|By Matein Khalid| After five years of pathetic under-performance, emerging markets are easily the asset class to own in 2016, as Europe is hit by a resurgent Euro/Italian banking woes and Japan by institutional gaijin selling and a stronger yen. A dovish Janet Yellen has talked down the US dollar and deferred the timing of FOMC interest rate hikes. The Chinese Politburo and People’s Bank have managed to stabilize the yuan despite the lowest economic growth rate in 25 years. Brent has surged to $45 despite the failure of the Doha deal as the market focuses on the Black Death in offshore/shale capex and output. The Russian rouble, recommended as a strategic buy in this column at 78, is now 65. If ever the macro stars were aligned for emerging markets, the first four months of 2016 have been it.
Brazil’s Petrobras corruption scandal has devastated the political stability, sovereign wealth rating, currency and stock market of Latin America’s largest economy, a $2 trillion colossus. In 2015, the Brazil Real lost a staggering 34% against the US dollar. However, the foreign exchange market and the Bovespa now price in a new government in Brazil as the lower house of Congress votes to impeach President Dilma Rousseff.
As Rousseff has no real support in the Senate, her only option is to resign and end 14 years of populist, corrupt Workers Party rule. This prospect is the reason the Brazil Real has surged 13% against the US dollar in 2016, even though the central bank in Brasilia has done its best to dampen its rise via reverse swaps. Brazil’s sovereign five year credit default swap has fallen 200 basis points from its crisis highs. This has led to a bull market in Brazil’s Bovespa stock market index. Brazil is still in recession, 150 legislators in Congress still face corruption probes, the GDP could contract 3.5% in 2016, the budget deficit is 8% and Vice President Michel Temer has low approval ratings only a little higher than the current disgraced President. There is a global component to Brazil’s spectacular 2016 performance but fund managers are now positioned for a Narendra Modi or Mauricio Macri style political regime change.
The ideal proxies for Brazil’s sovereign retreating are Banco Itau Unibanco, Banco Bradesco and shopping mall operator BR Malls while Ambev is not just a pure play Brazil stock. Temer will be Brazil’s President in the next four weeks. I expect the stock market rally to continue as Temer implements his ideas on fiscal austerity and structural reform.
The iShares Brazil index fund (symbol EWZ) is up 32% for US dollar investors in the first four months of 2016. I expect there is at least another 20% upside left in EWZ, in the land of samba, Pele, Gisele and yes, Dilma!
Argentina has defaulted on its sovereign debt eight times in its history as a nation, has a 30% inflation rate, a 6% fiscal deficit and publishes economic statistics that rival China in their unreliability. Yet Argentina is also the hottest sovereign bond issuer in the emerging markets. The world’s smart money bid $68 billion for $16.5 billion in new Argentina bonds, the first new issue since the $100 billion sovereign default in 2001. Argentina’s 13 year old Peronist nightmare under the Kirchners is over and President Macri’s peso devaluation, subsidy reform, tax cuts and deal with holdout creditors have all mesmerized the Euromarkets. Argentina’s US dollar ten year note is very attractive at 7.6%, given that Colombia yields only 4% and Paraguay trades at 5%. Index funds will be forced to buy $4 billion of the new issue and the sovereign credit cycle will be upgraded in 2016. A dovish Yellen Fed makes sovereign high yield debt a winner, especially since Argentina issued no dollar bonds after it was blackballed from the global capital markets. Unlike other frontier markets issuers Zambia, Ghana and Bangladesh, Argentina is a developed native, albeit in recession and vulnerable to the decline in both Brazil and agri-commodities. Argentine bank shares will also benefit hugely from Macri’s reformist economics.
Argentina’s ten year when issued bond has surged to 103 as I write, with the yield to maturity now at 7%. This is a blowout new issue. Obviously, investors without a credible allocation scrambled to accumulate Argentine debt in the secondary market. The successful sovereign issue now means the provinces of Córdoba, Mendoza and Entrerios can issue debt in the international capital markets.
Stock Pick – Blackstone is the world’s top property investor
With $344 billion in managed assets, Blackstone Group LP is the world’s largest alternative asset manager and has raised $200 billion in the last five years using strategies and product areas that did not even exist at its IPO in 2007, at the peak of the credit bubble. While its core is a private equity business not dependent on financial engineering or leverage to create value, Blackstone has also emerged as the world’s largest property investor. However, storm clouds in the financial markets mean its shares could fall to 25-26 due to lack of IPO exits and stresses in the high yield/bank loan syndications markets. The multi-strategy hedge fund business has delivered dismal returns. While Jonathan Gray’s $100 billion assets under management (AUM) property business has been a winner, Blackstone faces a potential peak in the commercial real estate plus lower allocations from sovereign wealth funds in the GCC/East Asia.
Blackstone has made huge bets with its LP capital in the global property markets. The Hilton buyout in 2007 was financed with $5.5 billion on cash and $20 billion in syndicated bank debt. Unfortunately, the leveraged buyout of Hilton, designed to transform a tired, America-centric brand into a global, asset light, managed/franchised hotel powerhouse, was spectacularly ill-timed. As the credit bubble peaked in 2007, so did the property cycle. The value of Hilton fell 70% as corporate/vacation travel budgets were slashed in the global recession and Blackstone was forced to inject more cash and renegotiate bank debt in its embattled Hilton buyout. Yet Blackstone was eventually able to transform Hilton into the world’s leading hotel management firm, floated its shares in a New York IPO in December 2013 and eventually earned $10 billion on its equity in the once underwater deal.
The 2008-9 banking and credit trauma changed the landscape of global property investing. Morgan Stanley and Goldman Sach’s buyout funds were devastated in the crash. Blackstone used the tsunami of home mortgage foreclosures to buy 50,000 homes, spent an average of $25,000 per house on refurbishment and rented them out to millennials disenchanted with the former American dream of home ownership. Blackstone is now the world’s largest owner of commercial real estate as well as the largest US residential landlord.
Even though Blackstone has made massive, concentrated bets on real estate bets, it has also nimbly timed the property cycle and not overpaid for assets, a fatal mistake since property returns are so dependent on bank leverage and capital markets. For instance, Blackstone sold vast parts of the $39 billion Equity Office Properties (EOP) office tower empire to New York developers, some of whom later went bankrupt because they overpaid for assets they financed with too much bank debt. Blackstone’s property funds have returned a stellar 17% composite return making them a magnet for the world’s savviest pension funds, sovereign wealth funds, insurance companies and family officers. No other property investor in the world has so successfully timed property cycles driven by cranes, construction, footloose capital and ego!
Yet private equity faces myriad challenges. Dodd Frank places private equity and hedge funds under the regulatory scrutiny of the SEC. Investors have revolted at the idea of paying exorbitant fees without value creation (value destruction, in the case of most GCC private equity fund houses, led by Global in Kuwait!). European regulators have cracked down on post-acquisition asset stripping and dividend recapitalizations. There are also Basel Three related constraints on US syndicated bank loans to finance leveraged buyout deals on Wall Street.
Blackstone shares have fallen 34% in the past year to 28. First quarter revenues 2016 dropped 65% and net income plunged 85% on the prior year. The dismal exit markets for leveraged buyouts, the risk premium spike in energy high yield debt and commercial mortgage backed securities and awful hedge fund performance have all taken their toll. Even though Blackstone slashed its dividend by 70%, its div yield is still 3%. The firm is now a $344 billion AUM colossus. My buy/sell range on Blackstone remains 26 to 35 in 2016.
Market View – Ventas and health care real estate investing
Healthcare real estate is a $1 trillion market in the US alone and can offer investors some of the most consistently profitable niches in global property markets. Ventas is Wall Street’s preeminent healthcare real estate investment trust (REIT), whose shareholders have earned more than 2400% since its IPO from its successful acquisitions in senior housing (assisted living) specialized hospital ownership and medical office buildings. As the Baby Boomers, the richest, largest generation in American history, reaches its retirement years and Obamacare adds 20 million people in to Uncle Sam’s insurance umbrella, I cannot think of a more profitable long term property investment theme than senior housing, medical office buildings and specialist hospitals. Healthcare spending per capita for Baby Boomers in the 50 – 65 age group is three times higher than the other demographic segments in US society.
This is the reason Ventas’s $3.1 billion acquisition of Atria Senior Living Group, the fourth largest operator of assisted living opportunities in the US, was a strategic coup. It is significant that Atria’s revenues are derived from private consumer demand, not US Federal government disbursements. Obamacare will also benefit the firm’s medical office building growth potential since it increases the size of the US insured patient pool.
While public companies own 50 to 60% of America’s shopping malls, only a mere 12% of the $1 trillion healthcare and senior housing real estate sector is owned by REIT’s. This fragmented ownership offers huge potential for a serial, experienced healthcare acquirer like Ventas. Ventas has done $5 billion in acquisitions in 2015 and has amassed a portfolio of 1300 properties. Ventas has also diversified its net operating income among the world’s leading senior housing/assisted living operators, from Atria to Ardent, Brookdale to Kindred and Sunrise. Its acquisition skill is matched by a track record of growing the platform of its operators. There is convergent trend in senior healthcare, with growing interconnections among hospitals, outpatient facilities, post-acute care facilities and community clinics that increase its long term franchise value. The US senior population will grow seven times faster than other adult demographic segments, while seniors spend five times more than other adults on healthcare. There are 20 million US “seniors” alive now but there will be 35 million in 2030 aged 75 or more. This makes senior housing a secular growth area.
Assisted living is 40 – 60% cheaper than recreating the same benefits for seniors at home. This includes savings in nursing care, emergency assistance, dining, social life, transportation and house keeping. Ventas estimates their benefits could be $12,000 a month in New York far higher than its $5549 monthly rate. Ventas’s ownership of acute healthcare facilities is a strategic winner, since shorter hospital stays means higher spending in acute care. Investing in hospitals is all about data on its local market share, patient profile, payer/provider leverage, scale, cost efficiencies, lease/credit structures and growth prospects. Ventas is also the owner of the largest US medical office buildings, with 94% occupancy rates and 87% affiliated to major hospital chains like HCA. My buy/sell range for Ventas is 54 – 70.
Demographics and stable, growing dividends make Ventas an attractive long term investment in healthcare real estate. Senior housing rental income is resilient to recession risk since many medical costs are paid by the US government. Rental growth in medical office buildings and senior housing also hedges investors against inflation risk, which I expect to rise in the next year. Fears about aggressive Fed monetary tightening led Ventas to fall from 71 to 50 in 2015. The June FOMC rate hike could cause Ventas to fall to my 54 entry level from the current 59 price. Yet this is the class act in healthcare REIT investing, with the best strategy, balance sheet, acquisition track record, operator platforms, tenant leases and management teams in the business. Any sell off in the shares this summer should be a buying opportunity for strategic long term investors looking for a 15% total return investment.
