Investment Banks Lose Interest in the Czech Stock Market

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 Research ‘Coverage’ Halves
A study by AKRO investiční společnost, a.s., a Prague based investment firm, shows that since the end of the financial crisis there has been a steep decline in the number of investment banks publishing up-to-date forecasts for companies on the Prague Stock Exchange.
Using Bloomberg Data, the analysis studied the level of research ‘coverage’ for companies included in the Prague Stock Exchange (PX) Index. The term research ‘coverage’ refers to the number analysts’ published financial forecasts for a given listed company. These forecasts are provided mainly by investment banks but occasionally also by independent research firms. For consistency, only forecasts included in the Bloomberg ‘consensus’ were included, thereby ensuring out-of-date forecasts were excluded.

For companies in the PX index, coverage peaked in 2009, with a total of 148 separate EPS (Earnings per Share) forecasts for companies in the index (Chart 1). As at June, 2017 there were a total of only 68 forecasts, a decline of about half (-54%). By way of comparison, in 2009, there were 11,407 EPS forecasts for constituents of the Pan-European STOXX600 Index (Chart 2). By June, 2017, there were 9,856 forecasts, a decline of just -14%.
The implication is clear, as investment banks have pared back their research coverage of European stocks, the Czech stock market has been marginalized.
Chart 1: Total Number of Analyst Forecasts for Constituents of the Prague Stock Exchange (PX) Index

Methodology: The analysis utilized Bloomberg data for the ‘standard consensus’ of sales, net income and eps.*With the exception of 2017 (data as at 30th June), all data is yearend data for the index constituents at that date. There is a variation in the total number of estimates for each data item (eps, sales net income) due to the fact Bloomberg excludes forecasts not done on a basis consistent with other forecasters.

Chart 2: Total Number of Analyst Forecasts for Constituents of the Pan-European STOXX600 Index

While the number of constituents in the PX index can vary year to year, rather helpfully both, at December, 2009, and June, 2017 there were 13 stocks in the index. Therefore, the decline in coverage hasn’t been a consequence of fewer companies in the index. Instead, it is a result of a broad based loss of interest by investment banks in following Czech companies. Table 1 looks in more detail at the number of forecasts for the individual constituents of the PX Index. Once again, ‘out of date’ forecasts have been excluded from the analysis.
Of the 13 index constituents in 2009, 9 still remained in the index, as at June, 2017. All experienced declines in research coverage. Czech ‘blue chip’ CEZ saw the number of published EPS forecasts for its stock drop from 22 in 2009, to 8 as at June, 2017. Similarly, Komercni Banka saw the number of forecasts decline from 18 to 10. Among the remaining companies in the index, with the possible exceptions of the dual listed Austrian titles (Erste Bank and Vienna Insurance Group), the figures look no better: CETV (from 10 to 3), Pegas (4 to 1), Erste Bank (24 to 18), Philip Morris CR (6 to 3), O2 CR (17 to 3), Unipetrol (8 to 2) and Vienna Insurance Group (11 to 8).
 Table 1: Number of Sales, Net Income & EPS Forecasts for Constituents of the PX Index

Source:BloombergData/ AKRO investiční společnost, a.s.                                                                                                               
Author’s note: Only forecasts considered as up-to-date, and therefore included in the Bloomberg ‘Consensus’, have been included.
Why Have Investment Banks Curtailed Their Coverage of Czech Stocks?
The halving of Czech research coverage needs to be seen in the context of generalized pressure on the research departments of investment banks operating in Europe. The painful restructuring of the European Banking sector, and the move to low cost passive (index) investing, has led to the overall decline in published research; as already noted earlier.
The particularly steep decline in the coverage of Czech stocks by investment banks isn’t hard to explain either. It’s the combination of the following:
·       Very poor performance of the Czech stock market.  Between Dec, 2009 and June, 2017, while the Pan-European STOXX600 index rose +49%, the Czech PX Index fell -12% (Chart 3). ECM, AAA Auto, Orco and NWR delisted during the period, meanwhile VIG fell -12%, CEZ fell -54%, and CETV a whopping -86%.

Chart 3: The Prague PX Index has Performed Poorly Compared to the STOXX600 Index

·       Lack of an appealing investment thesis. For many investment banks, covering companies in non-mainstream markets only makes sense if a positive investment case can be made. Perceived poor governance at State controlled utility CEZ and the potential negative implications for minority shareholders of any future restructuring of the company make CEZ a difficult company for investment banks to recommend. Similarly, the entire Czech banking sector remains under the cloud of a possible discriminatory tax.
·       Thin volumes. The Prague stock market has long-suffered from small ‘free floats’ (the number of a company’s shares freely tradable) and low trading volumes (Chart 4). During the period, the government lengthened the period (to 3 years from 6 months) in which capital gains became payable. This action merely incentivized Czech investors to trade even less. Recently, both Pegas Nonwovens and Fortuna have seen their free floats decline.
Chart 4: PSE Annual Equity Trading Volume (CZKbn)

Source: PSE/World Bank. Nb. Four equity issues account for approximately 95% of equity trading

‘Neglect’: Does it matter?
The lack of interest in the Czech stock market matters a great deal. As a recent World Bank report[i] noted, the Czech capital market already suffers from being too ‘bank-centric’. While bank finance is important, equity finance is generally a more suitable form of finance for the development of young entrepreneurial companies.
Negligible research coverage by analysts will undoubtedly inhibit the development of the Czech equity market. ‘Neglect’ by analysts is often associated with low equity valuations (implying an unnecessarily high cost of equity finance), low trading volumes, and increased scope for price manipulation and the mispricing of securities. In 2009, only one stock (AAA) was so ‘neglected’ that it had coverage by less than 3 analysts. By 2017, the number of neglected stocks had risen to 4 (Fortuna, Kofola, Pegas Nonwovens and Unipetrol). A further 4 stocks (CETV, Stock, Philip Morris CR and O2) were, as at June 2017, followed by just 3 analysts and therefore may be viewed as on the cusp of ‘neglect’.
MiFidII – From Bad to Worse
Next year sees the implementation of the MiFidII Directive, a monolithic document with reputedly some 1½ m paragraphs. A key aspect of this new regulation is the ‘unbundling’ of research services from dealing commissions[ii]. The separate charging for research services will undoubtedly put further pressure on the research departments of investment banks. If researching companies on the Czech stock market is of somewhat marginal importance for investment banks now, it will be even less so post MiFidII. In terms of research coverage, the Czech stock market is likely to be a major loser from the implementation of MiFidII.
The Prague Stock Exchange – In Terminal decline?
The slump in research coverage is just the latest symptom of that the Czech equity market is in crisis. What regular research there is, is now mainly undertaken by Czech brokers or banks which are based in the region. Otherwise, research into Czech stocks would appear somewhat ad-hoc and sporadic[iii]. This situation is unlikely to change in the near term. As discussed, the introduction of MiFidII will add further pressure on research coverage. Furthermore, the recent share purchases by strategic investors in Pegas Nonwovens and Fortuna means the tradable ‘free-floats ‘of these stocks is now minimal. This means there will be little incentive for investment banks to research these two stocks. The future delisting of both stocks is a distinct possibility. The ‘Czech’ stock market will look increasingly like a market in name only, ‘cobbled together’ by the inclusion of some dual listed stocks[iv].
  Time to Act
To reverse the waning interest in Czech equities, the development of the Czech equity market needs to be made a priority. In this context, the World Bank’s recent Capital Market Assessment /Market Development Options - Czech Republic is a timely and welcome contribution. The study contains numerous specific proposals. These proposals should be given serious consideration by the new Czech government.
More generally, however, there needs to be a change of mindset. As the World Bank report noted, efforts need to be made to build investor trust and confidence in the market. Investors’ property rights must be better protected than has hitherto been the case and much more effort must be made to promote Prague as a financial centre. In these respects, actions will speak louder than words.
Jeremy Monk
Investment Director,
AKRO investiční společnost, a.s.
27th October, 2017

To read this article in Czech, please click here.

The author would like to acknowledge the help and advice of Sayo Ando, Ami Yao, and Ponprom Rojanakiratikan at Bloomberg in compiling the ‘coverage’ data that went into this article.

[i] Capital Market Assessment /Market Development Options Czech Republic. World Bank Group. September, 2017
[ii] AKRO investiční společnost, a.s. has long had a policy of relying on proprietary, internally generated, research. External research and other services, where required, are paid for separately by the investment company as an expense and not ‘bundled’ into trading commissions, or ‘softing’ arrangements, where the costs are borne by client funds. AKRO investiční společnost, a.s. trades only through low cost, execution only, brokerage services.
[iii] As at writing, 26/10/17, of the 21 sets of forecasts for CEZ, only 11 are up-to-date.
[iv] 6 out of the 13 stocks in the Prague PX Index are incorporated outside of the Czech Republic (Erste Group-Austria, Vienna Insurance Group-Austria, Stock Spirits-Britain, Central European Media-Bermuda, Pegas Nonwovens-Luxembourg, Fortuna-Netherlands).