Following a tumultuous 2016 on the political front, 2017 was closing out to be a rather uneventful year. Europe had come through several precariously balanced elections largely unscathed, and political risk seemed to be receding. Then virtually out of the blue, Spain descended into political crisis.
An unauthorised referendum in Catalonia followed by a unilateral declaration of independence triggered a constitutional crisis, which led to the government seizing control in Catalonia. For the time-being, the government’s temporary measures have defused tensions, but with snap elections looming, uncertainty remains high and a significant amount of damage has already been done.
Exodus from Catalonia
Some 1800 companies are believed to have moved their domicile out of Catalonia since the beginning of October, and regional macro indicators have already begun to weaken. As contrarian investors, we are attracted to these kinds of situations, which may throw up long-term investment opportunities in high-quality companies.
We have struggled to find ideas in Spain of late, not for a lack of interesting companies, but because the strong economic recovery has largely been reflected in valuations. However, we are invested in the housing recovery in Spain, and the uncertainty caused by the Catalan crisis has provided an opportunity to add exposure to this trend.
Playing the Spanish housing recovery
Spanish housing is a very attractive long-term recovery theme, and has recently become accessible via the listings of Neinor Homes and Aedas Homes. Activity in the housing sector contracted very sharply after the financial crisis, but has begun to recover over the last couple of years. Housing demand is improving on the back of population growth, falling unemployment, low interest rates and better mortgage credit availability.
At the same time, excess supply has been largely absorbed. The pre-2008 housing bubble led to an excess of stock throughout Spain after the crash, forcing down prices. While there remains considerable stock in some regions, in the larger cities like Madrid, this has tumbled.
These supportive dynamics have seen house prices recover from their bottom in 2014-15. In 2016, house prices rose by 2%, although this varied significantly by region with prices in Madrid, Barcelona and Mallorca rising much more strongly. Despite this recovery, house prices remain c25% below the peak.
With housebuilding projects still c80% below their peak, the opportunity for a pick-up in housebuilding activity in Spain is considerable in our view. This is particularly positive for new and well-managed housebuilders, as most of the competition was wiped out when the housing bubble burst after 2008.
Enter the newcomers
Two of the major IPOs in Spain this year have been that of housebuilders: Neinor Homes and AEDAS Homes. As contrarians, we are often attracted to investors and companies with similar mindsets. In anticipation of a housing recovery, the backers of both Neinor and AEDAS saw an excellent opportunity to build up a high-quality land bank in some of the best cities and regions in Spain, at very cheap valuations.
With that land bank now secured, the management teams have raised capital from the public markets to allow them to fund and execute the building phase. We believe these two companies have top-tier land banks, first-mover advantages and high-quality management teams capable of executing their strategies.
This is a long-term theme, but we believe the cash generation potential is very strong and are happy to wait patiently for these rewards. Housebuilding is, however, not without its risks. The recovery is largely dependent on the continuing strengthening of macro conditions, and the Catalan crisis is a reminder of the political risk still present in Spain.
Will the Catalan crisis derail the Spanish housing recovery?
We think not, at least not in the long term. The structural drivers underpinning the housing recovery, coupled with strengthened banking system, will continue to support the broad-based recovery in the coming years. The Catalan crisis has shocked the regional economy, and doubtless will lead to a slowdown in Catalonia as investment is deferred. Accounting for around 20% of GDP,
Catalonia is an important part of the Spanish economy, so its slowdown will be felt across the country, but we believe this will be limited. A lot of the companies have simply relocated to other parts of Spain, meaning employment and investment is being shifted within the country, albeit outside Catalonia.
Approximately 15% Neinor and AEDAS’ land banks are exposed to Catalonia. It is early days, but we do expect both businesses to feel some effects in regional activity because of the current uncertainty. However, given the relatively limited exposure to the region, we believe this risk is manageable and largely priced in.
We will continue to monitor the Catalan situation closely, and assess whether any further turmoil will provide opportunities in housebuilding or in other themes.
Claire Shaw is portfolio manager of the Oyster European Mid & Small Cap fund at Syz Asset Management.