- Israel’s markets have shown resilience but optimism could evaporate if the war continues to drag.
- The conflict is now about as old as the 2006 Lebanon war.
- The country’s GDP growth could take a hit, but what about the nation’s biggest listed company Teva Pharmaceuticals?
- Can this war boost growth of Elbit Systems, Israel’s leading listed defense company?
The bloody conflict between Israel and Hamas rages on, despite cease-fires and truce talks. So far, more than 1,886 Palestinians and 67 Israelis have lost their lives. In addition to the tragic loss of life, it is becoming increasingly clear that the ongoing conflict could be one of the most expensive ones for Israel.
Initially, Israel’s stock markets reacted positively to operation Protective Edge. In the first ten days of the operation, Israel’s two leading indices, the TA-100 and TA-25 climbed by 1.4% and 1.6% respectively. This could be due to a number of factors.
Firstly, the current situation is nothing new for the markets that have witnessed several military operations over the last ten years, from Operation Rainbow in 2004 to Operation Pillar of Defense in 2012.
Secondly, both indices, particularly TA-25, feature some of the biggest Israeli companies, such as the world’s biggest generic drug maker Teva Pharmaceutical (NYSE:TEVA). These are global companies that do not depend heavily on Israel’s market. For instance, in the first six months of this fiscal year, Teva Pharmaceutical generated more than 81% of its revenues from the U.S. and Europe while the remaining came from its “rest of the world” segment which includes Israel, among other nations.
However, the market sentiment appears to be changing slowly. Since Israel began the ground offensive in Gaza, both TA-100 and TA-25 have fallen by 2% and 1% respectively, wiping off nearly all of the gains made in the prior weeks. Overall, since July 8, the TA-100 has fallen by 0.6% while TA-25 is up 0.5%.
So what has caused the markets to change its opinion? Again, this could be due to a number of factors but I believe that it is mainly because the conflict has dragged longer than market’s expectation. Inventors were probably thinking that the military operation would conclude by early August. This is evident in the prediction of one of Israel’s leading investment houses (mentioned below). However, the current conflict has already lasted nearly as long as the previous war with Hezbollah/Lebanon in 2006 which went on for 31 days. Moreover, the fighting does not appear to be coming to its logical end. As of the writing of this article, both Hamas and Israel were still engaged in rocket fire.
Secondly, following forecasts from various financial institutions, including the IMF and Israel’s central bank, the markets are now beginning to realize that this war could actually hurt Israel’s economic growth.
Missing Deficit Target
Fitch Ratings has said in a note released on Thursday that Israel might miss its budget deficit target for the current year, unless it beats market expectations for growth in the first half of fiscal year 2014. Israel’s Central Bank has said that the war could cost $1.44 billion, or up to 0.5% of GDP.
(Update August 13, 2014: Recent media reports have estimated the total cost of the month long war to be between $2.5 billion and $3.6 billion)
Israel’s investment company and the country’s biggest pension fund manager Psagot Investment House was a bit more optimistic by saying that the war will cost Israel around 0.25% of GDP growth. That said, Psagot’s estimates, which came out around two weeks ago, assumed that fighting would continue for about 10 more days.
Israel’s tourism sector could take the biggest hit and it could take a while for it to recover.
According to Psagot’s initial estimates, the industry could end up losing more than $1 billion due to this conflict.
In short, Israel’s current war with Hamas will likely have some negative impact on the country’s GDP growth which could hit stock returns this year.
On the other hand, wars are great for companies operating in the defense industry. Israel will likely increase its defense spending in the future. This could be good news for Elbit Systems (NASDAQ:ESLT), Israel biggest publicly listed defense electronics company valued at $2.6 billion.
Elbit has recently released its quarterly results that came in better than analysts’ estimates, thanks to the cost-cutting initiatives. The company’s revenues were $702.6 million, flat from the same quarter last year, while its income dropped by 11.5% to $43.9 million. The drop in earnings was largely due to one-off items. In adjusted terms, the company’s income improved by 4.4% to $52.6 million. The company’s backlog, by the end of June, stood at $6.1 billion, up from $5.8 billion a year ago.
That said, while the ongoing conflict might result in an uptake in orders from Israel, it is unlikely to cause a significant increase in Elbit Systems’ revenues or income. This is because Elbit Systems, like Teva Pharmaceuticals, is also a global company which generates more than three-quarter of its revenues from outside of Israel.
The company has been focusing on expanding in the emerging markets of Latin America and Asia, amid increasing competition from industry titans Lockheed Martin (NYSE:LMT) and Raytheon (NYSE:RTN) at home and in North America.
In the previous quarter, Elbit Systems generated 24% revenues from Israel while 76% came from its international customers. The company has also said that 72% its current backlog is related to orders outside of Israel.
The bigger beneficiaries might be the Israel focused defense companies, such as the government owned and privately-held Rafael Advanced Defense Systems, maker of the Iron Dome missile defense system.
Israel’s stock markets have been resilient but as the conflict drags along, the optimism could fade away. The longer the war continues, the bigger will be its impact on Israel’s GDP growth.
The fortunes of some of the largest blue chip TA-25 companies, such as Teva Pharmaceuticals or Elbit Systems, might not change as they generate a significant portion of their revenues from international markets. However, smaller companies that get most of their income from Israel, particularly those with exposure to the country’s tourism industry, could struggle with growth.
thanks to: seekingalpha