What is driving the sudden revival of interest in the Athens bourse?

The Athens bourse surprised even optimists last week as the General Index surpassed the 2600-point level, revisiting territory last seen in the fall of 2001. The move has caught the local investment community and analysts working for well-known foreign investment houses by surprise, looking for an explanation. With many factors at play at the same time, the explanation should be multi-faceted, including the prospects of corporate tax cuts, strong earnings growth, ample liquidity abroad and positioning ahead of anticipated privatization deals. What’s next? It is hard to say but it will require more than that, perhaps a big corporate deals and a few restructuring stories, to justify stretched valuations and produce Austria-like stock returns. After months of uncertainty surrounding the issue of marginal tax rate cuts on corporate profits, Economy and Finance Minister Giorgos Alogoskoufis officially stated last week in his keynote speech at the annual conference of the Hellenic American Chamber of Commerce that the government will slash the marginal corporate tax rate to 32 percent next year from 35 percent at present as part of a plan to cut it to 25 percent within the next three years. Although the news had been leaked out quite some time ago and a few government officials, including Alogoskoufis, had referred to it in the past, the positive reaction of the market should not surprise. As market players point out, Greek governments tend to leak stories to test the waters before they actually decide what to do. Bearing this in mind and fully aware of the fiscal situation, as well as the fact that the ruling conservatives had called for a 10 percentage point reduction in the tax rate applied on retained earnings in their economic program, many in the market were understandably very cautious. Alogoskoufis’s position clarified the matter, allowing analysts to revise upward their forecasts on the earnings per share of Greek corporates going forward. Corporate tax cut effect Although it is hard to say what the exact effect of the corporate tax cut on profits will be, as it varies across companies, it is generally estimated it will produce an average increase of 7 to 10 percent in earnings per share (EPS) of large-caps. Listed companies with larger cash flows, such as lottery operator OPAP, mobile operator CosmOTE and Duty Free Shops (KAE), are expected to benefit the most. According to analysts, the upward revision in EPS has resulted in higher target prices for most stocks, attracting more funds from abroad. Many compare the government’s move with a similar one taken by the re-elected center-right Austrian government in early March 2003. The Austrian government pledged to cut the corporate tax rate by 10 percentage points to 25 percent in 2005, providing a major boost to the local stock market, which has surged by more than 85 percent since then. Attractive banks Moreover, the ability of Greek large banks to deliver strong earnings in the last four or five quarters has increased the confidence of the foreign investment community in them. This, along with optimistic earnings projections running into 2006, have convinced some sell-side and buy-side analysts to recommend overweight positions. It is no coincidence that some well-known foreign investment houses believe large Greek banking stocks can trade at 11 times their projected 2006 earnings per share. The fact that there are a few other European banks offering similar growth prospects in the next couple of years has also worked in favor of local financial institutions, as a good deal of foreign funds find themselves with plenty of cash, looking for opportunities in the so-called Old Europe. In addition, some funds have been attracted by the restructuring story of the telecoms operator OTE. Comments by Alogoskoufis and other officials indicating government support for the voluntary retirement program pushed forward by OTE’s President and CEO Panagis Vourloumis have convinced foreign analysts and fund managers that restructuring will proceed this time round, perhaps paving the way for the sale of a considerable equity stake to a strategic investor, probably a large international telecoms operator. Still, a number of market participants link the greater inflows into a select group of Greek stocks to an «undeclared war» among major international investment houses, seeking to position themselves in view of next year’s privatization deals worth more than 1.6 billion euros. According to this line of thought, foreign investment banks produce more research reports and put more clients into Greek stocks in a bid to control the flows. This is supposed to work to their advantage when they try to convince government officials to give them a slice from the privatization pie and other advisory and investment banking deals. Still, officials from US investment houses point out that unlike in the past, a Chinese wall separates equity research from investment banking, pointing out they cannot risk being involved in such schemes. On the other hand, European investment houses have greater degrees of freedom. Hedge funds Although the above points are all valid, the sharp moves in the handful or so Greek stocks outperforming most of their local and European peers point to the presence of some players other than the usual mutual funds, closed-end funds, pension funds and insurance companies. It is the hedge funds – sometimes described as funds aiming at absolute returns – which account for a good deal of the daily turnover on the Athens bourse. Of course, there are no official statistics showing the extent to which hedge funds are active in the local market. Judging, however, from what brokers say and from price action in certain stocks, it would have been a surprise if hedge funds did not participate in the market extensively, providing more liquidity which, in turn, lures in more traditional institutional funds. Undoubtedly, heavy foreign inflows into Greek large-caps have been the major force behind the Athens bourse’s surge over the last month or so, and in so doing they are obviously welcome. Nevertheless, one should not lose sight of the fact that the valuations of some of the companies benefiting from these net foreign inflows have become stretched. Although the case of Austria points to further potential stock gains in view of similar corporate tax cuts, one should not forget that corporate restructuring and the entry of neighboring European countries into the EU also played an important role in the Austrian bourse’s outperformance since March 2003. Can Greece follow a similar path? The answer is positive, but requires tangible results and perhaps an unexpectedly big corporate deal.