Investors hungry for growth have fixated on a handful of U.S. technology giants. But those who cast a wider net are finding emerging market companies that are younger and sometimes cheaper than the FAANGs—
and Google parent Alphabet.
After underperforming the U.S. for a decade, emerging markets face an improving backdrop. More fiscal stimulus and a global recovery from the pandemic, along with a weaker dollar that makes foreign assets cheaper for U.S. investors, should help emerging markets over the next year, says Mona Mahajan, strategist at Allianz Global Investors.
What’s more, emerging markets are rife with internet and health-care companies that are earlier in their growth trajectories and have bigger market opportunities. Emerging market stocks on the whole trade at 15.5 times forward earnings, versus 22 for the
S&P 500 index,
attracting investors looking for relative bargains. Retail investors allocated new money to emerging market equity funds in 10 of the past 13 weeks, according to EPFR Global.
Some of that discount is warranted, as countries like Turkey and South Africa have been mired in political, economic, and fiscal strife, while Brazil and India entered the pandemic with weak economies, limiting their options for dealing with the coronavirus. The unevenness of the recovery was showcased in the International Monetary Fund’s latest outlook, with China emerging as the only major economy to expand this year and Latin America projected not to return to prepandemic levels until possibly 2023.
Since emerging markets don’t move in lockstep, selection is key. Fund managers favor Asian countries like Korea, Taiwan, and China, which entered the pandemic in much better fiscal health but also got an earlier handle on the virus, and are already reaping some of the benefits. Also favored: fast-growing technology and health-care stocks whose growth has been supercharged as the pandemic sped up digitization and sharpened the focus on health and drug development.
The preference for Asia is underpinned by China’s response to this crisis. Instead of rebuilding the economy through investments in roads, ports, and bridges that benefited much of the rest of the world after the global financial crisis, China is building its own economy and self-reliance, focusing on 5G, cloud computing, and health-care infrastructure that boosts domestic companies as well as those in Taiwan and Korea that supply the technology needed. It’s reflected in performance: The
iShares MSCI Emerging Markets
exchange-traded fund (ticker: EEM) is up just 3% this year, while the
iShares MSCI Emerging Markets Asia
ETF (EEMA) has gained almost 11%.
“In the past, we invested through China proxies, like Australian and Brazilian metals and mining companies or South African materials, but now you have to invest through China, focusing on its domestic economy,” says Todd McClone, co-manager of the
William Blair Emerging Markets Growth
fund (WBENX), which has its highest-ever allocation to China, Korea, and Taiwan.
China’s focus on itself benefits
(600406.China), which provides secondary equipment and software that are central to the transformation of the country’s power grid as digitization drives more demand, says Adam Montanaro, co-manager of the $4 billion
Aberdeen Emerging Markets
fund (GEGAX). For a company that should generate mid- to high-teens earnings growth, Montanaro says, Nari trades at an attractive 16 times forward earnings.
Also attractive are China’s consumer-oriented companies. Early data from this month’s Golden Week holiday suggested some return to normalcy, with more than half a billion local trips taken and travel traffic recovering to roughly 80% of prepandemic levels. However, Chinese are staying closer to home rather than jet-setting. That benefits
China Tourism Group Duty Free
(601888.China), which has gotten a boost from Beijing relaxing duty-free shopping-related rules. Yet, Montanaro says the market is “significantly underestimating” the company’s earnings, which could see compounded growth in the high teens over the next decade, as Chinese shoppers gain more access to duty-free shopping at home.
E=estimate. PEG=price/earnings to earnings growth. N/A=not applicable
Sources: Bloomberg; FactSet
Travel trends also benefit hotel company
(HTHT), which has had a strong rebound. The company trades at 24 times enterprise value to 2021 earnings before interest, taxes, depreciation, and amortization, or Ebitda. Huazhu is “growing into” that multiple quickly as the sector recovers and is able to be a consolidator of smaller, struggling chain hotels, says Montanaro.
The focus on consumers also feeds fund managers’ continued preference for technology. Many see even bigger growth potential for emerging market titans compared with their U.S. peers because these companies have been more one-stop shops, often mixing social media, e-commerce, financial technology, and gaming. And they are pushing into new markets that can be significant.
Alibaba Group Holding
(BABA) birthed fintech giant Ant Group, which is currently the most valuable start-up and is expected to raise as much as $35 billion in its coming public offerings in Hong Kong and Shanghai. Alibaba has a 50% market share in the Chinese cloud-computing market, which is much earlier in its development than in the U.S., and it is also building a health-care ecosystem with Alibaba Health.
“It’s growing faster than Amazon, has a larger addressable market, and is trading at a discount to Amazon,” says McClone. Alibaba’s sales grew 30%, and its net income growth was more than twice that in the last fiscal year, compared with 20% sales growth for Amazon and 15% profit growth. Yet, Alibaba trades at 28 times forward earnings, compared with Amazon’s 76 times.
Multiple digital businesses rolled up in one is popular elsewhere in emerging markets, creating opportunity even in countries with less attractive economic backdrops. India’s
(RIL.India) has transformed from an oil and gas conglomerate into a mix of the Chinese versions of
Facebook, and Amazon, attracting U.S. internet companies that want to push into India. Those partnerships have given Reliance an infusion of capital to reduce debt it accumulated to revamp its business.
At 26 times forward earnings, the stock has seen some benefit from this transformation, but McClone doesn’t see the stock as expensive when considering the longer-term growth prospects for its early-stage omnichannel retail and digital-services business. Plus, Reliance’s energy unit still makes up two-thirds of the business—and this cash cow is being transformed into an integrated oil and chemical company that should reduce its earnings volatility in difficult economic conditions and ultimately improve refining margins.
“The market has been behind this story because it’s been so dramatic. It’s like being behind on Amazon and Alibaba. It’s tough to value without a long-term view,” says McClone of Reliance, one of the William Blair fund’s larger positions.
In Latin America,
(MELI) is the region’s dominant e-commerce and fintech company. Although the stock has more than doubled this year and sports an astronomical price/earnings ratio, Sara Moreno, co-manager of the
PGIM Jennison Emerging Markets Equity Opportunities
fund (PDEAX), sees more opportunity. E-commerce penetration in Latin America, for example, is under 5%, compared with 20% in China, and Moreno says the market isn’t yet fully pricing in the company’s still-nascent fintech arm.
The noise level [between China and the U.S.] is going to stay high regardless of who wins, so you have to tread carefully.
“Higher-margin services like asset management and credit are just starting and can rise from their current 16% of revenues today to 40%-plus in the next five years, adding not just to [sales] but to margins, as well,” Moreno says.
(MGLU3.Brazil), known as Magalu, is another company that is still early in its growth. While shares have run up in recognition of the home-furnishing and electronics retailer’s evolution into an omnichannel retailer, Moreno says that the market doesn’t yet fully reflect the opportunity for the company’s credit and service business that helps smaller retailers with their digital evolution.
Another nascent sector attracting growth investors is health care, as rising incomes in the developed world fuel demand for better drugs, hospital care, and medical devices.
Roughly a quarter of the PGIM fund is invested in health care, with Moreno citing the breadth of opportunity. Among Moreno’s holdings:
(1801.Hong Kong), which Moreno describes as a potential leader in China’s emerging biotech industry, with a deep pipeline and partnerships with the likes of Eli Lilly and Roche, and
Jiangsu Hengrui Medicine
(600276.China), which has a strong oncology franchise and reminds Moreno of
in the 1990s.
Innovent’s shares are up 150% this year and may not look attractive by conventional metrics, given that it isn’t profitable. But long-term investors such as Moreno still see the stock as attractive because of its deep pipeline with a tilt toward oncology and autoimmune therapies. Analysts expect it to turn a profit by 2023.
The same holds for Jiangsu: While not cheap on the surface at 59 times forward earnings, the company has averaged 23% free cash-flow growth over the past five years. Analysts on FactSet have an average rating of Overweight and a price target of 102 yuan ($15.27), representing a 14% gain from a recent 89.58 yuan.
While much of the focus has been on Jiangsu’s PD-1 drug for Hodgkin’s lymphoma patients, Moreno says that several other treatments can deliver double-digit growth. It also has a leading position in China’s anesthetics and contrast-agent markets.
Fund managers with a heavy helping of Chinese stocks acknowledge the possibility of interim volatility from U.S.-China tensions, and some, like McClone, have swapped U.S.-listed Chinese companies for their Hong Kong listings and sold companies in the direct path of the technology battle between the two countries.
But analysts say that many China-related proposals, such as those aimed at restricting China’s access to technology, have been narrower in scope following implementation, with limited impact on the domestically oriented companies they focus on. “The noise level is going to stay high regardless of who wins, so you have to tread carefully. But the opportunity is undeniable,” says McClone.
Write to Reshma Kapadia at firstname.lastname@example.org