Growing Italy risk puts equities at deepest discount in 35 years

LONDON/MILAN, Nov 7 (Reuters) – Italian shares are trading at the biggest discount to global shares in 35 years as investors worry about the budget prospects in one of Europe’s most indebted economies, although some believe the shares are too cheap to ignore.

While Italian shares (.dMIIT00000PUS) have historically been cheaper than global shares, their discount has now widened to 50%, the biggest difference since 1988, and has remained at that level for several months. This is twice as large as the average gap of the past twenty years.

Yes, Milan’s blue-chip index (.FTMIB) has recovered this year as it is heavily biased towards banking stocks that have benefited from the euro area’s strongest ever rise in interest rates.

But domestically focused companies in sectors such as consumer and industrial have been hit by an aging population, debt exceeding 100% of GDP and two decades of near-zero economic growth, interrupted only briefly by a post-COVID recovery -crisis.

That has led to Italian shares being valued overall at a cheaper price than even battered UK shares (.dMIGB00000PUS), which trade at a 33% discount to global peers.

Italy’s domestic stock market “isn’t exactly an area I want to be exposed to,” said Chris Hiorns, head of multi-asset and European equities at EdenTree, citing concerns about Italy’s budget prospects.

Recent cuts to economic growth and increases in budget deficit forecasts have revived concerns about possible sovereign problems, boosting demand from premium investors to hold Italian 10-year bonds above safer Germany above 200 basis points (bps) last month.

That gap has narrowed, but remains vulnerable. A test looms on Friday when Fitch assesses Italy’s BBB rating and stable outlook.

“A change in the outlook cannot be ruled out given lower growth, higher interest costs and the deterioration of Italy’s fiscal position,” Barclays said in a note.

Goldman Sachs estimates that every 10 basis points increase in government bond spreads costs about a 2% discount on Italian bank stocks and a 1.5% discount on the FTSE MIB index. It recommends avoiding the blue chip index after its outperformance.

Italy’s financing needs are further complicated by the country’s difficulties meeting conditions set by the European Commission in return for billions of euros in post-pandemic recovery funds.

Meanwhile, conflicts in Ukraine and the Middle East threaten to trigger a new rise in energy prices and weaken growth.

The number of shares outstanding in BlackRock’s iShares MSCI Italy ETF has more than halved from 18.9 million in October 2021 to 8.6 million. The MSCI Europe ETF has seen its share count fall by less than 10% over the same period.

“RIDICULOUS MULTIPLES”

While Italy’s weak economic outlook and high debt burden suggest that a significant stock revaluation is unlikely in the near term, investors still expected some clawback given the deep discount some parts of the market are at.

The FTSE Italia Star (.FTSTAR) index, which tracks companies with a market capitalization of up to 1 billion euros ($1.07 billion), is down 10% so far in 2023, following a nearly 30% decline last year. By comparison, the FTSE midcap index (.FTMC) is down 5% this year.

Smaller Italian stocks have been hit by outflows following the end of a government-sponsored plan to promote investment in small domestic stocks, said Giuseppe Sersale, strategist and portfolio manager at Anthilia in Milan.

“Many companies are trading at ridiculous multiples. A window of value is opening up on small caps that is worth seizing,” he said.

Andrea Scauri, senior portfolio manager at asset manager Lemanik, says high visibility of profits due to higher rates and stronger balance sheets makes Italian banks less vulnerable to debt jitters than before.

“If the spread widens, there will be short-term consequences,” he said.

Scauri owns shares in smaller Italian lenders such as Banco BPM (BAMI.MI) and Monte dei Paschi (BMPS.MI), whose cheaper valuations make them more attractive than bigger banks, he said.

Banco BPM shares trade at around 0.55 times price-to-book value and Monte dei Paschi at 0.39 times, much cheaper than UniCredit (CRDI.MI), Italy’s second-largest lender by market value and trading at 0.66 times . LSEG data stream.

UniCredit shares are up almost 80% this year and are among the best-performing eurozone banking stocks.

Fidelity International portfolio manager Alberto Chiandetti said he was looking for opportunities in the battered industrial and consumer sectors in the FTSE Italia Star index.

“In many cases, valuations have already taken into account the economic slowdown, while not reflecting the value and growth that many of these companies will have in the coming years,” he added.

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