Synchronicity

Latin American stock markets have been explosive this year, far outpacing even the spectacular gains in the U.S. stock market.

Andy B. Skov, a San Francisco native, has been co-manager, along with Robert L. Meyer, of the Morgan Stanley Latin America stock fund since its inception in 1995.

Skov joined Morgan Stanley three years ago after a four-year stint at Bankers Trust New York Corp., where, as a member of the Latin American corporate finance group, he lived in Argentina for two years doing equity research and mastering Spanish.

Skov, 31, a Phi Beta Kappa graduate of UC Berkeley who majored in political science and economic development, also picked up Portuguese on the job at Morgan Stanley because of the importance of Brazil to the firm’s investments.

He was interviewed at his New York office by Times staff writer Thomas S. Mulligan.

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Times: What are the big themes in Latin America now?

Skov: Economically, we’re having for the first time in many years a synchronized expansion throughout the region, although different economies took different routes to get there.

Secondly, the giant wall of worries that all bull markets have to climb was erected very high after the Mexican [peso] devaluation in 1994. Since then, with the restoration of solid economic fundamentals and a continuation of the reforms, we’ve started climbing that wall of worry.

A third theme, which has really been the biggest engine for the market overall, is privatization in Brazil. In other countries, government-owned companies didn’t trade on the exchanges. They were usually sold to strategic investors and only later were floated onto the stock market. By the time public investors got access to them, two to three years into the process, a lot of the earnings growth had already taken place. In Brazil, though, you have government majority-owned companies that are slated to be fully privatized but have been listed on the exchange for years. So investors are able to participate from the earliest stages in the expected earnings growth explosion that’s going to come from privatization.

Times: What’s happening in the other big economies?

Skov: Chile, ironically, was growing too fast, and last year the government tightened monetary policy to slow down the economy.

Mexico and Argentina are both in similar stages of recovery, although Argentina’s recovery has been much more robust, in part because their recession was much less severe. Argentina is probably going to grow between 6% and 7% this year.

Times: What is leading the growth in those two countries?

Skov: In Mexico, it’s been exports. In Argentina, domestic investment, especially in infrastructure and mining. There’s been a great agricultural recovery as well because of high food prices worldwide. The consumer sector in both countries has been relatively weak. We expect a consumer recovery, but we don’t think it will be particularly strong.

Times: And yet I see your fund holds a number of retailers.

Skov: We’re very active in retail because of a trend we think will continue over the next 10 years, which is the replacement of small ma-and-pa stores with larger-format franchise chains. It’s something that Wal-Mart Stores has done in this country for 20 years, and now it’s happening in Latin America. We’re investing pretty aggressively in companies leading that change.

There’s Santa Isabel in Chile, Disco in Argentina, Lojas Renner, Lojas Arapua and Pao de Acucar--all in Brazil--and Soriana and Cifra in Mexico.

Times: Wal-Mart likes Cifra too--they just announced that they’re buying a controlling stake.

Skov: People always tell me, “Oh, if you like retailing in Latin America, why not just buy Wal-Mart because they’re going to kick the pants off these Latin American retailers.” But the fact is, Wal-Mart hasn’t necessarily done better than the Latin American retailers they’ve gone head-to-head against. Wal-Mart’s buying Cifra is an admission that they need local expertise.

Times: What kind of price-to-earnings multiples are you paying for stocks in Latin America?

Skov: Our portfolio right now trades at between 13.5 and 14 times 1997 earnings. Our projected earnings-per-share growth for those companies for 1997 is 18% to 20%, and we expect roughly 17% to 18% growth for 1998.

Times: Those P/Es are lower than the average for New York Stock Exchange companies now. Would you say the Latin American stocks are cheap?

Skov: Latin America has always been talked about as a great cheap market and a “value” play. But the problem with playing value is that by definition it’s a short-term view. If you buy something because it’s cheap, that means you’re going to sell it when it’s less cheap, as opposed to buying something because you think it’s growing and just let it grow.

The thing I’d rather emphasize is our stocks are growing their earnings 18% to 20%, and will grow roughly 18% next year. At this point, because of the perceived risk, we happen to hit that great growth at an inexpensive price, though I don’t think that will continue for very much longer as the fundamentals of the region continue to shine through.

Times: I notice that you hold pretty big positions--5% of the fund, or more--in some individual stocks.

Skov: Our style is to run a fairly concentrated portfolio of 50 to 60 stocks. We won’t hold many more than that ever, for a couple of reasons. First, the Latin American markets are themselves very concentrated--that is, they’re characterized by a few really large-capitalization stocks. Telmex [Telefonos de Mexico] represents 30% of the Mexican Bolsa, for example, and Telebras’ [Telecomunicacoes Brasileiras’] share of the entire Latin American portfolio index is 12%.

We prefer to run a concentrated portfolio because we think that the main risk is not knowing the stocks you own. It’s better to have a big position in fewer stocks, but ones you feel very strongly about.

Times: How do you get comfortable about these companies?

Skov: We make over 500 company visits a year. There’s no substitute for having a strong relationship with management and getting information directly from them, because information is sometimes not where you expect it, and things are changing so rapidly there.

Times: Tell me how an in-person visit has influenced your decisions.

Skov: Here’s a perfect one: I was in Mexico at the end of April for a three-day trip to visit all the front-line companies. First-quarter earnings had just come out, and a lot of the numbers were very disappointing to the market. The stock prices of these companies were collapsing--[Grupo] Televisa and Cemex, to give you two primary ones.

So I was visiting with management, and they were telling me about their businesses, and they sounded OK. But the stock market was telling me that things were disastrous. At that point, we decided to increase our exposure not only to Mexico, but to these individual stocks that were under such severe pressure.

[And] they’ve performed very well--Televisa and Cemex in particular.

Times: Wall Street always gets faulted for overreacting to short-term things like quarterly earnings. Is that fixation prevalent in Latin America as well?

Skov: Latin America is prone to very exaggerated swings in sentiment, both on the euphoria side and on the fear-and-pessimism side. We try to take a long-term view, even three years out, and position our portfolio accordingly. But occasionally, if we think sentiment has become exaggerated, we like to exploit those swings and enhance our performance by trading against them.

Times: Yet isn’t it hard to exaggerate the pain an investor can suffer from something like Mexico’s peso devaluation? Before the devaluation, in 1994, the very popular Telmex peaked at $78 on the NYSE. Now it’s trading at around $48. Do I have any assurance that won’t happen again?

Skov: In Telmex’s case, you had two things happen simultaneously: the introduction of competition in the industry and the devaluation. Competition started only this year, but the market started thinking about it a couple of years ago. Investors were so cautious that instead of paying 20 times earnings for Telmex’s growth, they wanted to pay only 10 times earnings.

In terms of overall risk, currency is always an issue. I would argue, though--and this is one of the things that gives me comfort through the whole region--that every government learned a lesson very, very deeply from the Mexican government’s mistake in handling the peso crisis. I would argue that the risks inherent in currency instability are lower now than they were in 1994.

Times: Let’s hear some stories about individual stocks.

Skov: Our biggest single position from an index-weight point of view is CRT [Companhia Riograndense de Telecomunicacoes], a regional telecom stock in the south of Brazil, run by Telefonica de Espana, a world-class telecom operator. This company is doubling its telephone lines in the next two years. We expect revenue growth to be at least 40% a year for the next two years and earnings to grow at a multiple of that. And we think, based on our own calculations, it’s selling at about eight times next year’s earnings.

Another great stock, which just became a New York Stock Exchange-listed ADR [American depositary receipt] a few days ago, is Brahma--the fifth-biggest beer company in the world. It has 50% market share and is the No. 1 beer company in Brazil. They’ve been able to benefit from rising disposable income and increased beer consumption. They’re trading at about 14 times this year’s earnings and are very shareholder-value-oriented. They’re spinning off a lot of free cash flow and have embarked on a share-buyback program.

Times: Anyone else you’d like to mention?

Skov: Televisa is a stock we like a great deal. While it’s not cheap by any valuation measure, we think they’re embarking upon a very positive restructuring that was initiated by the untimely death of [company founder] Emilio Azcarraga Milmo. Azcarraga’s son and the rest of management are refocusing on programming and lowering the cost structure.

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Morgan Stanley Latin America Fund

Strategy: Seeks long-term capital appreciation by investing primarily in stocks of Latin American companies. Opened in 1995

VITAL STATISTICS

Year-to-date total return: +39.5%

YTD total ret., avg. Latin Am. stock fund: +31.5

1996 total return: +47.4%

1996 total ret.,, avg. Latin Am. stock fund: +26.2

1995 total return: --20.4%

1995 total ret.,, avg. Latin Am. stock fund: --20.6

Five biggest holdings as of May 31: 1. Telebras (Brazil, telecommunications) 2. CRT (Brazil, telecommunications) 3. Cemig (Brazil, electric utility) 4. Femsa (Mexico, beverages) 5. Santa Isabel (Chile, retailing)

Sales charge: 4.75%

Assets: $7.7 billion

Min. investment: $1,000

Phone: (800) 282-4404

Morningstar risk-adjusted performance rating, 1-5: not rated (too new)

Sources: Morgan Stanley, Lipper Analytical, Bloomberg News