Created:
20 March 2008
Written by:
David Stevenson
In our , we ran through the reasons for investing in ‘frontier markets’. Now it’s time for th nitty gritty. Which are the hottest emerging markets on the planet, those that could be the next Russia or China? Here’s our shortlist:
Pakistan
This country doesn’t have the most positive image in the world but investors need to step back and take a more nuanced look at the real successes of this South Asian economy. According to Dr Feriani: “Real progress, albeit from a low base, has taken place in the economy”. As the sixth most populous nation in the world with a young demographic, the country is set to add 3.4m people to the labour force annually. If properly harnessed, this growth potential is substantial. Pakistan’s economy has grown at a five-year compound annual growth rate (CAGR) of 7 per cent, with the agriculture sector in particular benefiting from rising agriculture credit, improved water resource management and a government-backed fertiliser policy.
According to Pakistani-based research house BMA, this progress is mirrored across the economy: “Deregulation of the corporate sector and trade liberalisation has also boosted both industrial output and services performance. Per capita income has increased at a five-year CAGR of 12 per cent to $925 in 2007 and is expected to cross $1,000 in 2008.” With GDP growth this year expected to total 6.6 per cent and corporate earnings racing ahead by more than 12 per cent. Pakistan looks particularly well placed to weather the global economic storms as exports only account for 12.5 per cent of GDP, a much lower percentage than competitor countries such as Taiwan or an Indonesia which derive a significant chunk of GDP from exports. One statistic sums it up: in 2007 the economy grew by 7 per cent but exports only rose 3.5 per cent. Dr Feriani’s team is particularly enthusiastic about the local stock market: “The market is cheap in comparison to other emerging and frontier markets we look at ( 2008 PE ratio around 10 times), and has stagnated somewhat in the past six months having had a stellar run prior to this.” The KSE100 Index remains undervalued trading at a mere 11.4 times 2008 earnings estimates, or at an estimated 25.0 per cent discount to the region. Earnings growth is reasonable (in the low teens, though it has slowed a bit) and there are plenty of big themes to capture.
According to BMA, some of the big sectors worth watching include banking, oil marketing, fertiliser product, cement, mobile telecoms and the burgeoning media sector. This last sector is especially interesting - growth in TV has been spectacular with the number of channels increasing from just two domestic state-owned TV channels 10 years ago, to over 50 satellite TV channels, with 10 more channels in the pipeline.
Ukraine
The former Soviet Union state has boomed in recent years. Consumption has roared ahead and now accounts for around 80 per cent of GDP and the country has embarked upon a credit binge with consumers borrowing to buy consumer goods at a phenomenal pace - retail sales are growing by close to 30 per cent a year with consumer lending growing by 120 per cent. The global credit crunch spells bad news for the Ukraine in the short term, although that may be tempered by the recent elections which hold the promise of providing a more stable political climate under new prime minister, the stylish and rather eccentric businesswomen Yuliya Tymoshenko.
It’s also worth bearing in mind that the Ukraine has just joined the World Trade Organisation (WTO) and it is also co-host of the Euro 2012 football tounament. The big problem for investors is that Ukrainian shares are already fully valued - according to Dr Feriani the trailing PE ratio is now over 30-times compared with around 17-times at the start of 2007 and the local market (valued at $80bn) boasts a price-to-book ratio of four-times. Another problem is that, on average, only 4 per cent of the listed shares of local companies are actually freely traded, with oligarchs in particular retaining key strategic stakes. Another factor that the Progressive team cautions against is that the listed market is not totally “reflective of the economy with few consumer plays other than banks and an index that is dominated by old industrials (metals, electricity and machinery)”.
Long-term trends in the market include further privatisations and initial public offerings (IPOs), notably electricity generators and distributors, international fund flows, pension reforms, improving corporate governance and the potential for local retail growth as interest rates fall below 10 per cent.
Kazakhstan
The biggest of all the ‘Stans’ and victim of endless Borat jokes, Kazakhstan is fast emerging as the economic powerhouse of Central Asia in part because of its stable (though less than democratic) government and its huge natural resources. Intriguingly, the Advance Frontier’s team has cooled on the short-term potential for this country: “from late last summer the unfolding credit crisis has exposed weaknesses in the banking sector and the local stock market is dominated by banks. The crunch is constraining the financial sector’s ability to extend credit to the corporate, mortgage and construction sectors which is going to make life difficult.” The local stock market is only a small part of the equity picture as many of the bigger companies are already listed abroad, especially in the mining sector.
Egypt
The Arab world’s most populous and most influential state has long looked under siege from a combination of internal Islamist political pressure (and terrorism) and corruption. But in recent years the economy has powered ahead as the government has taken tentative steps towards reform and rebuilding the economy. Intriguingly the Egyptian market did not participate in the November correction of emerging markets. Instead the Hermes index reached its all time high at the end of 2007. That positive momentum has been prompted by the government reducing taxes, customs duties and energy subsidies, as well as by the growth of privatised enterprises. “With the help of high oil prices, FDI [foreign direct investment] inflows, a considerable expansion in agriculture, manufacturing, and construction and a surge in revenue from the Suez Canal, those reforms have pushed the economy to high levels of GDP growth, reaching 7.1 percent during 2007,” says Dr Feriani. “We expect these trends to continue in 2008. However, unemployment, particularly among the female population, remains a problem. Egypt recorded net FDI inflows of US$11.1bn after US$6.1bn in the previous year. Given continued Gulf States interest, net FDI inflows are expected to increase… Egypt is also a beneficiary of petro-dollar liquidity. Current oil prices around $100 a barrel ensure that the liquidity tap is not going to be turned off any time soon. It is also one of the preferred markets of Gulf investors. Valuations at 17.6 times PE ratio 2007 estimates are high, but earnings growth at 30 per cent make the outlook good.”
UAE
The United Arab Emirates is a federation of seven smaller emirates that includes giants such as Dubai and Abu Dhabi plus smaller Fujairah, Ras al-Khaimah, Sharjah. The local stock exchanges have romped ahead in recent years off the back of a huge explosion in oil wealth (the UAE owning the fifth-largest oil reserves in the world ) and a truly gargantuan construction boom in places such as Dubai and Abu Dhabi. That growth has also been accompanied by massive local inflation (not far under 10 per cent a year) and asset price increases prompting speculation that the UAE will revalue the local currency, the AED. “Despite the construction boom, the major source of inflationary pressures has been a shortage of housing,” says Dr Feriani. “Aside from inflationary concerns, the economic outlook is very positive with the UAE enjoying one of the highest GDP per capita in the region. The government has also been successful in promoting foreign investment, notably in Dubai, which has not only become a major tourist destination, but the region is also attracting a growing number of foreign banks to the Dubai International Financial Centre. Private consumption, meanwhile, is growing strongly on the back of rising income and wealth and low real interest rates. The domestic political situation remains stable and the UAE enjoys close relations with the West and most of its regional neighbours. 2007 estimated PE is around 13 times; earnings growth 50 per cent.”
Bangladesh. Like Pakistan, Bangladesh initially tends to get a rough deal when it comes to global perceptions - military rule prompted by rampant political corruption, made increasingly worse by climate change which is inflicting huge natural damage on the deltas of the Bay of Bengal. But Dr Feriani begs to differ. He sees more and more adventurous global money flowing into the $11bn local market. “I note the predictions of the CEO of the Dhaka exchange that he expects to see $15 bn by mid 2008 as more IPOs and privatisations occur (market cap to GDP remains low by emerging markets standards). A combination of reforms and privatisations is spurring interest. Economic growth at around 7 per cent in real terms seems maintainable - but perhaps it could do with more diversification away from agriculture and textiles and infrastructural investment is needed. The currency seems OK with solid reserves and record foreign worker remittances.”
International investor interest is also growing. Citigroup’s acquisition of a licence for investment banking is a sign of huge potential as is the entrance of many other multinationals (Shell, Unocal, BP, Mobil, HSBC, Citibank, Samsung, Toshiba, Cemex, Singtel, Orascom) into local markets. Research from JP Morgan also includes Bangladesh in their “Frontier Five” group of countries in mid 2007 (alongside Kazakhstan, Kenya, Nigeria and Vietnam) and Goldman Sachs also included Bangladesh in their ‘Next 11 countries to watch.’ “The scale and potential for Bangledesh is obvious - a population of 150m, strong demographics, a hard working people and the early signs of an emerging middle class.”
Nigeria
A growing number of mainstream fund managers are beginning to talk up the attractions of Sub-Saharan Africa, tempted in part by stellar returns. Nigeria was one of the best performing of the Sub-Saharan markets in 2007, generating a dollar return of over 100 per cent. At a recent Financial Times Emerging Markets event, Roelof Horne, manager of Investec Asset Management’s Africa Funds, noted that “Africa, excluding South Africa, has grown 7 per cent in five years and countries like Nigeria and Egypt provide good solid economic growth and reasonably priced investments.”
His optimism was backed up Jamie Allsop of New Star’s Heart of Africa fund who said|: “In Nigeria, only 10 per cent of the population have bank accounts and 20 per cent have mobile phones. There is obviously significant opportunity for growth.” That optimism is shared by Dr Feriani’s team. “The banking sector has been raising a huge amount of capital recently (about $15bn over the past two years) on the back of earnings growth in the region of 50 per cent. That focus on banks and financials has also meant that on valuation terms Nigeria is currently looking a bit ‘stretched’. But if one looks at PEG ratios they are more reasonable, assuming that the earnings can be maintained. Nigeria is one of the more liquid markets in the region and so is likely to continue to attract fund flows as the issuance of African related funds continues.” Around 20 Pan Africa funds have been launched in the region in the past 18 months with about $6bn in total being raised. This growth in liquidity could on its own propel the stock market forward, but the economic fundamentals aren’t that bad either. A recent Macquarie Bank report on Nigeria, called: Nigeria Awake! The beckoning Golden Age, painted a remarkably rosy picture with economic growth powering ahead leading to a likely local boom especially in the all important consumer products and mobile telecoms space.
THE REAL WILD FRONTIER:
Cambodia.
Talk to most Asian experts and they believe that war-ravaged Cambodia is the next state to watch. Its communist-led government has been closely watching Vietnam where economic growth has been phenomenal. The only big problem is that Cambodia does not yet have a stock market so there’s no real way of accessing the country’s huge potential. According to Dr Feriani, he and his team have just seen “what we believe to be the first Cambodian fund of any kind which will probably get launched towards 2008 with $100m or so”. Crucially the new stock market is due to open in 2009 and one of Dr Feriani’s team, Dr Chris Brader, recently visited the country. “I was very impressed,” says Dr Brader. “They have certain advantages over the Vietnamese in terms of lower levels of corruption and better English skills, but do not have the size of population, nor do they have a series of state-owned enterprises that can be groomed for listing. This economy is much less diverse than Vietnam where manufacturing is much more broadly spread. Economic growth is impressive and the people charming with an amazing demographic advantage of a very young population. They need to be found worthwhile jobs.”
Zimbabwe.
It’s clear that when Robert Mugabe does go or lighten his touch, this former economic powerhouse will recover its poise and shoot up. All the African fund managers that Progressive invests in rate this is a huge long-term opportunity. “When that will be nobody knows, but at present, Zim represents one of the most contrarian bets a global investor can make,” says Dr Feriani.“Survival of the fittest means that those managers still in business are among the best anywhere in Africa. As was the case in Brazil during its own period of hyperinflation, if you didn’t find ways to cope, you went to the wall.” Mr Mugabe does not look like loosening his grip any time soon, but it is possible that things are reaching their nadir. It is also a case of perception versus reality - according to Dr Feriani: “Many of our managers tell us that Harare is relatively safe compared to Johannesburg and that they thoroughly enjoy living there. Companies trade on very low multiples (well below replacement cost) and are available to buy on international markets.”
http://www.investorschronicle.co.uk/MarketsAndSectors/Markets/article/20080320/104e18ca-f66c-11dc-8f6a-0015171400aa/The-seven-hottest-emerging-markets.jsp
Despite the efforts of various parties led by corrupt and proven incompetent leaders, President Musharraff has steered and is continually steering the nation towards greater economic stability.
Under the government of Nawaz Sharif and Benazir Bhutto, accolades like these would have been a distant dream. Inshallah, President Musharraff will stay on and do his good work, and hopefully the corrupt warlords will prove for a third time their utter incompetence. Furthermore, all this shortage of rice and flour, are short time glitches. One must look at the bigger picture of things.
