Chile’s Micro-Macro Gap: A Structural Phenomenon?

Few countries in the world are experiencing macroeconomic growth at the quick pace of Chile thus far in 2012. This would typically imply a banner year for earnings growth and stock price appreciation at the microeconomic, or corporate, level. However, companies have shown relevant declines in year-over-year earnings growth through the first half of the year. Although cyclical factors have contributed to this, we are also seeing signs of structural factors related to a maturing economy.

These “growing pains” that have occurred (and often reoccur) throughout the developed world are healthy for any developing economy, but threaten to limit corporate profit growth in Chile and possibly stock market performance relative to other countries in the region that are earlier in the curve and experiencing greater dynamism at the microeconomic level.

According to the Chilean Central Bank, the IMACEC (real GDP growth proxy) reached 6.2% in August, lifting the annualized figure to 5.5%. Economists continue to raise their 2012 forecasts, which started the year at 4.0%, but have since crept higher surpassing 5% this month. Most of this growth has been driven by domestic demand, especially as it relates to personal consumption, helped by low unemployment and a strong currency. This is evidenced by strong retail sales growth, which reached 11.3% in August, accumulating growth of 8.6% in the first eight months of the year, according to the National Statistics Institute (INE).

In contrast to these strong macroeconomic conditions, we have seen weaker figures from companies, specifically those in the IPSA stock index. Although this index is not completely representative of the broader economy (lack of mining stocks is an obvious example), it serves as a solid proxy, especially given its greater domestic exposure, comprising many sectors that have been driving GDP growth. According to data from company reports and Bloomberg, earnings of the 40 IPSA-listed companies fell nearly 20% year-over-year in the first half of 2012, while EBITDA declined 4%, causing analysts to slash their full year 2012 and 2013 earnings growth estimates. It is also worth noting that half of the companies in the IPSA have expanded abroad in order to capture higher growth opportunities in other markets. Therefore, if we isolate the earnings growth of just Chile within these companies, we are likely to see even greater year over year declines.

This abysmal microeconomic backdrop has had a direct pass-through to stock market performance, with the IPSA index returning just 1% on a year-to-date basis through September, compared to 6% in Chilean Peso terms for the S&P 500 in the United States, a market which is facing macroeconomic challenges but has seen cyclical improvements in corporate earnings. The IPSA also lags regional peers: the Colombia COLCAP and Peruvian IGBVL indices are up 7% and 5%, respectively, in Chilean Peso terms.

A relevant part of the corporate earnings mismatch can be explained by cyclical factors, such as weak global growth (impacting exporters and overall confidence) and drought conditions, which have raised costs of producing energy and thus prices for consumers. However, we have also seen a greater impact from structural factors, such as tighter banking and credit card regulation, stricter environmental requirements for new projects and greater demands by employees (salaries and benefits), who have been emboldened by the increasing competition for human capital between employers. Chile has also suffered a tough year at the corporate governance level, with scandals in retail (La Polar), consumer finance (Falabella CMR via and now electricity (Enersis’ proposed capital increase), which is leading to greater regulatory and internal corporate oversight, while hurting competitiveness.

These structural factors are ultimately healthy for the economy, society and markets, as they guarantee the sustainability and strength of the model. They should also continue to contribute to the value added of companies and the government, which is the essence of GDP, while helping the acquisitive power of families.

However, all of these issues raise costs and will keep corporate profit margins and earnings growth under pressure. Although part of the maturation process, this will likely keep pushing Chilean companies, as well as both foreign and domestic equity investors, abroad in search of higher growth and returns.

Brian P. Chase is Portfolio Manager, Head of Andean Equities, at Itau Asset Management.