Irish stocks offer food for thought

Gartmore’s Irish Growth trust fell, as Ireland, the world’s second-worst performing market nosedived. But Gervais Williams, the manager of the trust, is optimistic about growth.

Which was the world’s worst performing stockmarket in 2007? Give yourself a pat on the back if you picked Venezuela, where the local bourse fell by 29%. But not far behind, and rather closer to home, was the world’s second-worst performing market, Ireland, where the index plummeted 25%.

Ireland’s ISEQ index is dominated by banks (nearly half of the entire market capitalisation) and construction companies. Mix the subprime banking crisis with falling house prices in the world’s most frothy property market, and it is not surprising that sentiment turned so strongly against Irish stocks. From its peak in February last year, the ISEQ is down 30%. For investors in Gartmore’s Irish Growth investment trust, the downturn is a shock. They became used to year-in, year-out strong performance from the fund. But over the past 12 months its share price is down 17%, made worse by the widening of the discount.

The first thing that has to be said about the fund’s downturn is that it escaped the worst of the market falls. Secondly, over five years it is up 292% and, thirdly, its manager Gervais Williams, is confident that the Irish growth story is not over. “We are already well into the housing slowdown, but Ireland’s demographics remain attractive, it has low taxation and interest rates are still subnormal. The ingredients for growth are all still there,” says Williams.

He’s expecting economic growth in the Republic in 2008 to be 2-2.25%, probably the lowest for more than a decade. Some commentators believe that Ireland is a mature economy, where incomes are at such a level that growth much above that level will be difficult to attain.

But Williams is optimistic. “The global credit crunch is all about balance sheets. A lot of countries have debt to GDP ratios of 60% or more. In Ireland the government has no debt, so it can commit to long-term spending plans on infrastructure and social housing. Over the next seven years the government will spend €184 billion (£137 billion) on infrastructure, which will be one of the main drivers of growth.”

One of the Irish economy’s key strengths, he says, is that it has managed to expand employment while keeping a lid on wage growth. Its open door policy to European Union migration has seen Poles and other East Europeans move to the country. Yet it has created a lot of high-wage jobs, too.

But what happened in 2007 was that sentiment turned savagely against Irish stocks. Ireland’s small market – it has only 80 or so stocks – makes up under 1% of the European index. At the beginning of the year, institutional fund managers looked at the country, saw which way the housing market was heading, and decided to take profits.

Then came the credit crunch, and Allied Irish Banks (AIB), Anglo Irish and Bank of Ireland all took a beating, even though there is little evidence of involvement in subprime or collateralised debt obligations. Today the Irish market is on a forward price/earnings multiple of just 9.6 and is yielding 3.3%.

Williams at one point pulled the fund out of banks, but has since piled back in. AIB is now 11% of his portfolio and he has also put 4% of the fund into Bank of Ireland. But although he says AIB is “very cheap” he’s not entirely gung-ho about Irish stocks. “We have been fully cashed up – at one point our cash levels were 17-18% – but that’s now down to 10%. I’m still rather prudent.”

One theme he is chasing is food price inflation. Ireland, despite its miraculous growth, is still an agricultural country. Williams’ second-largest holding is Glanbia, the Kilkenny-based dairy business that has become the biggest cheese producer in America. Its factories in Idaho produce 300,000 tonnes of cheese in a country where Williams tells me there’s a supply shortage. Its shares have managed to avoid the sell-off elsewhere in the market, rising to €5 from €3.5 a year ago.

Other food stocks held by Williams include Fyffes, a banana giant, whose performance has been, well, banana-shaped. They sagged during the year but have curved back up and now stand where they were 12 months ago. IAWS Group, best known for its Delice de France range, is another food holding, but which has had less of a good run, falling by about 30% over the year despite reporting a 24% gain in profits in June. Indeed, across the Irish market during 2007 earnings forecasts for all but a handful of industrial and financial stocks were revised upwards.

The doomsters predict that a sustained recovery in the Irish economy is unlikely given what is going on in the construction industry. It is Ireland’s biggest employment sector, with 280,000 workers in a country with a population of just 4m. But with house prices falling by about 10%, some fear that construction activity will come to a shuddering halt and provoke a nasty recession.

But this is not a scenario that Williams sees evolving. One of his most contrarian views is on CRH. The building materials group is the biggest industrial group listed on the ISEQ and has seen its turnover soar from under €1.3 billion 10 years ago to €18.7 billion in 2006. In a trading statement issued just two weeks ago, the company said it expected 2007 full year profits to be about €1.9 billion compared with €1.6 billion in 2006. Yet the shares are down from €38 in June 2007 to €23 in trading last week. The bulk of CRH’s business is in America, where the news from the housing market just gets grimmer. And CRH can hardly rely on the construction market in Britain or Ireland to take up the pace.

But Williams has bravely put 9.5% of the fund into CRH. “I’ve gone back into CRH as I think it is a hugely cash generative company, which may have a lot of US exposure, but it also has 20% free cash flow. It is a hugely cheap stock.”

Maybe Williams is right. Despite the market woes during 2007, he has proved to be the best stockpicker on the ISEQ market. There’s no reason to dump this fund and perhaps every reason to gently rotate into it.