Article / 11 July 2014 at 12:06 GMT

Portuguese decliners a falling knife or an opportunity?

Head of Equity Strategy / Saxo Bank
Denmark
By Peter Garnry

Every single individual who's interested in financial markets has by now heard of Banco Espirito Santo (BES), Portugal's largest listed bank. The reason is quite simply a 55 percent drop in its share price over the past month including suspended trading yesterday (trading resumed 10:30 GMT today).

Portuguese decliners the past month



















The reason for the turmoil is that  parent company of BES's largest shareholder Espirito Santo Financial Group (ESFG), Espirito Santo International (which owns 49.3% of ESFG through a holding company called RioForte) has missed a debt payment on one of its commercial papers, a typical short-term financing source. Rumours escalated yesterday that there might be a link from BES back through the holding companies to ESI exposing the bank to the credit event further up in the ownership structure.
Banco Espirito Santo ownership structure






















Source: BES Investor Relations

Late last night BES revealed more information on the matter following statements from the Bank of Portugal that BES was shielded from the parent company. In its statement, BES says that it has EUR 1.2 billion exposure to the group-related holdings below the EUR 2.1 billion capital buffer on top of the minimum regulatory capital requirement. 

The announcement has apparently not appeased investors sufficiently as the share price is trading just below the close price from yesterday's shortened session (see chart).

Banco Espirito Santo intraday share price the past 14 trading sessions
Banco Espirito Santo share price the past 14 trading sessions
















Source: Bloomberg

With such large declines what can we make of it? There are conflicting signals in the market. The November 2023 subordinated bond is trading up 2 percent today while the shares are down. Clearly credit investors are less worried about the lower end of the credit structure. In the credit default swap market, the insurance market against bond defaults, the EUR 5Y SUB is trading around 675 basis points which on a relative basis is high and up from 200 basis points a month ago.

BES is currently trading at a price-to-book ratio of 0.36x and a 24-month forward price/earnings ratio of 6.7x vs. 8.7x for the Euro Stoxx Banks Index. At these levels a lot of distress is priced in already so from a fundamental perspective investors will long-term horizons should consider getting exposure to BES. On a more short-term tactical level we see upside potential as markets calm down.

Another Portuguese stock that has been hit by the BES turmoil is Portugal Telecom (PTC), which is down almost 35 percent in one month. The company is connected to the Espirito Santo Group through a 2.1 percent stake in BES, and BES owns 10.1 percent of PTC. The reason for PTC's declines is its EUR 900 million exposure to commercial paper issued by RioForte, that is 100% owned by ESI, and with ESI's missed debt payment RioForte's credit quality is at stake which again put large investment risk on PTC's investment in commercial paper. PTC's commercial paper exposure is quite large given the market value of EUR 1.76 billion.

Portugal Telecom share price the past year
Source: Saxo Bank

The situation for PTC has further been exacerbated by the fact that PTC's credit rating is used in the merger with Brazilian company Oi which is a big strategic deal for PTC. With debt turmoil in the Espirito Santo Group, Oi's board will likely question the deal due to PTC's commercial paper exposure.

PTC is a stable telecommunication company with predictable cash flows and with valuations at a 15-year low point there is a good case for a short-term bounce in the share price.

-- Edited by Clare MacCarthy

Peter Garnry is head of equity strategy at Saxo Bank

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