo Chavez, a vocal critic of America.

Emerging markets around the world had a rough January and Colombia was no exception. The MSCI Colombia index is down 11% year-to-date, roughly equal to the 11.3% drop of the MSCI Emerging Markets index. The MSCI EM Latin America index is down only 8%.

Some analysts, however, are cautious optimists about Colombia.

Ben Laidler, a strategist at JPMorgan Chase, believes that Colombian equities "could positively surprise" this year. Key catalysts for that would be the lifting of capital controls, as well as strong economic growth, attractive stock valuations, the low level of foreign participation in the equity market and the recent listing of state oil company Ecopetrol, Laidler said in a research note dated Tuesday.

"The fundamental backdrop has improved significantly in recent years, driven by a dramatic turnaround in the country's security situation and the center-right reformist presidency of Alvaro Uribe, the most popular major leader in the region," Laidler said.

"Whilst the reform agenda is ongoing and fiscal and current account challenges remain, Colombia has reduced its external vulnerabilities and is on track to regain its investment grade status," Laidler said.

Colombia has the smallest free-float market capitalization in the MSCI Latin America index with only $9.6 billion and the smallest weight with only 1.4% of the regional index. The market capitalization of the local benchmark stock index, the IGBC General Index, is about $47 billion. The market's average daily volume is about $113 million.

With a population of over 44 million, Colombia is the fourth largest country in South America. Its recent history has been marred by years of brutal conflict involving rebel factions, illegal paramilitary groups and drug cartels. Kidnapping and drug-related crime are widespread. The gap between the rich and the poor in Colombia is one of the biggest in Latin America, with the top one-fifth of the population retaining 60% of the national income, according to the World Bank.

President Uribe, who is serving his second term, is credited with making progress on disarming guerilla groups and restoring public order, as well as boosting economic growth. Colombia's economy grew by about 7% last year and is expected to grow by 5.5% this year. Its top three exports are oil, coffee and coal; other exports include nickel, emeralds, apparel, bananas and cut flowers.

Geoffrey Dennis, an equity strategist at Citigroup, initiated coverage of Colombian equities this week with an underweight recommendation.

Capital controls are a major negative for the performance of the local equity market, but their removal could catalyze equities to outperform, Dennis said. Also hurting the local market are rising fiscal and current account deficits, and unattractive equity valuations, he said.

On the positive side, its large population, rapid economic growth and privatizations make Colombia one of the fastest growing equity markets among global emerging markets, according to Citigroup.

"We do not expect the Colombian equity market to outperform the region in the near term, except in the event of the removal of the recently imposed capital controls," Dennis said.

"Once capital controls are lifted, we would focus on growth stocks, such as beneficiaries of infrastructure spending." An example is cement producer Cementos Argos.

Ways to play Colombia
As in any frontier markets, liquidity is an issue in Colombia, though Laidler of JPMorgan Chase offers some ideas about how to play the market. The three biggest and most liquid stocks are Bancolombia (CIB), the country's largest bank and Colombia's only level three ADR, as well as Ecopetrol and Suramericana, a conglomerate with stakes in the insurance, social security, finance, cement, food, retail and textile sectors.

While liquidity of companies listed only in Colombia is limited, Laidler highlighted six stocks that can be bought without entering the local market by going through the U.S. or Canada. Those are Bancolombia; Petrominerales, an oil and gas exploration and production company which is also listed in Canada; Exito (ALAXL), the largest retailer; oil and gas company Pacific Rubiales Energy Corp. ; oil and natural gas company Solana Resources and coal miner Coalcorp. Mining .

Laidler also pointed to several major companies that have significant Colombian exposure, including his top pick to play the market -- Panama-based airline operator Copa Holdings SA (CPA) . Copa owns Colombia's number two domestic carrier AeroRepublica.

Other stocks with meaningful exposure to Colombia are brewer SAB Miller, which bought Colombia's Bavaria, the second largest brewer in South America; Chilean energy firm Endesa (ELEYY) and utility holding firm Enersis (ENI) ; Mexican companies Femsa (FMX), America Movil (AMX), Cemex (CX) and emerging markets mobile company Millicom (MICC) .
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Lifting of Colombian Capital Rules Would Boost Stocks: Analysts

By Fabio Alves

April 18 (Bloomberg) -- The possible abolition of capital controls in Colombia may prompt foreign investors to increase their holdings and boost stock prices, according to Deutsche Bank AG and brokerage Interbolsa SA.

Colombian Vice President Francisco Santos told investors during a conference in New York yesterday that limits on stock ownership by foreigners failed to stem the appreciation of the peso and that the government is considering dropping them.

Restrictions on buying and selling securities have capped Colombia's weighting in the MSCI Emerging Markets Index at 0.4 percent, the smallest in Latin America. Argentina, which also has capital controls in place, accounts for 0.5 percent of the index, a benchmark used by global investors.

``In the medium term, those controls are going to be gone,'' Santos said. ``What's happened to the peso shows that capital controls don't work.''

The Colombian peso had gained 20 percent against the dollar in the past year through yesterday, the second-biggest gain in Latin America. In comparison, the IGBC index of most traded stocks in the Bogota Stock Exchange fell 12 percent, compared with a 42 percent gain for the MSCI Latin America index.

``If capital controls in Colombia were to be revoked, that would benefit the equity markets and would improve the investment thesis of Colombian shares in light of the strength of the domestic economy and earnings growth,'' Guilherme Paiva, Latin America equity strategist at Deutsche Bank AG, said in an interview in New York. He has an ``underweight'' rating on Colombian stocks because of the restrictions.

Colombia's economy expanded 8.1 percent in the fourth quarter, bringing 2007 growth rate to 7.5 percent, the national statistics agency said on March 28.

Because of strong growth and the potential for higher returns, some investors choose to pay the maximum penalty imposed by the government in order to buy and sell securities freely, said Rupert Stebbings, head of international sales at Interbolsa.

``I'm very surprised that Vice President Santos made those comments on capital controls as the central bank has been tight- lipped about the subject and no other government official has even questioned the capital controls at this point,'' Stebbings said. ``Investors punish those countries, such as Colombia and Chile, so if he's speaking on behalf of the government and there seemed to be a shift in policy, the stock market would rise immediately.''

The IBC increased 1.1 percent as of 10:53 a.m. in New York.

To contact the reporter for this story: Fabio Alves in New York at Falves3 at bloomberg.net.

Last Updated: April 18, 2008 11:25 EDT

By sloopskipper on Apr 18, 2008, 10:15 in Friendly Talkzone.

Simon says on Apr 18, 2008, 10:22:

"With a population of over 44 million, Colombia is the fourth largest country in South America.

Colombia's population is the second largest in South America.

HERE'S SIMON!!!!

0 funny, 0 helpful.

sloopskipper says on Apr 18, 2008, 10:30:

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pedro says on Apr 18, 2008, 10:41:

Yeah, I always thought it was the second largest in South America by population, too.

Perhaps it's the fourth largest in land area?

That comment about removing the capital controls is pretty huge for the peso exchange rate.

que nota!

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Simon says on Apr 18, 2008, 10:45:

Yes, it is the fourth largest in land area, but they made it sound like we're the fourth largest in population.

HERE'S SIMON!!!!

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tejasmarcos says on Apr 18, 2008, 10:52:

"That comment about removing the capital controls is pretty huge for the peso exchange rate"

- that could possibly be the understatement of the year, pedro. anybody tracking that?

trying to walk a straight line on sour mash and cheap wine...

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sloopskipper says on Apr 18, 2008, 11:01:

I imagine Bloomberg will follow it, and I get yahoo alerts for Colombia news, which includes that sort of article.

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jh816 says on Apr 18, 2008, 18:55:

It would be nice to see Colombia continue its 6-year economic run. It has a lot going for it: a relatively free-market country, declining security problems, good natural resources, and a smart business-minded president.

A lot of things worry me about Colombia though.

1) The people just do not have the work ethic that the developed countries have. I'm sure this will peeve someone off here, but it is the truth. It is a play first, work later culture (and the work done is often shoddy). Because of this, as well as capital controls and tariffs, the productivity rate is among the lowest in South America. Example: When Uribe first came to power, he tried to decrease some of the nation's 18 holidays (the most in the world), of course there was a huge uproar and it never happened.

2) The education system here, especially public, is for the most part horrible. I try to talk to my students about Colombian history or some other basic topics and they have no idea (and many of my students went to private schools). They seem to be a bit more competitive in their own career track, but outside of that they're lost.

3) As much as I think Uribe and his boys are doing a great job, they still spend money like socialists. Public spending is out of control. Peru has used the last few years to build up a huge surplus in reserves, and for this has regained their investment grade status. What has Colombia done? The government continues to spend money like its going out of style. What is really crazy is that they are spending theirselves into huge amounts of public debt while at the same time raising interest rates so high they are choking off private lending and growth. Newsflash boys, the private sector spends money a lot more efficiently than you do. Lower the interest rates and let the economic growth take care of the rest.

4) Feeding into the whole system is the outrageous tax and subsidy system. 16% sales tax?! 35% business/personal income tax?! On top of this, if you are foolish enough to try to get ahead, you are taxed an additional 20-30% on most other services to subsidize the lower three stratas. I understand we need enough tax income to help out, but this is ridiculous.

I'm not even going to get into the prohibitive import tariffs and restrictions. Needless to say, Colombia has come a long way, and hopefully will continue to improve, but there are some serious cultural and structural changes that need to be made for any lasting growth.

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cali373 says on Apr 21, 2008, 10:51:

In the grand scheme of things a large population means nothing other than provide cannon fodder in a war.

Colombia's 44 million people is a major issue. It is overly populated and it needs an economy to support 44 million which it does not have. Venezuela and Argentina has about half of that amount, except that Argentina's economy is much bigger. Venezuela's economy is about a quarter smaller but then again it only has about half the population.

I agree the taxes as well as the banking system needs a serious overhaul, Something that Uribe the great has failed to do anything about, yet does not get criticized about in public.

The media talks only about what he does, and not what he does not do.

Smile if you are a thinker!

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