KWR SPECIAL REPORT ALERT:Thirsting For a Cuba Libre

Posted in Latin America | 06-Aug-06 | Author: Mark Turner and Keith W. Rabin| Source: KWR International Advisor

NEW YORK (KWR) August 3, 2006 -- As the world contemplates news regarding Fidel Castro’s surgery and the changes that might accompany a transition in Cuba, many investors are looking to position themselves for the gains that might be achieved.

Although news today from La Havana seems to suggest Fidel is on the mend, whether he bounces back and regains control in Cuba has yet to be seen. However the deterioration of his health is plain to see; his voice is but a harsh whisper, he missed the annual parade for the first time since the revolution this year, and clearly has trouble walking more than a short distance. Rumors that the surgery undertaken was to remove a malignant cancer tumor are unconfirmed (even denied by Cuba itself) but strong. His brother, Raul, 75, will have a tough act to follow and it is also believed by many that he too is not in the best of health. The USA has made their stance on Cuba plain for decades, and will have huge political and financial support from the wealthy Cuban ex-pats of the Miami area. We believe if the change in Cuba doesn’t happen today, it is only a matter of time before those in favor of the "transition to democracy and free markets" make their move, be it before or most likely -- after the funeral of the venerable statesman, now just days away from his 80th birthday.

Whatever the future holds and whatever government assumes power, we see Cuba as primed for an injection of foreign capital and economic expansion. With this in mind, it seems an opportune moment to look at possible investment opportunities with Cuban exposure.

Cuba’s main export is sugar, and with pure sugar plays hard to find, most eyes on Wall St would turn to Imperial Sugar (IPSU) to take advantage of the low production and transport costs to the US market that Cuban sugar would enjoy. Add the excellent earnings reported this week by IPSU, and the double figure jump seen on Wednesday is understandable. We see further upside in this company.

Sherritt International (S.TO) is Cuba’s biggest foreign investor and involved in the lucrative business of oil production off the Northern coast of the island. The profits from this business account for 23% of current quarterly revenues. However there may be a big problem for Sherritt in an open market scenario. They also currently run the country’s largest nickel/cobalt mine in a joint venture with the Cuban government. This mine accounts for 20% of their earnings. Nickel alone accounts for 20% of export revenues for Cuba. The rub is that before the Revolution of 1958, this mine was wholly owned by Freeport McMoran (FCX), who would almost certainly try to claim it back if political changes brought in a free market government. That claim may or may not succeed, but would certainly cast a cloud over Sherritt and future earnings. Thus we would avoid S.TO for the moment even though it is well positioned in Cuban industry, with a wide array of assets on the island, including hotels, tourism and agribusiness. On the other hand, while one should not consider FCX as a Cuba play per se, we do believe it otherwise offers good value given its other properties, with this being a potential plus should this issue be resolved in its favor.

The tourism industry is also enjoying strong growth in Cuba, with 7% YoY expansion reported for the last 5 years. If US sanctions are lifted, however, given its proximity 90 miles off the Florida coast that should expand dramatically. Any tourist related company that has existing ties with Cuba might come up on the radar of investors. We believe that Copa Airlines (CPA), even without any extra Cuban business, is one of the most undervalued airlines out there today. Add the expansion of its existing flight schedule into Havana airport and they become doubly attractive. It is, of course, sensitive to the price of oil, but still retains a PE of 10x and 43% YoY earnings growth. Carnival Corp (CCL), running their Caribbean luxury cruise ships, would be another company to consider. Hoteliers already established include Cuban market leader Sol Melia (, quoted on the Madrid bourse, enjoying robust growth internationally and with a stock price close to all time highs.

Cuban cigars are famed throughout the world as being of the highest quality. Although the large conglomerates like Imperial Tobacco and Phillip Morris would swallow up the production volumes with hardly a ripple on their balance sheets, we would be on the lookout for new enterprises willing to import Cuban cigars to niche markets in the USA.

A final play to consider would be mutual funds. Herzfeld Caribbean, a fund with the evocative ticker of CUBA, has enjoyed a fine week, with volumes 40 times average and a 30% spike in its price. The company has investment in Cuban exposed companies that would benefit from expansion under the current and more liberal governments, to quote their spokesman. On August 1st, it traded at a 5.44% premium to net asset value, and its five largest shareholdings included Florida East Coast Industries (FLA), Watsco Inc. (WSO) and Consolidated Water (CWCO), Florida Rock Industries (FRK) and Seaboard Corporation (SEB).

All this said, the present socialist government in Cuba is not yet out of power and the gold rush longed for by many Cuban-Americans and others may not arrive as quickly as expected. It’s also worth noting that Raul Castro, as the head of the Cuban military, will continue to benefit from the loyalty of these forces. However there would be little chance of seeing Cuban soldiers shooting at Cuban civilians live on CNN as the socialist government in Cuba has consistently been sympathetic to the views of the populace. As a result this support is more likely to be institutional in nature. If there is any groundswell of opinion from the street level in a post-Fidel scenario, Raul is not likely to oppose it. Although believed to be more pragmatic than his older brother, he does lack his political legitimacy and charisma, and no doubt recognizes the "revolution" is in for tough days ahead. Therefore he will seek to draw upon his base in the military to make the adjustments necessary to ensure survival.

In conclusion, we see plenty of opportunity to benefit from any change to the current government regime in Cuba. However, one should take into account that political changes are often painful experiences (we are reminded of the Former Soviet states). Buying into any fly-by-night stock may soon end in tears, but there is undoubtedly chance for the wise investor to get in early to one of the most promising areas of potential macroeconomic expansion on the planet.

Mark Turner is Latin American equities analyst for Hallgarten and Company and Keith W. Rabin is president of KWR International, Inc.

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