Contrarian Call In Emerging Market Utilities

AES Corp. (AES) recently announced guidance-beating second quarter results while Telefonica S.A. (TEF) posted accelerating revenue and cash flow growth that topped most analysts’ estimates.

Unfortunately, that good earnings news hasn’t prevented these stocks from dropping. The reason is politics. Each is caught up in developments that have called their respective value propositions into question, despite apparent good health now.

It’s wise to exclude political preferences from investment decisions. But politics often does play a major role at regulated essential services businesses.

Our view is investors are over-estimating the risks these four companies face from ongoing political developments, and thereby are under-pricing their strengths as businesses.

More valuable than the maxim “don’t catch a falling knife” is its corollary: Don’t buy stocks and bonds of a business that’s weakening. And if a company is doing badly now, much worse is likely when the economy slips and capital markets tighten.

Shares of AES and Telefonica have been pressured this summer by concerns about emerging markets. The election news from Argentina was the last straw for some investors, with results strongly indicating the Peronista movement will regain power next year.

That’s since triggered a rout in the Argentine Peso and stock market, and raised investor concerns about any company doing significant business in the country.

Fortunately for AES and Telefonica, they generated just 4.5 and 4.8 percent of their revenue in Argentina last year, respectively. And both companies have already taken substantial write-offs against their investments there, while hedging currency exposure.

If there is risk to these companies it’s if Argentina sparks a contagion that spreads to countries truly important to their results, such as Brazil, Chile and Colombia. And there is precedent, namely the “Asian contagion” of 1997-98.

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