Disruption is Changing the Emerging Market Consumer Growth Story

By Andrew Mathewson and Divya Mathur 
Portfolio Managers, Global Emerging Markets, Martin Currie


October 15, 2018

For investors in emerging markets (EM), long-term demographic trends of increasing working-age populations, rapid urbanisation and a rising middle class are well understood – and exciting. Yet only a high-conviction approach can pick the winners in this new environment.

The consumer sector’s representation within the MSCI Emerging Markets index has changed markedly in the last five years, shrinking by around a third. Meanwhile, the technology sector has effectively doubled, overtaking financials as the largest component of the index.

The reclassification of the technology sector to include new a sub-industry – and moving platform-providing companies from technology to the consumer discretionary and communication services sectors – is also evidence of the changing economic and social importance of many “new economy” and disruptive-technology stocks.

These are powerful, secular forces. We are seeing only the early stages of this evolution, and the beneficiaries of these trends will continue to capture growth opportunities well into the future.

THE GROWTH STORY HAS CHANGED

Consumer growth is unquestionably a long-term EM investment theme. But increasingly wealthier, urban populations with a propensity for technology adoption (aided by lower costs and higher functionality of mobile devices) are rapidly, irrevocably changing consumption patterns.

Digitisation and digital ecosystems (businesses often traditionally thought of as consumer plays in emerging markets) are having disproportionately disruptive impacts on consumer behaviours. Traditional distribution channels are being drastically redefined. New payment methods are allowing products to be purchased through faster, more convenient online-based solutions.

These disruptive trends represent a paradigm shift in the opportunity set for emerging markets. Financial, consumer discretionary and technology companies have already begun (and will continue) to emerge as the new corporate stalwarts, not just in emerging markets, but globally.

CONSUMER STAPLES – HIGH VALUATIONS, LOW GROWTH

Consumer staple companies in emerging markets have historically benefited from distribution strength, restricted consumer choice, low levels of competition, lack of price discovery for the end consumer, and relative corporate strength versus a large number of fragmented retailers. These stocks have been a reliable way of accessing EM growth potential.

However, much of the consumer staples sector is overvalued relative to the low growth on offer. The disruptive forces of technology and online retail can significantly erode the competitive moats many of these businesses enjoy. The sector re-rated following the Global Financial Crisis, with valuations peaking at historical levels of a next-12-months price/earnings ratio (p/e) of 23.3x. Currently at a p/e of over 22x, the sector still trades at a significant premium versus index. (All stats are from FactSet and MSCI).

We believe EM consumer staples offer poor risk-reward returns for investors’ capital.

UNDERSTANDING EM DISRUPTION: RISKS AND OPPORTUNITIES

From a stock-picking perspective, the shift from consumer staples has created an environment where many new winners are emerging, and established businesses are increasingly challenged.

Retail is evolving to the point where online players are beginning to invest offline, and we scrutinise how companies are preparing themselves. We look to markets that are already at the vanguard of global retail disruption – such as South Korea, China and the UK – to understand the consequences, and at countries not yet affected: Indonesia has very low online retail penetration.

There are attractively-valued companies in the healthcare sector, which enjoy many of the positive characteristics of staples companies without some of the existential threats.

Emerging markets also appear particularly ripe for alternative banking solutions. Almost 90 percent of the global population under 30 years old – typically a more “tech savvy” cohort – live in EM countries. Despite fast growth in recent years, 1.7 billion adults globally still do not have a bank account, the majority unsurprisingly also residing in EMs. Their governments are keen to accelerate financial inclusion with incentives and favourable regulation, adding another tailwind.

Many incumbent EM banks are well placed to benefit from technological advances, rather than be fatally disrupted. They typically have the advantage of scale, diversity, profitability and (most importantly) existing customer relationships. Many regulators seem to be favouring existing banks over fintech challengers, raising entry barriers for potentially disruptive third parties.

This is just the beginning, with many EM businesses only at the foothills of their real potential.

Andrew Mathewson and Divya Mathur are Portfolio Managers at Martin Currie, a subsidiary of Legg Mason. Their opinions are not meant to be viewed as investment advice or a solicitation for investment.

Andrew Mathewson

Andrew Mathewson

Divya Mathur

Divya Mathur


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