Erste Group Research CEE Equity Strategy | Equity | CEE 2Q 2021 CEE Equity Strategy Recovery tangible - question not if, but when Henning Eßkuchen Earnings growth needed as answer to most pressing issues – both rising +43 (0)50 100 19634 yields and the hope of a continued recovery have to find their justification in [email protected] further rising earnings growth. Inflation and rising yields – for now, inflation has a temporary touch, rising long-term yields can well be read as confirmation of the growth outlook. Not an individual issue – spreads to Bunds are not rising, with the exception of Turkey and partially Czechia. Impact via steepening slope of yield curves – would confirm the outlook for equities, qualifying this asset class as an inflation hedge. Financials might gain in outlook, sector rotation towards cyclical exposure is finding further support. Continued recovery out of pandemic situation – vaccination progress as a prerequisite for recovery remains slow, with Serbia and Hungary taking the lead. Containment measures remain at stable, burdening levels. Economic and corporate earnings growth – the recovery outlook is stabilizing, but some postponement into 2022 is becoming visible. CEE is leading in earnings growth momentum, with EPS in a strong trend. Poland has the Contents strongest momentum in CEE. Earnings growth needed as answer to most Valuation – a sound recovery is highly priced in. Vulnerability comes via the pressing issues 3 Continued recovery out of pandemic risk recovery continuing quickly enough; any delay/postponement creates situation 7 vulnerability. Valuation 11 Sentiment 13 Sentiment – the positive mood should generally remain intact, but fragile Sector view 14 market conditions will allow for consolidation episodes. ESG – positive correlation between ESG and financial performance 19 Sector view – fund flows indicate further rotation into smaller caps. There is a Conviction calls 21 cautious revival in EPS trends for cyclicals/financials. Consumer needs Top picks 23 earnings growth to level out valuations. Country allocation proposal 36 Country and sector view 42 ESG – meta study finds positive correlation between ESG and financial CEE macro economy 49 Fund flow 56 performance on corporate and market levels. Appendix 63 Country view – CEE and Poland on overweight, Turkey underweight, cautious Contacts 66 on SEE. Disclosures 68 Assuming that the current perspective on yields is a positive for financials, we have again added RBI, which comes with an argument of value as well. Immofinanz remains among our conviction Buy calls. Among consumer/cyclical exposures, we stick to Eurocash and Andritz. AT&S continues to be among our technology picks, alongside Ten Square Games, as a bridge between consumer and technology. Admittedly, both have some speculative character. Completing the more cyclically geared part of our list, we have OMV. STRABAG also continues to be a conviction Buy call. Krka and CEZ add to our list on the more defensive side. Erste Group Research – CEE Equity Strategy finalized and released March 31, 2021, 07:30, CET, reviewed by Fritz Mostböck Page 1 Share prices are as of March 29, 2021 – otherwise stated. For the exclusive use of Daniel LION (Erste Group) Erste Group Research CEE Equity Strategy | Equity | CEE 2Q 2021 CONVICTION BUYS Austria Andritz (Industrials) Buy, current price: EUR 37.52, target price: EUR 46.3 > Automotive rebound to drive sentiment and help business/margin recovery going forward. AT&S (Information Technology) Buy, current price: EUR 30.3, target price: EUR 33 > Sitting on long term growth trends and multi-quarter positive growth trends. Recent profit taking as opportunity. Immofinanz (Real Estate) Buy, current price: EUR 17.23, target price: EUR 22 > We expect strong figures for 4Q20 which should support the stock price OMV (Energy) Buy, current price: EUR 43.46, target price: EUR 46.5 > OMV could benefit from higher oil&gas prices and strong petrochemical margins. RBI (Banking) Buy, current price: EUR 18.4, target price: EUR 24 > Share price is far too depressed for our current forecasts, clearly undervalued vs. peers STRABAG (Industrials) Buy, current price: EUR 30.35, target price: EUR 42.62 > Strong fundamentals - but low free float. Poland Eurocash (Consumer Staples) Buy, current price: PLN 14.7, target price: PLN 23.54 > Remains vastly undervalued with Frisco growth above the market, more players entering likely to accelerate e-grocery in PL Ten Square Games (Information Technology) Buy, current price: PLN 525, target price: PLN 805.6 > If able to restore growth momentum of Fishing Clash, potential upside is significant, if not, we would see a downside CEE/SEE CEZ (Czechia, Utilities) Buy, current price: CZK 553, target price: CZK 634 > Cheap bet on CO2 prices and ESG rating improvement with dividends as a sweetener. FY20 results confirm our expectations. Krka (Slovenia, Health Care) Buy, current price: EUR 95, target price: EUR 115 > Robust 2020 results confirmed Krka's competitive edge, which is not yet fully priced in. Source: Erste Group Research Erste Group Research – CEE Equity Strategy Page 2 For the exclusive use of Daniel LION (Erste Group) Erste Group Research CEE Equity Strategy | Equity | CEE 2Q 2021 Earnings growth needed as answer to most pressing issues The two main pressing issues for equity markets currently should be a) a continued recovery out of pandemic-related depressions, and b) the impact of rising inflation/yields. Both questions should find at least one important part of an answer in continued earnings growth. For issue a) as a confirmation that we are on track and earnings are ready to justify market performance and valuation, for b) as a response to price increases, making equity investments suitable as a proper hedge against inflation as an asset class, hence removing elements of panic. Inflation and rising yields In general, we still tend to see the current price increase as mostly temporary and driven by base effects that should fade out over the course of this year (see the macro section of this report). Hence, we also tend to see inflation as mostly a confirmation of continued recovery so far and also as describing the success of public stimuli. While indeed public stimuli – in particular in the US – might turn out as overdone in dimension, the most immediate risk for market sentiment should stem from central bank responses. Recent history tells us that there is only a thin line between carefully normalizing monetary policies as much as accommodative policies are not needed anymore and triggering a taper tantrum again by overly sensitive interpretation of central bank communication. Hence, central banks in the CEE region will also have a hard nut to crack in terms of convincing markets, while inflation might touch or temporarily cross upper boundaries. Hence, the question will be how confidence in central bank average inflation targeting will hold up against positive activity data surprises. For views on related fund flow impacts, please see the Fund Flow section of this report. In EM Europe, Turkey should continue to build confidence in more conservative policies, while Hungary might also find it hard to formulate market compliant policies. Czechia should be the market to expect rate hikes first, potentially even this year. Another, albeit long term factor, might be obviously that rising debt levels will find it difficult to be rolled over at low rates, once rising sustainably. Hence, the requirement of getting in particular public deficits under control as soon as possible is mandatory. Any impact of yield outlook on the USD, making this currency stronger, should be another negative for EM markets in our region, in particular for Turkey. Not an individual issue Current changes in yields are not a particular phenomenon that would pose some particular risk on regional markets. Initially, when the coronavirus found its way into Europe, regional markets did face some higher spreads to the Bund, while such risk premia have declined and stabilized since then. Due to the unfortunate decision regarding its central bank governor, Turkey is clearly facing increasing risk premium, which should not come as a surprise. Some increases in Czechia might be explained by the fact that the market is most likely to be earliest in hiking rates later this year. Erste Group Research – CEE Equity Strategy Page 3 For the exclusive use of Daniel LION (Erste Group) Erste Group Research CEE Equity Strategy | Equity | CEE 2Q 2021 Premia – local spreads to bund Source: Bloomberg Impact via steepening slope We believe that a currently steepening yield curve should serve well as an argument for an improving long-term growth outlook. Major markets do show some positive correlation that would support the view that yields rising at the long end more than on the short end are providing a supportive outlook for stock markets, in particular for the US. Also, for CEE markets a synthetically aggregated slope of the yield curve would show this positive correlation, even over a longer history. Slope of yield curves US/DE… … and CEE* *based on Erste Group Research coverage universe / Source: Bloomberg, own calculations Erste Group Research – CEE Equity Strategy Page 4 For the exclusive use of Daniel LION (Erste Group) Erste Group Research CEE Equity Strategy | Equity | CEE 2Q 2021 Impact Fed model Low and lower yields have pushed the upside relative to implied valuations based on a Fed model to partially insanely high levels and have demonstrated market reliance on monetary policy and consequently placated the risks of a taper tantrum. Hence, continued earnings growth and consequently earnings yields compensating for rising risk-free rates are mandatory as part of an attempt to gain something positive out of the current yield/inflation discussion. So far yield rises have not tangibly reduced the yield buffer, i.e. the amount by which yields could be rising to reduce implied upside based on a Fed model to zero and assuming that earnings yields would remain stable.