Government instability and lack of structural reforms - key vulnerabilities of the Romanian capital market

Reporter: East Capital Group manages funds that invest in the capital markets of Eastern Europe, including the Romanian market. In your opinion, what are the main strengths or opportunities presented by the leading companies on the Bucharest Stock Exchange? Could you elaborate?

Eglė Fredriksson: We see strong investment opportunities in Romania through, for example, the Eastern Europen convergence theme to the west. The penetration of essential services such as banking, healthcare and others remains lower than in the broader EU and also compared to other Central and Eastern European countries. This creates potential for structural growth.

We like companies that offer this type of structural growth and who are market leaders in their sectors, offering strong double-digit topline growth and superior margins. Additionally, while many of these companies are in an expansion phase, we place great emphasis on the ability to generate long-term free cash flow and ultimately deliver value to shareholders in the form of dividends too.

Reporter: What investments do East Capital Group funds hold on the Bucharest Stock Exchange (in terms of companies or sectors)? What were the reasons for choosing these investments, and what prospects do you foresee for them?

Eglė Fredriksson: We do not comment on individual investments but, as said, we like banks, healthcare and consumption companies with good growth and FCF potential.

Reporter: What do you consider to be the primary vulnerabilities of the Romanian capital market?

Eglė Fredriksson: The Romanian capital market faces several key vulnerabilities. Political risks, government instability and lack of structural reforms remain major concerns.

Additionally, economic growth has slowed in 2024, impacting investor confidence and raising macroeconomic concerns for both bond and equity investors.

Liquidity remains limited and the market still lacks visibility - international recognition and investor awareness.

Valuations have also become less attractive, as stocks are no longer trading at the deep discounts seen previously.

Furthermore, the absence of new IPOs and decline in dividend payments compared to 2023 means few market triggers that attract investors.

Reporter: The valuations of the leading stocks listed on the Bucharest Stock Exchange are lower than those of Western European markets and even lower than those of comparable Eastern European markets (see Note 1). What do you believe are the reasons for this valuation discrepancy?

Eglė Fredriksson: While the Romanian market is often perceived as undervalued, if we look at the forward multiples for 2025e, it is not much cheaper when compared with markets like Poland; Bloomberg consensus values Polish Wig20 index at 9,2x while the corresponding multiple for the BET index is 13x. Additionally, earnings growth expectations differ significantly - analysts project a 28% EPS growth for the Polish Wig20 index while the corresponding EPS growth for the aggregate holdings of the BET index is a decline of 11%. This gap could be why investors see that the valuations on the Romanian market are currently not very attractive.

Reporter: According to the Federation of European Securities Exchanges (FESE), the Bucharest Stock Exchange is the second largest in Eastern Europe, ranking above the Hungarian and Czech stock exchanges. However, the value of transactions is significantly lower (see Note 2). What, in your opinion, are the reasons for this situation?

Eglė Fredriksson: I think Romania has potential with its large midcap universe but many of these midcaps are currently still too small for interanational investors looking for higher liquidity and/or attractive multiples to compensate for lack of liquidity.

In comparison, markets like Hungary or Czech, while not large, feature several highly liquid blue chips that attract foreign investors, who may then eventually also include some midcaps in their portofolios. Such larger liquid blue chips are not currently available in Romania, and the valuations of the larger index constituents are more fully valued compared to peers.

Reporter: Following Hidroelectrica's listing, the likelihood of the Romanian capital market being promoted to the MSCI Emerging Markets category has increased. How close do you think the Romanian market is to achieving this status?

Eglė Fredriksson: The promotion of the Romanian capital market to MSCI Emerging Markets status is a possibility, but Romania needs more liquid companies to comfortably qualify for EMs, especially as liquidity in other blue chips has declined.

Reporter: What measures do you think could be taken to develop the Romanian capital market further?

Eglė Fredriksson: To further develop the Romanian capital market, several measures could be taken. Increasing the number of sizable listings and expanding free-floats would enhance market liquidity and attractiveness to international investors. Additionally, hosting more capital market events, such as investor conferences, could help raise Romania's profile among global investors. Lastly, improved political and macroeconomic stability would provide a stronger foundation for sustained market growth.

Reporter: The current geopolitical climate is characterized by several challenges: the rise of extremist movements in Europe-whose economies are relatively stagnant, tariff increases by the Trump administration that could escalate into trade wars, an armed conflict on Europe's border, etc. How do you view the macroeconomic prospects of Eastern Europe in this geopolitical context?

Eglė Fredriksson: Despite global geopolitical challanges, Eastern Europe continues to demonstrate resilience, with strong domestic economies driven by healthy consumption and competitive industries. Moreover, countries that effectively utilize EU funds and invest in infrastructure are well-positioned to attract further investment and strengthen their banking sectors.

A potential ceasefire in Ukraine could significantly reduce risk premia and create new opportunities, particularly in the reconstruction of Ukraine. While global risks are rising, we expect Eastern European to outperform both broader European and global markets in the long run.

Reporter: Thank you!