+ Exchange business are attractive both for their moat and resilience in an inflationary environment.
+ GPW is trading a highly attractive valuation where even a bear case gives upside in share price.
+ Attractive dividend yield north of 5%.
+ Polish stock markets have not seen the rally developed markets have, perhaps the best is yet to come?
– Poland is politically moving in a worrying direction and GPW is majority own by the state.
– Although revenue has increased nicely in the past 10 years, net income has not expanded as much.
First, thank you all for the warm words in the comment section, it’s good to be back! The inflation debate is still raging, transitory or not, at least temporarily it is a reality. Some companies are really hurt by inflation, struggling to pass on the cost, others do better. I put quite a lot of thought into what companies except banks do well in a high(er) inflation environment? I came to the conclusion that stock exchanges with reasonable current valuations (not priced for too much growth) could be a sweet spot. The hunt started and I quickly honed in on the Polish exchange – GPW. A lot of listed exchanges has re-rated in the past 5 years, many driven by the strong local equity markets, buyouts etc. Others, like Hong Kong Exchange have benefited from the US/China conflicts with Chinese companies opting to list in Hong Kong. But Poland has not seen a proper equity bull market for a very long time, valuations are still very reasonable in general and the country and its savings/pension mechanism are in early days. So the days in the sun for the Polish exchange seems to still lie in the future. Let’s dig into what the company is about and if it’s something for our portfolios.
The Warsaw stock exchange held its first trading session on April 16, 1991 with five listed companies, all of which were formerly State-owned companies that had been privatized. In 1999, Poland reformed its pension system, which contributed to an increase in domestic institutional investment, and in 2004 it joined the EU. With a record high growth in EU over the past 20 years, all these developments helped to boost trading volume on the exchange. In 2010 Giełda Papierów Wartościowych w Warszawie (GPW) listed on its own exchange.
Through my other Polish holdings I have written about how Poland is one of Europe’s strongest growing markets. On the back of such growth naturally a large population like Poland is creating national champions. Two worthy mentions would be CD Projekt (18bn PLN) and Allegro (71bn PLN) which recently listed. Overall the Polish equity market is very strong in gaming companies with many smaller players listed. GPW has also successfully developed a commodities exchange over the past 10 years. Today the commodities segment revenue is as large as the Equity/Fixed Income trading segment. To summarize on the back of Poland’s growth, so has also the exchange grown. That said, GPW is still tiny compared to developed markets with a market cap of 430m USD. Being in such an early stage of development I see plenty of long term growth opportunities for Poland and the exchange.
To get a better grasp of the company the below picture gives a good overview of how revenue is generated (press to read more):
The key revenue drivers are the equity and commodity markets. The clearing leg which often for listed exchanges is a significant income contributor is held in separate entity KDPW, where GPW Group holds a 33.3% share. Since GDP is not a majority shareholder GPW receives a profit share of KDPW, which in 2020 stood at 15.3m PLN (about 10% of Net Income).
Poland in the European context
The combined market cap of companies listed on the Polish exchange is very small compared to developed markets. On the other hand the number of listed companies is large (why I really like Poland as hunting grounds). Given the growth of the Polish economy is not an unlikely scenario the overall Poland MCAP closes its gap toward the developed markets. Let’s take a look at how the Polish equity and commodity market compares to European peers.
On the commodity side the TGE exchange that GPW operates is actually a bit more sizable compared to other venues.
Volume of trade in electricity on European exchanges in 2019 (spot) [TWh]
Volume of trade in electricity on European exchanges in 2019 (forward) [TWh]
Volume of trade on European gas exchanges in 2019 (spot) [TWh]
Volume of trade on European gas exchanges in 2019 (forward) [TWh]
Interesting short term is perhaps the gas exchanges given the huge volatility in gas prices seen in the past months. This must have created huge flows of hedging needs.
The State Treasury of Poland has the largest stake (35%) and the majority vote (52%) in GPW. The so called free float is split up below:
In general I like to buy founder led businesses, that said I also have to accept that investments are rarely perfect and ticks all boxes. As I shared in the intro over the past months I was specifically searching out exchange investments and there is to my knowledge none that is family/founder owned. In GPW’s case the State Treasury of Poland has the majority vote (52%) in GPW. So the leadership and direction of GPW is a partly political decision. This has created some hiccups in the past. In 2017 the CEO Małgorzata Zaleska was voted out by the State Treasury, who then nominated and voted in Rafał Antczak as the new CEO. Only a few months later Rafal resigned at the request of the Ministry of Development, who wanted to propose another candidate. Later that year that proposed candidate became the current CEO Marek Dietl.
Obviously its a negative if a company gets tangled up in politics, which is a risk for GPW. Then again business wise incentives should to a large extent be aligned, I’m sure the State Treasury and Poland wants to have a successful stock exchange. This type of ownership does lower the chance of a buy out, which has been common elsewhere. With all that said let’s take a brief look at the current management.
Marek Dietl was appointed CEO in 2017 at the age of 39. A graduate of the Warsaw School of Economics , where in 2012 he became an assistant professor. After the mentioned CEO shifts he has brought some leadership stability with his four year tenur. He is paid a base salary of about 100k USD and variable pay which can double that. His private shareholding in GPW is not significant (actually I can’t find an exact disclosure of shares held).
Dariusz Kulakowski is the CIO, which should be a very important position in a technology driven company. He worked in the very early days of exchange as a team lead (1993–2001). From 2006 he rejoined GPW to lead the Technology side and was later promoted to CIO.
Financials & Volumes
In its reporting GPW present a lot of data, both in terms of exchange volumes and other metrics as well as internal splits of revenue and costs. This is great, but it’s so much data that I almost struggled to see the forest for all the trees. I tried to dig out some key metrics below I found interesting.
GPW is not a high growth company but rather slowly growing. The commodities segment drove faster growth in early 2010s. Since 2015 commodities revenue has stabilized and been flattish.
As you can see EBT and especially Net Income has not followed revenue upwards in the past 3-4 years. For Net Income there was a sales of asset in 2018 that makes it harder to compare, so I will focus on EBT excluding such unusual items. Even EBT has not followed revenue upwards, meaning the margin has decreased. One of the reasons for this has been the increase in FTEs which can be seen to have a clear negative correlation with margins in the graph below. This FTE increase is at least partly to handle the expansion plans currently in development (more on that later). Other reasons are supervisory fees and charges which the company claims are hard to predict or control. The FTE costs are of course sticky but should yield a return (with a lag) as projects finalize. All in all GPW seems to have been taking costs for the future, combined with some unfortunate headwinds that would not necessarily repeat. Even if equity markets would be softer in the near term it seems likely GPW can generate Net Income around these levels.
Talking about equity markets, it’s not like the Polish market has been bullish, it has been rather rangebound. So I would not say that GPW currently is trading on some type of cycle/bull-market high level of revenue. Since 2010, after the GFC recovery the Polish stocks have been trading sideways (as many other parts of emerging markets). Will it rally from here? My guess is no better that anyone else. I can only look at the facts that the company valuations seems low/reasonable and the country has a strong track record of GDP growth. It seems reasonable that some day, Poland will have a strong bull market. If it’s tomorrow or in 10 years, who knows. The point is, the optionality is on the upside, it’s like a free/cheap call option that if Poland has a bull market, GPW will do very well.
Warsaw WIG Index
Warsaw New Connect Index
Although the market has been range bound actually volumes traded has increased. That is probably thanks to companies like CD Projekt and more recently Allegro that not necessarily pull up the stock index, but does increase volumes traded. Clear positive for GPW.
Commodities (Volumes trades)
In the commodity segment at first glance it looks good, electricity trading is up but unfortunately much of that is taken away by the decrease in property rights. Gas being stable so far, one would expect a large increase in the second half of this year. Again the headwind of property rights declining is masking good growth in electricity trading volumes. Perhaps if the former stabilizes we can continue seeing growth in electricity given how volatile this market been lately. Here have very little insight though, except observing crazy electricity and gas pricing lately.
One can approach the financial outlook in many ways with an exchange. One can try to analyze trends in trading volumes, factors that affect that etc. One can also take a macro approach looking at how Poland develops as most likely the exchange will develop as the country. One can also look at what GPW has in its tech pipeline, new products or offerings that could boost revenues. I try to look a bit at everything.
It’s hard to predict how trading volumes will develop in the future for either equities or commodities. What GPW spends quite a lot of time explaining in annual reports etc is the developments of the pension system. A growing pension system would boost trading volumes and potentially even valuations. Like many countries, especially developing ones like Poland seems to have had its fair share of set backs in creating a stable pension system. There has been reforms in the past which basically clawed back pension into some new common pool, trust has been lost. Without going into all the details, its basically been a mess with multiple reforms. This perhaps sounds bad, but even in developed European countries this is often a mess, or at least poorly managed. A new pension reform is recently rolled out and people have the choice of using an individual pension accounts (IKE) and employer sponsored PPK. I try to take a more helicopter view on this. As Poland grows richer people will save for their pension, perhaps more if the state sets up great pension systems. But even with terrible pension reforms I believe enough people have some type of self preservation to put some money aside for old age. In the end it’s mostly a function of how well Poland is doing. So how is Poland doing?
Outlook for Poland
OECD data shows how exceptional Poland’s GDP growth been (compared with Europe). This is one of the main reasons I believe GPW growth will be better than for most of other European exchanges. Poland has been hard hit by Covid though and vaccination hesitancy seems a bit high (55% vaccination rate). Even so the country is on a path to opening up and should from that perspective have the worst behind itself.
From a political perspective though there are still things to worry about. Poland is currently clashing with EU over a number of topics where EU is threatening to pull huge sums of development grants that would be allocated to Poland. I don’t have a strong read on the situation except that majority of Polish people are not interested to leave EU, as long as that is the case I think most of this will solve itself.
My high level view is that Polish businesses are doing a lot of things right, the population is hard working and well educated. These factors, just like for China, will be the major factors for a continue nice trend of strong GDP growth. In the counterbalance as often is the case in Emerging Markets is the political situation, which seems to go in the “wrong” direction so to say. I’m not a deeper expert at this than that I will just try to monitor that nothing too strange happens politically that could derail the country. If that does happen I expect to see this expressed by much more clever people through for example the exchange rate. There are no such signs currently.
Tech prospects and other initiatives
I good interview with the CEO Marek (a three part series) which walks one through quite a lot of the new developments GWP is up to can be found here (part 1): https://www.youtube.com/watch?v=EuEltWBsF4M
Here is a summary of some of the few points Marek touches on:
- Frontier markets
- GPW has a clear ambition to be the leading exchange for the so called east block. Companies in countries like Ukraine, Georgia, Czech Republic and Armenia does not see it as attractive to list on the local exchange (which is too small). At the same time the company might not be large enough to list in the US, London or similar. The Warsaw exchange would then be a middle ground, which lower listing costs in a country which is next doors.
- Listing business
- Marek explains that Venture Capital did basically not exist some 15 years ago in Poland. Small companies used the New connect (venture) exchange, in the past to raise money. This is the main reason GPW has so many tiny listed companies. Since VC is very much alive and kicking since a number of years, this resulted in a decline of small companies coming to the market. Which is a clear negative for an exchange. But what drives volumes and revenue for GPW is mostly large companies. What Marek believes (and it sounds reasonable) is that these VC funds that snapped up these small companies over the past 5 years often wants to make an exit at some point. So Marek expect a pipeline of new medium/large companies that will come to market in the future through the VC firms.
- Blockchain/token platform
- GPW is as many financial firms looking into blockchain technology and plans to launch a token platform. This is at least partly driven by the large number of gaming companies in Poland. These companies wants to finance projects, through crowdfunding which could be enabled through this type of platform.
- Selling exchange system – Warsaw Automated Trading system
- Helping smaller exchanges (again perhaps the frontier markets mentioned might be early customers) with a small modular system who don’t have the capabilities to build an advance exchange themselves. First launch will be for bonds. In 3-4 years will be for equities and later derivatives and commodities.
- Global Connect
- The Global Connect foreign stock market is to be launched in the fourth quarter of this year, and initially its offer will include shares of Western European companies. The WSE hopes that approximately 100 companies will ultimately be on this market.
Competition and valuation comps
Exchange are very special/unique entities in terms of moat. As soon as a company has decided to list on your exchange it’s kind of stuck/trapped there. Some companies can choose to dual list, but rarely would they de-list. Competition in the equity space happens to a large degree before listing. A Polish company can choose to list for example in London instead. This happens a lot in developing Europe and Eurasia, where the local stock exchanges are too small. Another type of competition are alternative exchanges, so called MTFs or dark-pools. These draw liquidity from the exchange and provides better execution price/services through their exchange, one such example would be Turquoise.
Scale problems can make an exchange unattractive in many ways, if there is not enough liquidity on an exchange companies list elsewhere. So that such a large company as Allegro choose to list in Poland is a huge feather in the hat for GPW and a strong signal that the exchange got enough clout to pull off larger companies listing there. Larger exchanges obviously also has the financial muscles to make technology investments needed for regulatory requirements etc. Here I think GPW can compete with larger exchanges because of cheap local labor that still has the necessary IT skills.
Below are some of the main listed exchanges and the P/E rations over time for these companies. 388 HK, the Hong Kong exchange is by far the one with highest valuation. GPW has over the last 3-4 years not enjoyed the multiple expansion that other exchanges seen.
To zoom in one one example here is an even more glaring example since GPW is accumulating a net cash position which grows larger, meaning Enterprise Value becomes lower. GPW and Nasdaq used to trade in-line back in 2010-2015, after that as you can see Nasdaq’s multiple has re-rated and GPW is trading at all time lows.
Moscow exchange has in the past been mostly trading at a lower P/E multiple than GPW but they are currently trading in-line after a strong stock performance for MOEX.
Overall exchanges worldwide has been bid up to higher multiples, GPW is the odd one out still trading cheap and I don’t really see the reason for it.
GPW is a highly cash generative company with a net cash position. It seems to be able to fund development projects inhouse by existing and increased headcount and still maintain a strong profitability. According to the current strategy it is the intention of the GPW Management Board to recommend to pay above 60% of the consolidated net profit in dividends. This gives a very attractive dividend yield of about 5.7% currently.
GPW has the past 5 years grown revenue with 4% annually and by 6% the past 10 years.
- Discount factor: 10%
- Tax rate: 19%
- Revenue Growth rate next 10 years
- Base: 4% (60% probability)
- Bull: 7% (25% probability)
- Bear: 0% (15% probability)
- Base: 62 PLN
- Bull: 74 PLN
- Bear: 50 PLN
- Weighted target price: 63 PLN per share (43% upside to current price)
I’m always happy when my bear case is actually higher than the current price. That gives me a lot of comfort that I reduced downside risk and have a good margin of safety. The current MCAP is actually pricing in a yearly decline of -3% in revenue for the coming 10 years. This seems highly unreasonable, even if we see a stock crash tomorrow. Revenues would recover in the next few years after that (it even did after 2008). In general GPW is a low risk case where potential upside is not huge but waiting for the upside to materialize pays you today over 5% dividend yield. I’m happy to take a position here, which I already announced (position taken at similar price as previous close).
This is the DCF or dividend way of looking at things, one can of course also do a peer valuation comparison. With a stronger sentiment in the Polish stock market and a commodity market that starts to increase revenue, it’s not hard to see GPW trading up to a multiple more in-line with peers, so at least P/E 20 which would be in-line with the bull case scenario.
Hope you enjoyed another stock picking deep dive, this took a lot of time to research as exchanges was a new area for me. Learned a lot so it was well worth it. And I probably need to dig even deeper to build more conviction. As always comments and thought appreciated. Hope some of you got my reference to the 30 year jubilee of Nirvana Nevermind 😉
Key Metrics to ongoingly follow
- Political situation in Poland
- No operating margin deterioration
- Revenue growth