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Argentina: In Distress

Argentina may be the most distressed story in Latin America, but it is also the most undervalued.


A wave of bad news swept over Argentina last week. The departure of Economy Minister Martin Lousteau, the decision by Standard & Poors to place Argentina on negative outlook and the after-effects of global deleveraging left many investors running for cover.

Although Minister Lousteau was already on his way out, many people were caught by surprise. Carlos Fernandez, the head of the tax collection agency (AFIP), was selected to be his replacement. Although Fernandez is not much of a technocrat, he is more mature than his young predecessor and could be more cooperative with members of President Kirchner's inner circle. Interior Commerce Secretary Guillermo Moreno was the biggest point of confrontation, given his propensity to meddle in all economic matters. Moreno is a close ally of the Kirchners, and he is the architect of the price controls.

Standard & Poors immediately reacted to Lousteau's resignation, reducing Argentina's outlook to negative. The rating agency's rapid response to the news from the low-issuing sovereign was impressive, and it was in sharp contrast to the torpid reaction to changes in politically-sensitive issues, such as mortgage-backed securities and monoline insurance companies. Last of all, the deleveraging of the global financial system took its toll on Argentine asset prices. Prop desks are shutting down and investment banks are slimming their repo books, releasing a deluge of paper onto the street. Unfortunately, the wave of negative news did not engender a warm reception for Argentine paper-resulting in a downward gap in asset prices. Despite the negative sentiment, however, opportunities abound in Argentina. The global environment remains favorable and Argentine valuations are dirt cheap.

The reincorporation of China and India into the global economic community is increasing the demand for soft commodities. In addition to grains, the demand for rice is soaring. Argentina is one of most competitive producers of soft commodities on the planet, due to its fertile soil, abundant water supply and temperate climate. Moreover, Argentina has a well-developed infrastructure that facilitates the transportation of its agricultural products, as well as a cohesive tax code that allows for vertical and horizontal integration. This is the reason why farm land in Argentina is often 3 to 4 times more expensive than in Brazil--despite the exorbitant retention taxes. Furthermore, the departure of Minister Lousteau could suggest a softening of the government's aggressive stance towards farmers.

Although the departing minister was said to be against the measures, he could be used as a scapegoat. This would give the government an opportunity to change course. Although populists, such as the Kirchners, never admit mistakes, since it is construed as a sign of weakness, they can always blame someone else for their policy missteps. The rabid reaction to the increase in retention taxes was clearly not expected, and the government will surely have to turn away.

Consequently, Argentine asset prices are now at one of the lowest levels since the debt restructuring. Considering that almost a payout of 5.30 is all but assured during the next 19 months, then the Argentine GDP warrants are trading at very attractive levels. Subtracting out the payments that are assured by growth that was already, or being, realized, the New York Law dollar warrants are trading below 6 cents, Argentine Law dollar warrants are below 5 cents, euro-denominated warrants are less than 4 cents and the peso warrants are almost 3 centavos. However, there will be more than 40 cents residual value to be recovered in the warrants, once the next two payments are made. A similar situation exists in the Discount bonds, trading below their original issue price. Even with the under-reported inflation rate, the
Discounts are yielding almost 20 percent. This means that the yield could soar higher, if the government begins to report more accurately. Argentine corporate bonds and equities were also under pressure, providing lucrative entry points for one of the fastest growing economies in Latin America.

Argentina may be the most distressed story in Latin America, but it is also the most undervalued.

Walter Molano is head of research at BCP Securities.

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