Emerging-Market superstars: hidden in plain sight

Sammy Suzuki (pictured) is the manager of AB Emerging Market Equity Portfolio.

Great companies can come from anywhere, and emerging markets have more than their fair share. We’ve identified three megatrends we expect to give birth to tomorrow’s superstars—and that no globally inclined portfolio should be without.

The case for emerging equities has improved. Bellwether gauges of collective emerging-market (EM) economic growth—including China’s power, steel and cement production and even Macau casino visits—have ticked up, as have earnings expectations. Fiscal and capital-market reforms continue to advance across various countries. To top it off, EM valuations remain enticing relative to those in developed markets.

There are still plenty of challenges. We’re watching closely for potential stresses arising from normalising US interest rates and possible new US trade barriers. But not all emerging economies or companies are equally vulnerable, if at all. Fundamentals are diverging, making for rich pickings for resourceful investors who can separate signal from noise.

So, after distilling these macroeconomic concerns, we continue to find diverse opportunities. Here are three megatrends that should shape the EM investing scene for years to come.

Premiumisation—or nothing but the best

The growing EM middle class continues to show a voracious appetite for premium-priced, upscale products. This “trading up” phenomenon is particularly pronounced in China, where upper-middle and affluent urban households are expected to account for roughly half of total urban real disposable income by 2020—twice their share in 2010. It’s also gaining momentum in India.

Premiumisation is driving Chinese demand for foreign luxury goods, from US-made Steinway pianos to South Korea’s AmorePacific skin care. But it’s also boosting the sales of mass-market consumer goods such as Japan-made Merries disposable diapers and Starbucks coffee.

It’s also come to the food aisle. Chinese are eating far more pork, chicken and beef than their forebears. And as they migrate to cities, they are buying more of it prepackaged from a store.

Companies like Smithfield Foods (owned by Chinese company WH Group) and Walmart Stores’ Sam’s Club in China are tapping into this trend.

Meanwhile, local mass-market brands such as Bright Dairy & Food packaged milk and Nongfu Spring beverages are also repositioning to higher-quality offerings and emphasizing the quality of their ingredients in their marketing. As premium domestic brands gain consumers’ trust, they are increasingly winning share from foreign incumbents.

New giants on the global stage
EM multinationals aren’t as globally expansive as their better-known rich-world counterparts. But they have their own way of thriving outside of their home country.

These new global giants have taken multiple paths to success. Some have used their popular local brands as springboards into international markets. Mexico’s Gruma and its tortillas, for example, have grabbed a dominant position in the US. Others—like Brazilian jetmaker Embraer or South Korea’s Samsung Electronics—have transformed low-cost local manufacturing and engineering excellence into innovation on a global scale.

Another group enjoys global leadership in niche markets, including Taiwan’s smartphone-lens maker Largan Precision and white-box server provider Quanta Computer. Some commodity producers, such as Brazil’s Vale, became global powerhouses via smart investments in marketing and logistics.

Others developed a new or improved business model and rolled it out to many different markets. These include Mexico’s Cemex, which has developed a rigorous IT-driven system for managing acquisitions to become one of the world’s largest suppliers of ready-mix concrete, and India’s pharmaceutical and IT outsourcing firms.

China’s inconvenient truth
Deadly smog is exacting a particularly heavy economic and public-health toll across emerging Asia. China and India alone accounted for roughly half of the more than 4.2 million premature deaths caused by airborne pollution worldwide, according to one recent study.

Amid the surging public outrage, both countries face mounting pressures to tackle the problems caused by toxic air. China has tightened emission norms for coal-fired power plants, continues to invest in renewable energy, and is slowly shutting down outdated facilities in industries such as cement, pulp and paper, shipmaking, aluminum, glass, and steel. Though far behind its neighbor, India may start to take many of the same steps.

The investment implications are wide-ranging. Among the most obvious beneficiaries are commodity exporters, as tightening supplies bolster prices. Improving commodity profitability should also alleviate pressures on banks, as the number of bad loans shrinks.

Prospects also look good for renewable energy producers and equipment-makers; clean-power technologies (e.g., electric cars, energy-saving appliances and energy-saving building materials); and natural gas producers and refiners (as higher gasoline quality standards lift margins).

Dig Deeper
These transformative forces are driving new sources of growth and prosperity among developing-world businesses.

But the mix of winners arising from these themes is likely to be highly company-specific. Finding tomorrow’s EM outperformers will take rigorous research, entailing local knowledge and global industry insights, and a finely tuned risk radar.

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