Italy is highly unlikely to leave either the European Union, or the euro currency, according to Janus Henderson’s Ollie Beckett. In fact, the Italian constitution makes such a scenario virtually impossible - but the fear of an Italexit is creating investment opportunities.
Italy’s “slightly strange coalition” government of populist parties from both the left, in Five-Star, and the right, in Lega Nord, has led to repeated clashes with the EU.
Last month, the European Commission rejected Italy’s Budget proposals and told the Government to come back with a revised plan that was in line with EU rules. That plan, which centred around high spending and tax cuts, still did not satisfy the EU.
Italy’s debt currently stands at 130% of GDP, proportionally second only to Greece, which has only recently escaped its long bailout programme. Meanwhile, its deficit is set to stand at 2.4% of GDP for the next three years.
Markets in Italy have been running scared since May, with yields on its 10-year Government bond having climbed from around 1.75% to 3.5% today. The FTSE MIB, Italy’s blue-chip stock market index, is down 24% in that period.
On Wednesday, the European Commission said it would take action against Italy’s Government which could see it impose a fine on the country. “With what the Italian Government has put on the table, we see a risk of the country sleepwalking into instability,” said Valdis Dombrovskis, vice president of the European Commission.
Fears that abounded for a while now that Italy would seek to leave either the European Union or the euro have only been heightened. However, markets are currently pricing in an eventual compromise between both sides.
Indeed, the 10-year bond yield eased 3% yesterday, while the stock market ticked up 0.5% on news the Italian Government would be open to compromise.
Beckett, manager of the TR European Growth Trust (TRG), thinks that is possible, but says the tone of the Government’s rhetoric needs to change, and the only way that will happen is if their popularity starts to wane in the polls.
He says: “The problem is the other parties in Italy are a shambles. That’s why at the moment they are able to be quite confrontational.”
Italexit is Highly Unlikely
Confrontational rhetoric aside, Italexit is highly unlikely to happen. In fact, Beckett says, “there’s no way under the Italian constitution currently that Italy can leave the European Union – there’s no method to even get there”. Article 75 of the constitution forbids referendums on anything related to international treaties.
But Beckett does not think there is any support within Italy for leaving the EU, anyway. “Even Five-Star have realised that and very much backed away from that,” he notes.
Beckett also thinks the fact that Italy is now the third-biggest contributor to the EU means there’s likely to be “a bit of give and take” from the EU’s side, “particularly with the UK leaving, they need the Italian money”.
On the investment side, clearly the top-down noise is not good and investors are “just dumping anything in Italy”. But he sees this as an opportunity to go against the crowd and pick up some bargains in his European small-cap universe.
Amongst those opportunities is a play on the Italian Government’s weak financial position, Banca Farmafactoring (BFF).
The €763 million company offers factoring of receivables services for businesses that are awaiting payment from the Italian Government. While these companies are waiting for those payments, they will sell their accounts receivables to a third party – Banca Farmafactoring – at a discount in order to meet their immediate cash needs. The firm currently pays a double-digit yield.
“The risk on this stock, if you like, is that the Italian Government start paying much quicker. I don’t want to be flippant, but that’s a risk I’m willing to take,” says Beckett.
Other more traditional banking institutions he likes includes Credito Emiliano (CE), which he says is considered to be the best-run bank in the country. It is conservatively run and offers services to customers in Reggio-Emilia, which is a wealthy region.
FinecoBank (FBK) is a top 10 holding in the trust and Beckett says “it’s how you would design a bank today if I gave you a blank piece of paper” – online-only and with up-to-date IT systems and infrastructure.
That contrasts with most of the large Italian banks. “They’ve all got the beautiful branches throughout Italy that nobody wants to go in and they have IT systems that are completely outdated.”
Fineco continues to gain assets and new customers. It has recently moved into Ireland and plans on launching in the UK, targeting Italian expats.
Away from the banks, Beckett also likes a micro-cap firm called Indel (INDB), which services the hospitality industry, supplying mini-bars for cruise ships liners and refrigerators for trucks.
Valuations are "Mad"
But it’s not only in Italy where Beckett is seeing opportunities in the European smaller companies space. The trust has recently upped its gearing significantly to 14%. It may have started “slightly too early”, although it hasn’t impacted performance, Beckett says he thinks it is the right thing to do.
“Sentiment is unbelievably negative, the likelihood of a trade deal is reasonable and, in this scenario as a closed-end vehicle, I think we have to use that opportunity to pick up one or two names which are looking very cheap.
“It’s not a top-down call; it’s very much a bottom-up call. Individual stocks look cheap and the trust gives us the capability of picking those up when open-ended funds are clearly having to run away because they’re having outflows.”
The portfolio currently consists of 144 companies, with the top 10 accounting for around 17% and the two largest holdings, Van Lanschot Kempen (VLK) and GTT (GTT), at 2.5% and 2% respectively. But that could all change, soon; the portfolio could become more concentrated.
“Now I think there are one or two names that are so significantly undervalued that it might be right for us to make some bigger stock calls,” says Beckett. “To move to more 3% or 4% weights in certain stocks because I just think the valuations are plain mad.”
In fact, he’s been topping up positions in some of his largest holdings in recent weeks. These include French high-voltage cable maker Nexans (NEX), which has been one of the worst performers in the fund this year.
A number of problems like losing its chief executive without explanation of why he left, and delays on a few projects have seen the stock halve in the year-to-date.
“You’ve reached a point where you’ve got a company on the wrong price. You’ve reached a point where I don’t care about the next quarter,” Beckett says, focusing on the long game.
He adds the new CEO is “credible”, having already turned around the firm’s European operations and shares up 15% in the past week alone.
