As the financial news media has expounded Europe's emerging debt crisis, investors have shied away from companies with significant operations in Europe. Austerity measures are expected to hurt the economy, and so investors have looked elsewhere for opportunities. But is the European situation really that bad?
Companies operating in Europe are still free to only allocate capital to projects they expect will generate returns, which may seem obvious but appears to be something we take for granted. While the focus has been on Europe, severe economic problems in a country much closer to home (for North Americans, that is) have gone largely unnoticed. Venezuela has seen its economy contract 5.8% in just the first quarter of the year! While its economy is quite small compared to some of the European nations undergoing austerity measures, the effect can be much stronger for companies with interests in the small, Latin-American country due to the policy impositions of the government.
Consider a company that does business in both Europe and Venezuela. Audiovox (VOXX) derives a significant portion of its revenues from Europe, and a comparatively smaller amount from Venezuela. But consider how recent events in the different regions have affected operations and results.
Regarding Europe, the company notes that the economy is more tenuous than that of the US, and that the decline in the Euro will negatively affect results throughout the year. Nevertheless, the company sees business expanding in this region as the economies in Eastern Europe improve and exports to the region increase.
Quoting the company's CEO on the latest conference call, "Venezuela, on the other hand, is a different story." Sales were cut in half in the first quarter, as the government stepped in to control the exchange rate. Audiovox has been unable to convert Bolivars to USD (or any other currency, for that matter) so that it can procure materials to sell! Furthermore, customers are unable to obtain currency to even purchase from Audiovox.
Earlier this year, we discussed the importance of understanding the political regime under which a company's assets operate. Emerging markets can be a source of excellent investment opportunities, but not paying attention to government policy can result in a complete loss of principal, which isn't in keeping with the first rule of value investing.
While the problems in Europe are headline news, companies operating in Europe are at least free to shift capital and reduce labour to match costs with revenues and maintain margins in the long-term. But investments in companies with significant operations in countries with intrusive regimes represent substantially more risk to investors.
Disclosure: Author has a long position in shares of VOXX
