Less than a year has passed since analyst Meredith Whitney published her negative report on Citigroup. Her paper brought her fame and made her name on Wall Street. Whitney wrote, among other things, that the biggest bank in the United States was being managed in a manner that would lead it to bankruptcy. Citi will have to raise more capital, sell assets or reduce its dividend payments, or perhaps all three, she wrote.
Her bald declaration jolted Wall Street because Whitney was right, and nobody else had dared to say it before her. Four days after her report, Citi CEO Charles Prince resigned, the bank started to write off billions, and in January, it reduced its dividend payments and started to raise capital.
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We have no Whitney. We do have good analysts who have made a name for themselves and made some good calls, but not even the best have issued warnings that shocked the market, or even a single share. How it is that not one equity analyst foresaw the trouble at Bank Hapoalim? Do the analysts really learn the companies thoroughly enough to made predictions? Can investors rely on their reviews?
"I understand where the criticism comes from," says Yuval Zehira, head of equity research at Tel Aviv-based I.B.I. "It's true that in the U.S. you have analysts who cover the same company for 20 years, and here you have novices issuing recommendations. One reason is that our capital market is still taking shape."
I.B.I. takes starting analysts and cultivates them, he explains, citing techniques including frequent meetings with company managements, maintaining direct contact, and studying the sector. Zehira for one holds no truck with technical analysis: Ultimately a company's share price will reflect its performance, while technical chartists take historic figures and try to extrapolate to the future, which can't be done, Zehira says.
"It's all wrong. Obviously there will be new developments. Analysts should look only at the company's activity," he recommends. "Charting" may look sexy and clever, but it isn't good enough. "When Israel Chemicals was trading at a market capitalization of $10 billion, chartists couldn't predict that it would reach $24 billion, but analysis of its business showed the potential," he says.
Naturally, there are also bad analysts, he agrees, and even some who basically do no more than gamble. "When Chaim Katzman of Gazit Globe started buying large amounts of Ormat shares, some analysts issued recommendations to buy shares in the geothermal energy company's stock based solely on his action, which looked like a control battle. Nobody could know when he'd stop buying, but his purchases were supporting the share price, which naturally took off. That's a pure gamble," explains Zehira.
That story ended when Ormat founder Lucien (Yehuda) and Yehudit Bronicki shored up control: They borrowed $150 million and repurchased 7% of Ormat's stock, widening the gap between their controlling interest and the interest Katzman had built up. Ormat's stock started to fall and anybody who bought based on the recommendation lost money."
What does I.B.I. recommend about Ormat these days?
"Ormat is interesting, but not as cheap as before. We maintained a Buy recommendation for its stock throughout six years and the share price flew from NIS 7 to NIS 58," he says. At that point I.B.I. figured that Ormat wasn't about to rise any more and downgraded the stock to Neutral. Ormat's share price has fallen from there but the weak dollar is hurting the company, so I.B.I. isn't upgrading it back for now.
Moving on to Bank Hapoalim, I don't recollect I.B.I. spearheading any negative coverage of the bank.
"Bank Hapoalim is a great example. When the story of the provisions is over, its stock won't wait. That's why we recommend buying it now." Trying to fine-tune your move to buy precisely at the lowest point never works, he adds.
Israeli analysts are accused of too rarely issuing sell recommendations. Which stocks do you recommend against?
"Until a week ago we had a Reduce recommendation in place for [agrochemicals company] Makhteshim-Agan and now we're Neutral on its stock. We also counsel investors to reduce holdings in food companies Osem and Strauss Group. The rising prices of commodities in the world can be expected to impair their operations because they'll find it difficult to roll the full extent of the increase onto consumers."
I.B.I. also recommends reducing holdings in Bezeq because of competition from HOT and the cellular companies, Zehira adds.
No shame in being wrong
Zehira points out that companies (or their sectors) can take unexpected turns, rendering an analyst's paper moot, at least in the short run. All the analyst can do is predict the most likely scenario, based on deep familiarity with the company and its business. "We aren't ashamed to correct mistakes," he says. But sometimes the market can get it wrong, investors can overshoot, creating warps in share prices.
Analysts are too reluctant to issue Sell recommendations when warranted, Zehira agrees. "Stop wriggling," he chides his colleagues. "Some institutions have only Outperform, Sector Perform and Underperform in their ratings lexicon, and most companies get rated Outperform. Not many get Sector Perform, so who's going to underperform?" he asks. I.B.I. also has three ratings, but they're Buy, Neutral and Reduce, he says.
Analysts shy from Sell ratings not because they're irrepressible optimists, but because corporate managements hate them, and later may refuse to cooperate. It takes courage to recommend against a stock in tiny Israel, says Zehira: It's a small pond, but the companies should be mature about it.
Personally, Zehira's beat is the big "classic" holding companies, and this isn't a good time for them, he says after perusing their financial statements for 2007. Nochi Dankner's IDB had a terrific year, this is true, Dankner rode the wave well - knowing when to buy and sell and raising money at the right time.
But nowadays it's hard to borrow, especially on good terms, and the strategy of buying low, selling high and lapping up dividends isn't going to work right now. Prices are low and tycoons may talk about opportunities in the dip, but who's selling? It's all talk, says Zehira. "Everybody's sitting on the fence."
One massive project that falls under his purview is the Las Vegas adventure of Yitzhak Tshuva and Nochi Dankner, who have teamed up to build a landmark casino-hotel-residences complex at an investment as high as $8 billion. Under the circumstances, can they still pull it off? That's a yes, surmises Zehira. The two groups are patient and powerful enough to pull off the next stage of the project without borrowing heavily. Later they'll need to borrow, he says.
But he points out the lesson of the Plaza Hotel. When Tshuva bought it for $625 million (and that's before spending $400 million on renovations), everybody thought he'd be lucky to make a cent on the deal. Actually, he made about half a billion dollars, says Zehira, and that's just from selling apartments in the building. In short, he has the touch.
Back to the banks. What's your recommendation?
"Israel's banks aren't a major growth story like the banks in the emerging markets, but the investment risk in them is lower. Prices are comfortable today," he says. Their exposure to problem borrowers is low and their exposure to real estate has dropped dramatically, he adds. "The big banks will weather these times better than the medium-sized ones."
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