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Last week, Grupo Galicia (GGAL), a leading Argentinian bank, reported fourth quarter financial results which demonstrated significant financial improvement. As we noted when we first wrote up GGAL, the company´s financial statements are quite complex, and as such we´ll just focus on two big picture points in this post and reiterate why we remain bullish on the shares for the remainder of the year.

Balance Sheet Strengthened

Perhaps, the most important event for the company in the quarter, were a series of deals with the Argentine Central Bank that both increased the company´s cash position, while simultaneously significantly decreasing its liabilities to the Argentine Central Bank.

As the company explains:

The execution of the above-mentioned advance and its repayment, strengthens the Bank’s balance sheet by reducing risk concentration and making an asset of a very significant amount available for the expansion of the business.

Standard & Poor’s in considering an upgrade of the bank commented on the: 

“improvement in the Bank’s medium term operating results, following the significant repayment of debt with the Central Bank and the subsequent reduction in the cost of funding” and that it also reflects Standard & Poor’s “expectations of an increase of the Bank’s capitalization as a result of the forthcoming stock offering”.

Deposit Growth Is Very Strong and Loans are Increasing

Reflecting renewed faith in banks, and solid economic growth, the Bank’s deposits in Argentina reached Ps.10,592 million by year end 2006, representing a 30.7% increase from December 31, 2005. Total loans to the private sector granted by the Bank’s Argentine operation increased 50.1% between December 31, 2005 and December 31, 2006, while the regional credit-card companies’ total loan portfolio increased 36.2% during the same period.

Interestingly, as we predicted in our initial write-up, mortgage loans and mortgage interest were among the fastest growing parts of the banks balance sheet and income statement.

Where to Now?

We still think that the vast majority of US investors and market commentators are completely oblivious to the revival of the, previously-bankrupt, Argentinian economy. As more investors discover Argentina, particularly its lively real estate market,  they will gravitate towards shares of GGAL, one of the leading banks in Argentina, and one of only a handful of Argentinian ADR’s. In fact, the low supply of Argentinian ADR’s, and the potentially strong demand for foreign investment in the country from emerging market funds, supports the notion that GGAL could perform very well for quite some time. Interestingly, it was only last week that JPMorgan finally decided to upgrade shares in GGAL, demonstrating that Wall Street is only beginning to warm up to the story here. 

At the same time, from a basic economic perspective, GGAL should continue to benefit for quite some time, from the renewed growth in Argentina and the booming real estate business in Buenos Aires.

Based on the above, we still remain bullish on GGAL for the remainder of the year. However, please refer to our first post on GGAL for the risks you face when investing in Latin American stocks, like GGAL. As you may have already noticed, these stocks can be quite volatile. However, if you keep in mind the current strong underlying economics of the Argentinian economy, coupled with the lack of suitable ADR’s from the country, it should be easier to withstand the volatility and possibly buy more on any dips.  

Please Note: We first recommended GGAL at about $9.55 per ADR share, and still hold a position in the stock. All ideas, opinions, and/or forecasts, expressed or implied herein, are for informational purposes only and should not be construed as a recommendation to invest, trade, and/or speculate in the markets. Any investments, trades, and/or speculations made in light of the ideas, opinions, and/or forecasts, expressed or implied herein, are committed at your own risk, financial or otherwise.

Emerging market stocks did well in 2006 and expectations are for another solid year of performance in 2007. Since we’re not fans of chasing stocks, we were happy to find one emerging market that has yet to truly heat up and which we think could outperform significantly in the coming year.

Thankfully, we haven’t seen this market mentioned yet in any mainstream financial media, which gives us some degree of confidence that even though we’re not early, we’re definitely not late to the party here. In addition, in keeping with our turnaround/restructuring theme, this market is also one of the more impressive major macro-turnaround stories we’ve seen in quite some time.

So what’s the country we’re talking about and how do you play it?

Without further adieu, the emerging market that we think has the most upside potential over the next year is: Argentina.

Our preferred way of investing in Argentina is via Grupo Financiero Galicia S.A., the largest bank in Buenos Aires, the political and financial capital of Argentina. Grupo Financiero Galicia S.A. is member of Argentina’s Merval Index and its ADR’s trade on Nasdaq under the symbol: GGAL.

GGAL is currently trading at about $9.55. The stock is up quite significantly over the past few months, but we think it will continue to perform well in 2007. Importantly, we think the risk in GGAL is low over the next year given Argentina’s improving economic outlook, and the still relatively low participation by funds in an increasingly hot Argentinian stock market.

Cautionary Advice

Latin American Markets are Risky

It’s never been easy investing in Latin America, given the generally corrupt political system and unstable currency environment. In fact, a mere four years ago, Argentinian authorities devalued the Peso, precipitating one of the worst currency crises in modern history. Clearly, any investment in this region is very risky and you should expect a fair amount of volatility.

Financial Analysis of GGAL is Very Difficult

It is also important to note that our opinion is that individual stock analysis is a complete waste of time in most emerging markets and the only way to make serious money is to play certain leaders based on a believable macro-economic/social perspective. With Argentina and GGAL, in particular, it’s next to impossible to perform any serious valuation analysis since Argentinian GAAP is completely different than US GAAP, rendering GGAL’s financial statements incredibly confusing. Moreover, GGAL has a huge amount of government securities on its balance sheet which we’re not sure anyone knows how to truly value.

So in sum, it’s a mess out there, which is why you will not see any financial figures in this pick. In order to separate the forest from the trees, though, we suggest that you read thru GGAL’s Risk Factors in its 20-F SEC filings to get a good understanding of the qualitative investment factors in this situation. Briefly, all you really need to know is that the current economic growth of Argentina, especially in real estate and other lending markets, will clearly benefit GGAL, one of the leading financial institutions in Argentina.

In terms of specific reasons for our bullishness on Argentina, in general, and GGAL, in particular, we offer the following:

• A Post-Bankruptcy Play on the Mend


As you probably already know, for various reasons we are big fans of post-bankruptcy/restructuring/recapitalization stocks. If there ever was a post-bankruptcy play, Argentina is it. Following the financial crisis in 2002, the entire country was basically bankrupt and the banks, including GGAL, for all intents and purposes were insolvent. However, fast forward four years, and Argentina is by all measures clearly recovering strongly from the past financial crisis. And yet, many investors still cringe at the thought of investing in Argentina, much as they feared Russia after that country’s debt debacle in the late 90’s. However, as investors increasingly forget Argentina’s past crisis and begin to focus again on its renewed growth, the Argentinian stock market should do well. Banks, like GGAL, in particular, should rise sharply, as financial institutions are always the prime beneficiaries of economic revivals, particularly when they are emerging from a period of insolvency.

• Brazil’s Looking Good and Provides a Model for What to Expect

The recent re-election of Lula in Brazil, means that we’re likely to see a fairly stable and predictable political and economic environment in Brazil over the next few years. As the economic powerhouse of Latin America, and a major economic partner for Argentina, the strength of Brazil should spill over to Argentina.Importantly, in recent years, Brazil’s strong growth has attracted a large amount of foreign investment igniting heavy investor/fund interest in the region. We think it’s only a matter of time before this enthusiasm for Brazil spills over into Argentina. We would note that following Brazil’s recovery from its own currency crisis earlier in the decade, shares of the country’s leading banks soared. For example, Unibanco (UBB) appreciated nearly 15X since just 2003. GGAL’s market value, despite it’s stature in Argentina, is tiny compared to these more well-known, Brazilian banks, lending support to our upside thesis for GGAL shares.

• Peso Seems Undervalued


The Peso, Argentina’s currency, is currently very weak relative to the Real, Brazil’s currency. In fact, the Real continues to strengthen against the dollar, making trips to Brazil relatively expensive right now, especially for Latin Americans. It’s the exact opposite for Argentina.Currently, when you travel to Buenos Aires in Argentina, you inevitably run into tons of Brazilians who are taking advantage of the once-in-a-lifetime currency gap to go on shopping sprees in Buenos Aires’s chicest areas. In the past, Buenos Aires was as expensive as New York City, but it’s now one of the cheapest cities in the world even four years after the currency crisis.
In fact, Brazilian businesses have taken advantage of the currency situation by buying up some major Argentinian corporations.

In truth, we are not really qualified to speak of currency values, but given the history of the region and after witnessing the current economic activity, we can’t imagine that the Peso can stay this cheap for much longer. Either prices will need to rise rapidly in Argentina, and/or the Argentinian government will need to relax some currency controls and allow the Peso to strengthen somewhat. In either case, investors in Argentinian bank stocks, like GGAL, will benefit.

• Buenos Aires Real Estate Market is Booming, but Mortgage Volumes Are Still Very Low

While the US is facing a real estate correction, Argentina is in the midst of a tremendous real estate boom. We witnessed this first hand when we traveled to Buenos Aires. It also appears as if the real estate boom could go on for several more years because almost all deals are still being done with cash, implying that there is absolutely no bubble scenario yet. Compare the situation with the US where cheap credit from banks has been the primary driver of the real estate bubble for more than five years.

The reason for the lack of loans in Argentina is that the depth of the crisis in 2002 caused tremendous harm to depositors’ confidence in the financial system. Without deposit growth, you have no lending capacity and without lending capacity you cut off the primary profit center for banks and main credit line for consumers.

Despite the fact that loan origination has resumed since 2004, credit activity in Argentina still remains low and a return to its pre-crisis levels still remains uncertain. Deposits in the financial system have resumed growth, but since most new deposits are short-term time in nature, it is still difficult for banks to lend money on a long-term basis.

However, our belief is that above situation merely presents an opportunity. As economic prosperity continues in the region and money is made in real estate transactions, confidence in the financial system will slowly recover enabling a substantial part of the country’s savings to be channeled back into the financial system on a long-term basis. When this happens (and it’s actually happening now), lending volumes will increase, particularly in the real estate/mortgage market, and the income generating capacity of Argentine financial institutions, like GGAL, will improve dramatically.

• Foreign Funds Still Have Not Discovered Argentina


Interestingly, despite the positive environment in Argentina, the country’s capital markets have yet to really experience a major influx of “hot” fund money. In fact, despite the size of the economy, there are only a handful of Argentinian ADR’s to choose from and there are few if any financial pundits pushing Argentina as a sound emerging market investment. The same can’t be said of the Brazil, India, and China trio. This lack of overweighting by funds, supports our notion that the risk in the Argentinian stocks, in general, and GGAL in particular shares, is low over the coming year. At the same time, as other investors discover the exciting growth prospects in Argentina, the shares could appreciate significantly.