Don’t let the credit crunch blind you to consumer booms in more obscure emerging markets, write Eoin Gleeson and Jody Clarke
The credit crunch isn’t the end of the world. Sure, it might feel like it to consumers in the West, particularly in America and the UK, as they watch the value of their over-inflated houses tumble and their mortgage bills soar.
But on the other side of the world, consumers in the East are just beginning to see the fruits of globalisation. Emerging economies have been buoyed by both the commodities boom and an influx of foreign capital hunting for cheap labour. This is leading to strong infrastructure spending and the growth of a middle class, hungry for the trappings of success that Westerners now take for granted.
This new-found prosperity has been most obvious in the BRIC economies – Brazil, Russia, India and China. But already rapid development in these countries is pushing up wages and jeopardising their success. Last month the corporate management team at Nestlé’s Moscow office arrived to find more than 200 placard-wielding workers picketing outside. Nestlé moved operations there more than ten years ago, partly because of lower labour costs. But now workers were demanding a 55% rise in wages to $1,104 a month, four months after a similar demonstration forced the auto giant Ford to agree to a 16% rise for its St Petersburg staff.
Meanwhile, in China last year wages rose 18.7% on 2006 in urban regions, says the country’s national statistics bureau. China sold 2.6% fewer toys abroad in the first two months of 2008, a big shift from the 20.3% rise in 2007. This is partly down to the rising yuan and slowing US economy. But overseas manufacturers aren’t taking any chances. Rising Chinese wages are eating into their margins, so they are moving at least part of their operations to Vietnam, Bangladesh and other low-cost destinations, according to a joint study from Booz Allen Hamilton and the US Chamber of Commerce.
Other lesser-known emerging markets, such as Nigeria, have seen money flow into their coffers as a result of soaring oil and commodities prices. This in turn has led to money entering infrastructure and services, boosting employment and wages, leading to increased domestic demand. These frontier or “emerging emerging markets”, as one Merrill Lynch analyst has called them, are undergoing similar transformations to the BRICs, but as yet have not drawn the same level of attention from investors.
While we believe that Asia and other emerging markets cannot survive unscathed as the US economy falls into recession, these economies are at an earlier stage of their development, and in the longer run seem like good bets. And investors keen to find ways to diversify their portfolios will be interested to know that the S&P/IFCG Extended Frontier 150 Index (made up of the “largest and most liquid firms” from a range of smaller markets) has shown a correlation of just 0.42 with the MSCI World Index of developed markets. This compares with a 0.85 correlation for the big emerging markets (a reading of one means the market moves directly in line with one another). Here are three we think are worth keeping an eye on, while in the box below we look at ways to invest in them.
Frontier markets: Vietnam
Just as China has become a victim of its own success, countries are lining up to take its place as Asia’s cheap labour engine – and Vietnam is the perfect candidate to do so. With an educated workforce – the country has a 90% literacy rate – and wages half that of China’s, Vietnam is already attracting a flood of foreign direct investment. In 2007 alone, more then $20bn of foreign cash piled in, around 40% of Vietnam’s gross domestic product.
Most of that money has poured into the south of the country, to the two main cities, Hanoi and Ho Chi Minh City, which remain Vietnam’s main business hubs. The cities have been fizzing with the new cash – motorbikes swarm the streets, where only a few years ago everyone got around on pedal bikes.
The country remains overwhelmingly rural, with less than 25% of the populace living in urban areas. But news of opportunities in the south has travelled fast. By as early as 2010, the World Bank expects fully a third of the population will have moved to the cities. That flow of young, educated and cheap labour into its major cities will fuel Vietnam’s emergence as Asia’s new manufacturing base, moving the economy beyond the traditional business of exporting rice and coffee.
And to lay the ground for the new business, the Vietnamese government is giving the economy a dramatic facelift. A remarkable course of privatisation has been set in place that aims to move the economy away from its reliance on agriculture. Twenty to 30 state-owned companies, the guts of the Vietnamese economy, are expected to list on the Ho Chi Minh City exchange within the next three years – a long list of telecommunications, banks, energy and infrastructure companies. By the end of 2009, the market capitalisation of the Vietnamese market could be as large as $100bn, four times bigger than it is today.
Of course, such rapid growth is not without its problems. The market capitalisation of the stockmarket has already grown from $1bn at the start of 2006 to $25bn. Meanwhile, the country is experiencing dangerously high inflation, currently running at 19%. There have been a rash of strikes, as food shortages and fuel hikes have upset workers. That, combined with fears of a global economic slowdown, has dealt the market a dose of reality this year – it has fallen 44% since the start of 2008, and more than 50% from its October peak.
But having fallen so far, there is now a decent buying opportunity in what is probably the most promising emerging market currently around. Sustaining growth will mean a major investment in infrastructure – the World Bank reckons the country needs to spend $200bn over the next ten years. But with 2,140 miles of coastline, Vietnam is an ideal export base – if it builds ports and lays the tarmac, it has all the credentials to become the next China in the coming decade.
Frontier markets: Nigeria
Most Western investors associate Nigeria more readily with email scams involving gold dust than with genuine investment opportunities. And you would be right to be wary– the country is rotten with corruption. It’s estimated that 80% of the oil revenues that flow to the government find their way into the pockets of a handful of power mongers. Violence in the Niger delta saw attacks on wells knock 40% off oil revenues last year.
Nigeria’s enfeebled power supply also needs a radical overhaul. Power generation is currently about a third of estimated demand, forcing businesses to rely on horribly costly power generators.
Even so, things are looking up for Nigeria. Despite the corruption, the oil boom has seen the country amass a $40bn oil fund over the past decade, driving annual growth that has reached 7% in recent years. A vigorous banking and insurance sector has sprung up around the oil industry, while privatisation and public sector reforms at government level have freed up public money to pour into agriculture and manufacturing.
Nigeria has one other invaluable resource – labour. With a population of 140 million, Nigeria is the most populous country in Africa, with more than 50% of the population under 20 years of age. And these young people are moving to the cities in droves. More than 60% of Nigeria is expected to be urbanised by 2025, a growth rate of 5.8% per annum. Half the population still lives on less than a dollar a day, but life in the cities offers the real promise of a better future.
As urbanisation takes hold, incomes have risen, inflation dropped to single digits and a vast number of people have been lifted out of poverty. A tentative middle class has emerged over the past four years – buying phones, opening bank accounts and filling their fridges at home.
Banking in particular has benefited, raising $15bn in capital over the past two years on the back of earnings growth in the region of 50%. This success has followed in the wake of a huge overhaul of the sector – with 85 banks being consolidated into just 24 since 2005. Yet just 10% of the population has bank accounts, so there’s lots of room for growth.
A recent report by Macquarie Bank suggests that consumer spending in the country is set to grow by around 10.3% per year over the next five years. Oil prices may slip if there is a global recession, but are likely to remain high by historical standards, suggesting that the driver behind Nigeria’s boom won’t go away any time soon.
Meanwhile, ongoing infrastructure development and a rich supply of crops from Nigeria’s fertile valleys (particularly at a time of soaring food prices) will also bolster Nigeria’s prospects, even if those in power remain determined to hoard the country’s energy resources for themselves.
Frontier markets: Indonesia
The world’s fourth-most populous country, Indonesia, was a basket case when President Suharto came to power in 1967. Per capita GDP stood at $70 per person, half that of India and Bangladesh, and ordinary Indonesians could count themselves among the poorest in the world. Today, after rebuilding itself on the back of a commodities boom, GDP stands at $3,400 per person, well ahead of the average Indian and Bangladeshi, on $2,700 and $1,400 respectively.
Awash with palm oil, coal and natural gas, Indonesia has spent the past few years acting as a sort of natural resources bread basket for India and China. Ordinary Indonesians have begun spending the resulting money in many of the new shopping centres springing up around the country’s enormous cities, fuelling a consumer boom.
In Jakarta alone, there are 17 million people, with another four million or so in each of the next three largest cities. It’s these people who are fuelling the boom. Consumer spending has been growing at an annual rate of 10% a year over the past five years. The services sector now accounts for more than 35% of the country’s economy, as ordinary Indonesians snap up everything from mobile phones to automobiles. Vehicle sales grew 36.2% last year to 434,449 units and continued to rise in the first quarter. And while exports remain an important part of Indonesia’s economy, domestic consumption now accounts for around 63% of GDP growth.
Indonesia also remains an attractive low-cost destination for manufacturers. If export demand continues to slip, they’re more likely to seek out new, cheaper bases to defend their margins. According to the Hong Kong Trade Development Council, it costs $110-$135 a month to hire a worker in Jakarta, against an average of $200 in Guangdong, while office space is also cheaper. In 2007, it cost $657 per square metre to rent out a luxury office in Ho Chi Minh City. In Indonesian cities, you can bag one for $111.
Recognising the need to diversify the economy away from commodities, the Indonesian government has also begun investing the windfall from higher commodity prices elsewhere, including areas such as infrastructure, which now accounts for around 3% of GDP. This proportion will only continue to grow. Just 15% or so of Indonesians lived in cities back in 1975. That figure now stands at about 30%, and is expected to grow to 60% by 2025.
How to invest in frontier markets
Investing in Vietnam
With the Ho Chi Minh index dropping off 44% since the start of the year, now looks like it could be an excellent time to get into the Vietnamese market. For broad exposure, Vietnam Opportunity Fund (VOF) allows you to tap the vibrant financial, property and beverage sectors. The fund has returned 24% over the past year and is trading at a discount to its net asset value.
With Vietnam needing to invest heavily in infrastructure between now and 2020, as mentioned above, Aim-listed Vietnam Infrastructure (VNI) will be investing in companies building highways, bridges, airports and power plants. The fund raised $402m on listing last July, recently announcing earnings totalling $22.9m for the first year after investing in several companies developing industrial parks and power plants.
Meanwhile, to play the wave of privatisations coming to the Vietnamese market, Aim-listed Vietnam Holdings (VNH) specialises in buying privatised state firms, with pharmaceutical, plastics and power companies among its largest holdings.
Investing in Nigeria
The success of Nigeria’s efforts to reform its banking sector is reflected in the valuation of its banking shares. Two Nigerian banks have issued global depository receipts in London so far, Diamond Bank (DBGA) and Guaranty Trust (GRTB). Both trade on pricey-looking valuations, with Guaranty the more reasonable of the two on a forward p/e of 20. But as David Stevenson points out in Investors Chronicle, earnings growth is so strong that the valuations are more than justified.
The success of the oil and banking sectors has helped feed into other consumer areas. US-listed Shoprite (PK:SRHGF), as Nigeria’s single dominant retailer, is ideally placed to benefit from the rising standard of living in the country, says Kathryn Cooper in The Sunday Times. Like-for-like sales rose 25% last year, profit margins come in at 7%-8%, and the stock is valued on a p/e of just 11. And with only 20% of the country owning mobile phones, there is a substantial opportunity to tap into a fledgling phone market as well.
Phone connections have soared from 450,000 in 2001 to 42 million today. South African mobile phone outfit MTN Group (Berlin:MTNJ.BE) has 16.5 million subscribers so far and is one of best plays on Nigeria, according to analysts at Macquarie Bank. It’s valued on a forward p/e of 16.
Investing in Indonesia
Mobile telephony is also a good play on Indonesia. Only 40% of Indonesians currently have a mobile, but competition between providers is growing, pushing down call rates and making them more attractive to consumers. This may affect profit margins in the short term, but rising sales should be good news for the country’s biggest phone company PT Telekomunikasi Indonesia (US:TLK). The group trades on a forward p/e of 14, and boasts a 20% annual growth rate. It added 12.2 million users last year, and expects to gain another nine million this year.
In terms of infrastructure plays, Holcim Indonesia TBK (US:PTHIF) is a large cement company that owns and operates everything from stone quarries to transportation services. Cement sales are on the up in Indonesia, with sales of the building material rising to 2.7 million tons in February, up 18% on the year. It trades on a forward p/e of 19.
If you’re looking for a fund, unfortunately there are no exchange-traded funds tracking the market at present. However, if you’re looking for active management, you can access the Indonesia Fund (US:IF), which has large stakes in PT Telekomunikasi Indonesia and Bank Central Asia. Its top ten holdings trade on an average p/e of about 18.8.