The bombings in the northeast city of Barranquilla at the end of January are a savage reminder of the evolving political setting in Colombia. Despite the government’s signature agreement with the Revolutionary Armed Forces of Colombia, commonly called FARC, other terrorist groups continue to operate. In this most recent incident, the National Liberation Army, known as ELN, claimed responsibility for the series of attacks, killing seven police officers and wounding dozens. Cross-border investors are unnerved by these headlines.
Isolated terrorist incidents, albeit tragic, will not derail a strong economic story. In Colombia, GDP growth could reach 2.9% this year, well above the 2.0% or so expected on average in Latin America. Recovering commodity prices are a huge boost, so too are outsized infrastructure outlays. As a testimony to this growth outlook, the Colombian central bank announced that its 25 basis point interest-rate cut at the end of January would be the last for this easing cycle.
Global investors tend to focus on headline political developments in emerging markets in ways that local investors do not. Politically-motivated violence has been a recurring backdrop in Colombia for at least two generations. FARC, for instance, was formed in 1964. The stock market was volatile after the recent Barranquilla bombings, but that actually reflected oil-related trading patterns in Ecopetrol, the largest single stock by capitalization on the Colombia Stock Exchange. The broad-based Colcap Index is otherwise up a dollar-based 11% in the year-to-date period through February 2.
Ecopetrol is the local blue-chip benchmark. Colombia ranks as a top 20 oil exporter; its capacity is similar to the United Kingdom or Azerbaijan. Ecopetrol controls a dominant portion of the domestic business, although it is not a strict monopoly. Among cross-border investors, Ecopetrol is considered a more conservative portfolio holding than Pemex and Petrobras, the Mexican and Brazilian oil giants. If the oil price continues to improve, Ecopetrol’s stock price should also be buoyant.
The real gem in Colombia, however, may be the financial services sector, representing the largest component of the domestic economy at about 20% of GDP. One reason for that largess is that the country runs a mandatory pension-contribution system. The combined market capitalization of the major bank stocks is near one-third of the total stock market, or about twice the size of Ecopetrol.
Global investors should be encouraged by the fundamental story among Colombia banks, the largest of which is Bancolombia. You can scratch the classic emerging-market stereotype of slow-to-innovate financial institutions that are dogged by government regulation. As a group, these banks are altogether different. We see two trends worth watching, both of which should propel bank stocks over time:
Asset Growth. Financial inclusion rates are low. According to the World Bank, only 39% of the Colombian population over 15 years old has a bank account. Compare that to 68% in Brazil and 63% in Chile. As the volume of bank accounts grow, the role of credit in the economy should also expand.
Financial Technology. The major Colombian banks are highly profitable, empowering them to go on a startup acquisition binge, especially among local fintech players. Average return-on-equity among the major banks is close to 15%, compared to about 10% among US banks. The ratio is lower in Europe.
The fintech angle deserves attention. Colombia has the third largest number of fintech companies in the region at 124 firms, compared to 230 in Brazil and 238 in Mexico, according to Finnovista, a venture-development consultant. Take-over expectations may be one reason why valuation levels among some Colombian startup companies are so lofty, in our view. Acquisitions by traditional banks of fintech companies could have a further impact on enterprise innovation.
The dark shadow lingering over the investment story is the May presidential election; there is also a March parliamentary vote. President Santos is constitutionally barred from running again. He is also deeply unpopular. One reason is that many feel the FARC deal is overly generous. Another is ongoing corruption scandals. A prominent case involves bribes paid by the Brazilian construction giant Odebrecht to Colombian officials.
Santos’ weak approval rating opens the door to emerging national politicians. The front runner is Sergio Fajardo, a recent governor of economically-powerful Antioquia Province, where the city of Medellin is located. Yet Fajardo is vulnerable. Provincial debt levels ballooned enormously under his leadership. The opposition is likely to paint him as a fiscal profligate. Adding texture to the race, the former FARC guerilla commander Timochenko is now set to run in the May election.
The political setting could upend interest in the stock market over the next few months, but we are still drawn to the opportunity because of the underlying growth potential. A primary focus is the robust banking sector. We are prepared to look beyond sporadic violence. Local companies can probably manage that risk better than distant analysts. ■
Our Vantage Point: Cross-border investors may be surprised at the upside potential in Colombian equities in 2018. We expect to see most of those prospective gains in the second half of the year, after investors are more comfortable with now-uncertain election results.
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