Ireland Moves Forward Ireland Moves Forward Page 2 Ireland Moves Forward CONTENTS Executive Summary ...................................................................................... 4 1. Irish Economy – Challenges ahead ......................................................... 7 2. Irish Banks - Deflationary environment set to prevail.......................... 24 3. The Irish Equity Market ........................................................................... 35 4. M&A – A Good 2010, Cautiously Optimistic for 2011........................... 46 5. Potential Disposal of State Assets ........................................................ 48 6. Technology sector – FDI in action ......................................................... 51 7. Renewable Energy: indigenous companies make their mark............. 55 8. People and the Economy........................................................................ 58 Appendices .................................................................................................. 67 Company Snapshots................................................................................... 71 ESN Recommendation System .................................................................. 99 Page 3 Ireland Moves Forward Executive Summary Boom and bust of epic proportions After a boom of epic proportions, Ireland has been hit by a bust of equal magnitude. From 1997 to 2007, real GDP grew by 6.7% per annum, but by 2010 it had collapsed back to 2005 levels, a reduction of 12% from peak levels. The ensuing dislocation in the public finances pushed the government’s annual budget deficit to almost 12% of GDP. Meanwhile the over-borrowed private sector has created massive losses in the banking area and this has required substantial State support. As a result, Irish gross debt has ballooned to 95% of GDP and is expected to rise to 113% by 2014. An escalating funding crisis, as markets lost confidence, led to the EU/IMF rescue package requiring severe fiscal retrenchment to 2014. Yet all is not lost amid the economic turbulence. Political change but social cohesion intact A general election is set to take place on 25th February 2011 and a centre government with a slight leaning to the left is the most likely outcome. Despite political uncertainty in the run up to the election, the Finance Bill, allowing the EU/IMF rescue plan to proceed, has been passed with broad political support. Social cohesion remains intact despite massive fiscal consolidation of 14% of GDP taken to date and a further 6% outlined over the period 2012-2014. There continues to be cross political support for EU membership. Economic growth a challenge Growth will be a challenge for the Irish economy given the public and private debt overhang and fiscal austerity measures. However Irish competitiveness has improved significantly through the downturn, evidenced by the balance of payments current account, which registered a surplus in Q3 2010 for the first time since 2003. Infrastructure across the country has been significantly improved through the boom years. Irish exports increased to the highest figure ever recorded in 2010, increasing 7% year-on-year. A two tiered recovery will be the order of the day for the Irish economy in 2011 with exports continuing to grow but domestic demand remaining weak. It will be a jobless recovery in 2011 and possibly beyond as we expect employment to contract marginally this year. Low corporation tax will remain Despite having received aid from the EU/IMF, Ireland did not have to make any commitments to alter its corporation tax rate of 12.5%. The rate forms the backbone of Irish FDI and export policy, regardless of which government is in power. Nonetheless, at the broader EU level the EU Commission continues to progress its work in bringing forward a proposal for a common EU-wide base for calculating corporation tax, known as the common consolidated corporation tax base (CCCTB). However it is important to remember that the CCCTB cannot be imposed on Member States. Unanimity is required for all decisions taken on taxation issues and Ireland has a veto. Page 4 Ireland Moves Forward Property market has yet to bottom House price declines in Ireland are not over, we expect the average national peak to trough decline in achieved prices to be in the region of 45-55%. This equates to a further 10% fall from peak levels. NAMA, the government’s recently established vehicle for addressing problematic bank loans, has quickly become one of the largest property companies in the world. It is likely to pursue further asset sales, initially in the UK, and will be a critical determinant of the supply/demand balance in Ireland over the medium-term. Banks insolvent and illiquid but for State and EU support The banks remain reliant on the sovereign for capital and on the European and Irish Central Banks for liquidity. The March 2011 stress tests will determine whether any additional capital is required apart from the €10bn already earmarked to bring Core Tier 1 (CT1) ratios above 12% by the end of February 2011. Sovereign debt restructuring can’t be ruled out In the low growth scenario, and even in our base case scenario, it is difficult to see how Ireland would be able to wean itself completely off EU aid post 2013. As such, our central view is that Ireland will need EU help to raise funds and as a result be rolled into the permanent European Stability Mechanism (“ESM”). Sovereign debt restructuring may form part of the ESM, but we see it as being a last resort after other efforts have been exhausted. A lowering of the interest rate on EU loans, however, would give Ireland a higher probability of weaning itself off aid by 2014. Bond market has priced in the worst We like Irish bonds which mature before June 2013 on an outright basis – they are essentially guaranteed by the EU/IMF. We see the markets implied probability of default on Irish bonds maturing post June 2013 as being too high. Even though restructuring is a possibility, we would advocate switching a portion of bond funds into Irish government bonds to avail of the pick‐up in yield. Equity market has limited exposure to Ireland Irish profits now represent only 17% of overall operating profit of our sample for Irish publicly quoted companies. This compares to 36% in 2006. The names we favour in the Irish equity market are CRH, Ryanair, Smurfit Kappa, Irish Continental, C&C and ARYZTA. Smaller names continue to offer value and are often neglected, and on this basis we favour FBD, Abbey, CPL, Donegal Creameries and Origin Enterprises. Page 5 Ireland Moves Forward M&A activity on the up 2010 saw a recovery in the Irish M&A market and we should at a minimum see an M&A market in 2011 similar to that of last year. In relation to the Irish financials, The Governor of the Central Bank has previously referred to the possibility of “some or all” of the Irish banks becoming foreign owned. NAMA will be a significant dictator of activity in the property sector in 2011 and beyond. Publicly quoted companies in the food and construction sector are likely to be active acquirers. Potential disposal of state assets Given the condition of government finances, the sale of state assets cannot be ruled out. It has been reported that there has been foreign interest in potential asset sales in Ireland. We identity a number of assets which could be sold including those in the areas of forestry, energy, networks and ports. FDI remains robust Foreign Direct Investment (FDI) in Ireland increased significantly in 2010, despite global FDI declining by 8%, with the Industrial Development Agency (IDA) securing 126 investments and IDA sponsored firms creating almost 11,000 jobs. Ireland has developed a fast growing reputation as a favourable location for global technology companies with 9 of the World’s top 10 ICT companies now located in Ireland. Renewable energy – indigenous companies make their mark The area of renewable energy/cleantech continues to be an area of significant investor interest both in public markets/IPOs and venture capital fundraising. There are several Irish companies (mainly privately owned) with significant exposure to the demand arising from efforts to achieve the EU’s 2020 targets including Kingspan (public), Glen Dimplex (private) and Mainstream Renewable Power (private). Page 6 Ireland Moves Forward 1. Irish Economy – Challenges ahead 1.1 Introduction Growth will be a challenge for the Irish economy given the public and private debt overhang and fiscal austerity measures. Despite these challenges, the Irish economy did return to growth on a quarterly basis in 2010. Growth in the economy was driven by the impressive performance of the exporting sector. A two tiered recovery will be the order of the day for the Irish economy in 2011 with exports continuing to grow but domestic demand remaining weak. It will be a jobless recovery in 2011 and possibly beyond as we expect employment to contract marginally this year. The economic outlook in Ireland is complicated by the banking sector, the relationship between Ireland and its overseers and finally the political negotiations at the European level. As such, we assess the Irish economy under 3 scenarios in order to assess the stock of public debt come 2014. The assumptions in the scenarios are not mutually exclusive but rather illustrative. In the low growth scenario, and even in our mid (base) case scenario, it is difficult to see how Ireland would be able to wean itself completely off EU aid post 2013. As such, our central