Argentina's Default Worries: 3 Stocks in Focus - Analyst Blog

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On Sunday, advertisements from the Argentinian government appeared in several major U.S. newspapers. The beleaguered country stepped up its game against hedge fund investors asking US courts to facilitate "fair and balanced" discussions to resolve the deadlock over debt payments. As things stand, Argentina is headed for a sovereign default, a virtual replay of the events of 2001.

First Sovereign Default

In late 2001, Argentina suffered the largest sovereign default in history at the time. The amount was close to $100 billion and the country experienced a virtual evacuation of all foreign capital over the next two years. The situation was resolved through large scale debt restructuring.

The majority of bondholders accepted a government offer to exchange older bonds for newer issues, worth only a fraction of those issued earlier. An economic recovery and the new terms of debt repayment helped the government tide over the crisis over the following years.

Holdouts or Vulture Funds

However, a small fraction of bondholders, around 8%, refused to accept the terms of the two bond swap transactions of 2005 and 2010. They continued to hold the older bonds which ended up with a group of investors who "held on" to obtain greater value.

Others refer to such bondholders as "vulture funds". These are hedge funds or venture capital funds which purchase public debt of entities whose financial positions are precarious. In the Argentinian case, these investors have bought sovereign debt at a low price and are willing to undertake the cost of litigation to obtain the full value of these bonds.

Judgment and its Implications

The plaintiff in question is NML Capital, the largest of such "holdout" bondholders. This company is a subsidiary of Elliot Management Corporation whose CEO Paul Singer wants Argentina to pay the full value of these bonds. NML Capital had purchased the majority of these bonds at very low prices from secondary markets. These purchases were made when the country was already in serious financial trouble.

Last Monday, the US Supreme Court declined to hear an appeal made by the Argentinian government against a lower court ruling. The Second Circuit Court in New York had ruled in favor of NML Capital. The judgment itself does not mean that NML Capital will get paid, but it has other, more serious implications.

The ruling will indirectly force Argentina's hand. The country has to pay the "holdout" bondholders an initial amount of $907 million by June 30. If it fails to do so, it will be unable to use the US financial system to pay those who had agreed to the initial debt restructuring exercise. While, debts owed to the "holdout" group amount to around $1.5 billion, the second group is much larger and their bonds are worth $24 billion.

Argentina's Options

The country's options are extremely limited. Firstly, it can pay the initial amount to the likes of Elliot which would be politically unfeasible for Argentinian President Kirchner. Much of her credibility rests on the success of the debt restructuring exercise, following the default of 2001. The payment would also lead to the country running out of a large chunk of its foreign reserves.

The second option is to default once again. Even though this move will be a consequence of the ruling, the effect would be identical to that of 2001. The country would once again be starved of foreign investment, delivering a body blow to a weak economy.

Settlement in the Cards?

Argentina changed its tone on Monday, asking U.S. District Judge Thomas Griesa for more time to reach a settlement with the group of hedge funds led by NML Capital Ltd. Judge Griesa has appointed Daniel Pollack to oversee negotiations between the Argentinian government and the plaintiffs.

Meanwhile, reports have emerged that Elliot Management is willing to negotiate with Argentina. Further, there are indications that the company may accept bonds or a mix of cash and bonds as payment. The company is evaluating agreements concluded between Argentina and other creditors to arrive at a possible model for a settlement.

Stocks in Focus

Argentina's stocks and bonds registered gains on Monday following the request made to Judge Griesa. The country's Merval stock index gained 8.4%. However, we haven't heard the last word on the matter and the risk of a sovereign default continues to plague Argentina. The country's economy contracted by 0.2% in the first quarter of 2014 following a 1.4% expansion in the fourth quarter of 2013. Inflation is rising and a default could only weaken a beleaguered economy even more. We now examine certain stocks which may be significantly affected in case of a sovereign default.

BBVA Banco Frances S.A. ( BFR ) is a full-service banker offering both financial and non-financial services. It has a network of more than 25 branch office focused on middle market businesses and 239 branch offices focused on retail customers. Seven offices are dedicated to servicing institutional and corporate customers.

Financial institutions are the first to feel a systemic shock such as a credit default. However, the company has strong fundamentals and has gained more than 75% year to date. Following reports that the dispute between the Argentinian government and creditors may soon be resolved, the stock gained more than 6.6% on Monday.

BBVA Banco Franc holds a Zacks Rank #1 (Strong Buy). The forward price-to-earnings ratio (P/E) for the current financial year (F1) is 7.10 which makes it an excellent value proposition.

YPF S.A. ( YPF ) is an integrated oil and gas company. It has a dominant position in Argentina's exploration, production, refining and marketing sectors, as well as a growing presence in petrochemicals. In 2012, the Argentinian government acquired a majority stake in the company, a move criticized by analysts and investors alike.

However, YPF reached a $5 billion settlement with Spanish oil giant Repsol. This ended a two-year long dispute and also restored Argentina's standing in the international community to a certain extent. Despite the settlement, YPF is a nationalized company and its fortunes are tied closely to that of the nation itself.

Currently the company holds a Zacks Rank #3 (Hold) and has a P/E (F1) of 14.88, compared to an industry average of 17.

Grupo Financiero Galicia S.A. ( GGAL ) is a financial services holding company. It offers a wide range of financial products and services to large, small and medium business as well as individuals. It offers credit cards and consumer finance across Argentina.

Like BBVA Banco,this company may also be one of the first to feel a systemic impact. It may also be investigated for forex transactions performed on a specific day when the peso lost 12%. However, it is a market leader and these accusations are as yet unfounded.

Apart from a Zacks Rank #3 (Hold), the company has a P/E (F1) of 6.71, compared to an industry average of 12.10.

Possibly, the most important implication of this judgment is that the corporation can triumph over countries. This has serious implications for further debt restructuring exercises. The IMF could play a crucial role in ensuring that a dispute mechanism system is put in place so that such standoffs are avoided in future.


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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Business , Stocks

Referenced Stocks: YPF , GGAL , BFR

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