Hungary investors should Czech out Eastern Europe

They’re off and running again.

Eastern Europe’s major stock markets are building on last year’s momentum and outpacing emerging markets in Latin America and Asia just as they did last year. As of March 2, the Morgan Stanley Capital International Eastern Europe index had jumped 9.5% while the Latin America index had advanced only 2.5% and the Far East index only 1.5%.

This year’s performance in the Eastern Europe index comes after an 88.5% surge in 1999. Last year the Morgan Stanley Capital International Latin America index catapulted 83.6% while the Far East index soared 53.3%.

As of March 8, the Czech Republic’s PX-50 index had ballooned 35% to 661, a 31% gain in dollar terms. Meanwhile, Poland’s WIG index forged ahead 20.4% to 21,765.8, a 20.3% advance in dollar terms. Interestingly, Hungary’s market, the all-around favorite of most investors, is the laggard. The BUX shot up 15.6% to 10,193.9, an 8.8% increase in dollar terms.

Some analysts believe Eastern Europe’s markets are becoming frothy, but investors continue to be enamored with the countries’ eventual accession to the European Union.

“These countries are going to go through a process that is going to make them behave in a certain way, a Western way,” says Sonja Gibbs, an East European economist at Nomura International PLC in London. “There is nothing like that going on in Latin America or Asia.”

West helping east

That positive view is bolstered by an expected recovery in Western Europe, which buys both raw materials and finished goods from Eastern Europe.

A one percentage point increase in Germany’s industrial output growth can add 1.6 points to Hungary’s gross domestic product, 0.8 point to the GDP in the Czech Republic and 0.4 to Poland’s GDP.

GDP rates in Hungary and Poland are expected to grow 5% this year. Meanwhile, the Czech Republic is recovering from a recession and its GDP is expected to increase between 1.5% and 2% after falling an estimated 0.5% last year.

Moreover, the technology and telecommunications stock craze that has swept Western markets has infiltrated Eastern markets as well, especially in Poland. There are several software and computer stocks on the Polish market that have skyrocketed more than 50% since the beginning of the year.

“The theme of convergence into Europe is going to be important in these markets for the next three to five years,” says Allan Conway, head of global emerging markets at West LB Asset Management in London. “We think there is a lot of additional growth potential in this particular theme. It can’t be underestimated.”

Indeed, West LB is so enthusiastic about the prospects of the EU aspirants that it actually dropped stocks in Africa that were in the portfolio so it can include only countries slated eventually to join the EU. The $30 million open-end fund is now called the European Convergence Fund. It is up 27.5% since the beginning of the year, and assets are growing about 10% a month since the name and focus change three months ago.

Nonetheless, Mr. Conway says he is not overweighted in Eastern Europe markets globally. In fact, the global funds hold Hungarian stocks only, because the worthwhile companies in the other countries have become overvalued, he says.

Other managers disagree. Glenn Wellman, managing director at Credit Suisse Investment Management Ltd. in London, says the $750 million his firm has invested in emerging markets is 25% overweighted in Eastern Europe.

“These markets just continue to impress,” says Mr. Wellman.

Likewise, Robin Geffen, global chief investment officer of pensions at Orbitex Investments Ltd. in London, says his funds now hold the maximum amount of Eastern European stocks allowed in their charters, 10%. Six months ago, Eastern European stocks accounted for only 5% to 6% of the holdings.

“In these markets you are still buying earnings, growth and assets cheaply,” says Mr. Geffen.

For example, he says, Hungarian stocks are trading around an average of 17.3 times this year’s earnings, while Poland’s issues have a price-earnings ratio of about 17.1. He said in France and Britain the average is about 23.

The Budapest bourse might be the laggard of the group but it remains an investor favorite because of good corporate governance and the country’s strong economic outlook. In early February, Standard & Poor’s Corp. raised Hungary’s sovereign credit rating to BBB+ from BBB. Despite early concerns, Hungary managed to cut its current account deficit to 4.2% of GDP last year from 4.8% in 1998. This year it could fall to 3.5%. Meanwhile, direct foreign investment continues to pour into the country, tax collection is improving and inflation is falling.

One reason Hungary’s stock market advance hasn’t matched that of its brethren is a lack of technology stocks. It has only one pure play, which is Synergon Information Technology Rt., the country’s largest systems integrator. The stock performed badly last year, but has been rebounding as the company moves to increase its activities in the consulting end of the business.

But analysts have found other interesting stocks in Hungary that have been overlooked because of the technology craze, such as drug companies Richter Gedeon Rt. and Egis Rt. Indeed, if Western investors, now pushing up biotech stocks, go east for new opportunities, these stocks could rise dramatically.

Other favorites include OTP Bank Rt., the country’s largest bank, and Matav Rt., the phone company, which has just bought a mobile phone operator and is forging into the cable and Internet businesses.

Poland’s market has been a star because of its relatively large selection of technology and Internet-related firms. It also has been given a boost from more local investment since last year’s pension reform. Stocks such as software developer ComArch SA, and systems integrators Prokom Software SA and Softbank SA have soared more than 50% since the beginning of the year.

Is it too late?

Some analysts argue the boom is over, but others insist it isn’t too late to buy. Poland is home to 40 million people and the region’s largest economy. Individuals and companies are becoming increasingly Internet- and computer-savvy, and these companies will benefit.

“These companies are going to be important as Poland goes forward and keeps developing,” says Mr. Wellman.

Ironically, despite its hefty increase, the Czech market is the least favorite among investors and analysts. Czech stocks have been rising, in part, because they started from such low levels. The Czech Republic notoriously has lagged behind Poland and Hungary in reforming its economy. There are signs that is changing. Ceska Sporitelna, one of the country’s banks, was privatized. Preparations are under way to sell a stake in Komercni Banka to a strategic investor later this year.

But here especially, investors are sticking with the big companies in major industries. Czeky Telecom, the phone company, and Czeke RadioKomunikace, which operates the country’s second-largest mobile phone company, are among the market’s strongest performers.

“It is hard to argue with market perception and the market seems to be saying this is the year of the Czech turnaround,” says Ms. Gibbs. “I’m still pretty cynical.”

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