Equity market approaches correction territory

During the first quarter of 2017, the MSE Equity Price Index was trading at its highest level in 9 years but by Monday 9 April 2018 it had dropped by just over 9%.

In financial terminology, a stock market correction is normally defined as a decline of 10% from a recent high while a bear market takes place when an index or a particular equity drops by 20%.

Although we are comparing the reading of the MSE Equity Price Index of Monday 9 April 2018 to that of 3 March 2017 – a period of over 13 months which may not be considered to be a recent reading – few Maltese investors may have realized the extent of the decline. As such I will highlight the main contributors to this decline and what may have caused the index to perform negatively over the last 13 months. It is also interesting to note that almost half of this decline took place within a relatively short period of time of just two weeks as the index shed 4.6% between 27 March 2018 and 9 April 2018.

As I have highlighted in various articles in the past, changes in the share prices of the larger capitalized companies have a bigger impact on the movements in the index when compared to the smaller companies.

When one compares the share prices of all the companies on the MSE between 3 March 2017 and 9 April 2018, it is immediately evident that the share prices of the two largest companies on the MSE (namely Bank of Valletta plc and HSBC Bank Malta plc) both declined by just over 20% and they are therefore in bear market territory. This therefore accounts for a sizeable part of the decline in the index over the past 13 months.

The main reason for the decline in BOV’s share price from €2.21 to €1.75 was due to the €150 million rights issue which took place late last year at a price of €1.43 per share and which was heavily oversubscribed despite the sizeable amount of shares being issued. While the financial statements for the 15-month period to 31 December 2017 showed an overall positive performance, unfortunately some announcements in recent weeks and months did not positively impact sentiment.

On 1 December, BOV announced that it was informed that the rights entitlement of UniCredit S.p.A. (the bank’s second largest shareholder after the Government of Malta) had been assigned to another investor. The local media had then immediately confirmed that the National Social and Development Fund had purchased these rights which equate to 2.9% of the current issued share capital of the bank. However, the price at which these rights were exchanged had never been disclosed. Meanwhile, the decision by the Arbiter for Financial Services may not have been a material development and in fact the share price of BOV had begun to recover ahead of the publication of the 2017 financial statements. The share price advanced from a low of €1.74 in early December 2017 to €1.90 on 23 March 2018. However, two important announcements exactly after the publication of the financial statements dented investor sentiment and led to a renewed decline in BOV’s share price. Within 24 hours, BOV issued two unexpected but important announcements. The bank first announced on 26 March that it had been informed by UniCredit S.p.A. that it intended to dispose of its total shareholding in BOV to an investor that had already been identified. Yet again, no price was mentioned of this agreed transaction. Additionally, the day after, BOV informed the market that it received notice of a precautionary warrant by an Italian Tribunal for €363 million. The Bank reiterated that it has a strong legal case and is appealing the precautionary warrant and that it is firmly rebutting the claims instituted against it before an Italian Tribunal. BOV immediately convened a meeting with financial analysts to explain this serious development in further detail but since then, the bank has not yet confirmed that it lodged the appeal.

During the first quarter of 2017, the share price of HSBC Bank Malta plc had recovered strongly from the 12-year low of €1.55 that was reached in August 2016. The lackluster financial performance for the first half of 2017 showing the impact of the bank’s restructuring and de-risking strategy coupled with the continued impact from the negative interest rate scenario that is affecting all banks across Europe, led to a renewed decline in HSBC Malta’s share price during the second half of 2017 and the first few weeks of 2018. However, HSBC’s equity then recovered strongly following the publication of the 2017 annual financial statements and the announcement of the sizeable dividend (including a €20 million special dividend).

Although the share price of HSBC dropped back towards the €1.84 level as the equity turned ex-dividend on 12 March, the major downturn in the share price took place after an article was published on Bloomberg on 4 April in which it was intimated that the HSBC group is considering exiting a number of countries in which it operates including Malta. In essence, this implies that if HSBC were to really confirm this strategy it will therefore seek to dispose of its 70% shareholding of the Malta subsidiary.

Although HSBC Malta labelled this as pure speculation in a Company Announcement on 5 April and during the Annual General Meeting that took place last week when the bank also explained its future strategy of growing its business in Malta, the market will likely remain attentive to further announcements by the HSBC group. The Bloomberg article had indicated that the new CEO will be announcing HSBC’s strategy in June which is when a further update on the decision on the Malta subsidiary can be expected.

The MSE Equity Price Index measures the market capitalization based on the number of shares listed on the MSE. Since Malta International Airport plc only has its ‘A’ shares listed on the MSE amounting to 81,179,990 shares (representing 60% of the total issued share capital), the market capitalisation for the calculation of the index is around €398 million as opposed to €662 million if one were to include all the shares in issue. This makes a significant difference to the performance of the MSE Equity Price Index and in fact while it would be fair to say that MIA is larger than HSBC Malta, the index ranks MIA in third position after HSBC. As such, although the 15% increase in the share price of the airport operator over the past 13 months had a positive impact on the performance of the index, it would have been much greater had all the shares been listed and taken into consideration.

The market capitalisation of GO plc and International Hotel Investments plc are very close indeed at around €360 million and their ranking as 4^th and 5^th largest on the MSE changes often as the share prices of both companies fluctuate from one week to the next. While IHI’s share price performance has continued to disappoint many investors and continues to trade at well below the net asset value per share, GO’s share price only edged marginally higher over the past 13 months despite the encouraging financial performance and the recent announcement of an 18.2% increase in the dividend which places GO among the highest yielding equities on the MSE.

Although the major part of the decline in the index is due to the negative performances by BOV and HSBC, several other companies also suffered double-digit declines in their share prices. FIMBank plc was the worst performer during the past 13 months with a decline of just over 41% possibly in anticipation of the large rights issue which was only announced a few weeks ago.

The 9% decline in the MSE Equity Price Index may be difficult to understand especially given the general improvement in the financial performance of most companies on the MSE reflecting the very strong economic growth in Malta. It is a well-known fact across international financial markets that share price movements generally do not immediately reflect a country’s economic growth and the improved ratings by various international rating agencies. The upturn in the financial performance of most Maltese companies could gather momentum given expectations of a continued positive trend in economic performance, thereby enhancing profitability levels further in future years and providing companies with an opportunity to continue to reward shareholders accordingly with attractive dividend payments. This would translate into more attractive financial multiples which is the most important aspect for long-term value investors.

Meanwhile, the immediate performance of the overall Maltese equity market will be influenced by the news that will emerge from the reporting season which is coming to an end within the next 10 days. Several companies will be publishing their 2017 financial statements, namely International Hotel Investments plc, RS2 Software plc, Medserv plc, Tigne’ Mall plc, Grand Harbour Marina plc and MIDI plc. The performances of these companies, any dividend declarations and the outlook provided by each of these companies will condition overall investor sentiment. However, possibly the most important event to affect sentiment will likely take place in June once the HSBC group reveals the final details of their strategy going forward and any news related to the fate of the HSBC Malta subsidiary.

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