By Kajanga Kulatunga
Since the presidential election last year, investor attention has focused on politics. With few professional fund managers predicting the election outcome or the markets’ positive reaction, a flood of research and articles dedicated to analysing political and policy risk has followed.
Focus has firmly been on the broader implications of the new US administration’s tax and deregulation agenda and the expected boost to US shares. Developed markets in Europe and Japan have also been gaining attention and favour due to the potentially negative impacts of rising interest rates on US company valuations and a rising US dollar.
A consensus investment theme has developed favouring these mature, developed markets over emerging markets – the “darlings” up until 2014. Both investment flows and returns have shown a sharp divergence in the performance of developed markets’ and emerging markets’ assets. However, we believe the fundamentals driven by demographics and consumption shouldn’t be overlooked for listed emerging markets companies.
Performance of emerging markets companies started to unravel in 2014, following the fall in commodity prices (eg in Brazil and Russia) and rising political tensions (eg in Turkey and Thailand). The sell-off was deep and brutal with some markets reaching seven-year lows.
As shown in Chart 1, the prices of commodities continue to be strongly correlated with many emerging markets, particularly in Latin America. However, local consumer-focused stocks are potentially where future opportunities lie. This is highlighted in the following company case studies.
Source: MSCI, as at 28 February 2017.
In 2002 the Thai government privatised the state-owned Airports Authority of Thailand, forming the publicly listed Airports of Thailand PCL (AOT). The Thai government continues to own 70% of AOT.1
AOT is the operator of six international airports in Thailand and also provides other transportation-related services. Importantly, as can be seen in Chart 2, the passengers who use these six airports are from the broader Asian region where air travel is set to increase over the coming decades.
Travellers from these regions do not appear to be as sensitive to domestic political events as those in the US or Europe. This has meant the company’s revenue has generally been immune to political upheavals. Throughout a politically tumultuous five-year period, AOT has averaged free-cash flow margins of 37% pa and return on invested capital of 11% pa.2
Source: ‘Annual report 2016’, Airports of Thailand. Based on the year 2016.
India has remained a favourite country for investors over the last two years since the election of Prime Minister Narendra Modi and his promise to overhaul a vast government bureaucracy to advance economic growth. Asian Paints Ltd (Asian Paints) and Housing Development Finance Corporation Limited (HDFC) are two companies that have participated in India’s rapid development to date and will likely continue to do so as economic growth picks up.
Asian Paints is a business which includes the manufacturing, selling and distribution of paints, coatings, and products related to home decor, bath fittings and the provision of related services (Chart 3). Asian Paints is India’s largest (with 54% of the overall market3) and Asia’s fourth largest paints company.4 The company’s dominant market position has provided a strong tailwind to investors. This is despite the chaos caused by the government’s unexpected decision to remove from circulation two of the country’s most widely used currency notes, as part of its anti-corruption crackdown. Five-year net profit margins have averaged 10.6% pa and return on invested capital a healthy 34% pa.5
HDFC is one of the largest diversified financial conglomerates listed on India’s stock exchange. Its core business is as a large purveyor (supplier) of mortgages in India. HDFC also has presence in banking (holding around 21% of HDFC Bank), life and general insurance, asset management, venture capital and education loans.6 In India, 21% of the population took loans to finance health care needs, 10% to finance education, 9% for business, and just 4% for mortgages.7 As the Indian economy becomes more formalised, the demand for mainstream credit is expected to increase, driving returns for the financial sector.
Source: ‘IIFL investor conference, Mumbai, India’, Asian Paints, 21 February 2017. Based on the 2015-2016 financial year.
Not all companies exposed to emerging market consumers are listed in those countries. MercadoLibre is listed on the US’s Nasdaq Stock Market. However, it is an e-commerce platform exclusive to clients in Latin America. It’s the most popular e-commerce site by number of visitors in Latin America. Originally founded in Argentina, it now has presence in 13 countries. While economic slowdowns in a lot of these countries has impacted on the overall returns of the company’s stock price, net profit margins and return on capital remain at around 17% pa.8
Source: FactSet, as at 31 December 2016.
As one can learn from the healthy financial situation of these select companies serving emerging market consumers, in spite of challenging macroeconomic conditions, investment outcomes depend on the age old factors of a company’s pricing power, margins and good management teams.
1. ‘Annual report 2016’, Airports of Thailand. Based on the year 2016.
2. FactSet, as at 10 April 2017. Past performance is not a reliable indicator of future performance. The value of an investment may rise or fall with the changes in the market.
3. ‘CMR IMG Q2 2016: Indian paints sector’, Cyber Media Research Ltd. Based on data for 2015 financial year.
4. ‘IIFL Investor Conference, Mumbai, India’, Asian Paints, 21 February 2017. Based on the 2015-2016 financial year.
5. FactSet, as at 10 April 2017. Past performance is not a reliable indicator of future performance. The value of an investment may rise or fall with the changes in the market.
6. HDFC Bank, as at 30 September 2016.
7. Financial Inclusion Data/Global Findex, The World Bank, 2014.
8. ‘Fourth quarter and full year 2016 financial results’, MercadoLibre, 23 February 2017. Past performance is not a reliable indicator of future performance. The value of an investment may rise or fall with the changes in the market.
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This information may constitute general advice. It has been prepared without taking account your objectives, financial situation or needs and because of that you should, before acting on the advice, consider the appropriateness of the advice having regard to your personal objectives, financial situation and needs.
Past performance is not a reliable indicator of future performance. The value of an investment may rise or fall with the changes in the market.
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