8 April 2014
Nick Griffin, Jeff Thomson, James Tsinidis, Kieran Moore
Over the past few months we have been asked quite regularly about our views on emerging versus developed markets, and whether we think now is the right time to wade back in. In recent times emerging markets have considerably underperformed developed markets, leading to many queries about whether emerging markets now offer compelling value. As a broad response to this query we would offer the observation that emerging markets are simply giving back part of the considerable outperformance they have achieved through the 2000s, (see Figure 1). While we acknowledge that this is a fairly crude metric, we would also flag that emerging markets, while now cheaper versus developed markets, are also suffering from a weakening economic growth environment versus a strengthening environment in most developed economies, (See Figure 2.).
Ultimately as interest rates globally begin to normalise, excess liquidity levels will shrink. This will slow the tailwinds in developed markets but in emerging markets capital is likely to exit due to their higher risk nature. This has been, and is likely to remain, an economic and investment headwind for developing economies over the medium term.
This analysis amounts to a fairly sombre macro outlook for emerging markets and not a great investment outlook as an asset class in comparison to developed markets. Despite this fairly sombre outlook, we don’t think that emerging markets are opportunity free. On the contrary, there are huge opportunities emanating from the demographic and structural changes that are occurring in emerging markets. We see companies in both emerging and developed markets as big beneficiaries from these changes and would flag that many of the opportunities that emerging markets present can occur independently of the previously mentioned weak macro outlook. Below we highlight one large emerging market led mega trend which looks set to dominate the profit outlook for numerous corporates for years to come.
The emergence of the Chinese consumer
One doesn’t have to look far these days to find evidence of the Chinese consumer permeating our everyday life, whether on a plane, at a tourist attraction, queuing outside a luxury goods store or enrolling in education. Chinese consumers are becoming wealthier and as consumers they are some of the most veracious the world has ever seen. The best example of this in trend has been the rise of Macau as a gaming destination. There are no legal gambling areas in China and consequently Macau is the major destination for wealthy Chinese to exercise their desire to gamble. Since the opening of Sands Macau in 2003, visitor numbers and gross gaming revenue has been on a strong upward trajectory to the point where Macau as a gaming centre is already 6 times the size of Las Vegas by gross gaming revenues, (as shown below).
While this is a staggering statistic in itself, what makes it more interesting is that Macau has only just scratched the surface of what is possible. While Macau receives 20 million visits by mainland Chinese annually, (30 million visits in total), some of the companies based there estimate that this represents only 7 million actual individuals, (i.e. the average person visits 3 times each year).
While there is no doubt that the appetite to gamble is strong, (based on gross gaming revenue growth), the issue holding back more visits is infrastructure congestion and a lack of hotel rooms.
Again, according our investee companies and corroborated by industry analysis, there are approximately 100 million Chinese that fit the visitor demographic of Macau. This demographic represents around 7.2% of the total Chinese population. If you consider that there are currently 7 million unique visitors to Macau (i.e. 0.5% of the population) the potential upside is huge. Even if you take the 20 million visitors number as all being unique entrants, this depicts that only 1.5% of the total Chinese population have actually visited Macau, yet it is already six times larger than Las Vegas!
Witnessing the success of Macau, it is not hard to extrapolate what the emergence of the Chinese consumers could do to other supply constrained industries, such as the luxury goods sector, the major branded goods sector and the aircraft equipment sector. Below is a list of corporates in both developed and developing markets that we have identified who are exposed to this structural trend and are set to benefit over the short and long term.
Our current macro thinking suggests it is too early to re-enter emerging markets as an asset class. However, this view does not mean we don’t see many opportunities for developed and developing world corporates from the emerging middle class and within that we highlight the potential large opportunity that Chinese consumers represent for global corporates going forward. At K2 International we approach the world in a completely sector and regionallyunaware manner, focused primarily on corporates exposed to strong secular earnings trends. The rise of the Chinese consumer will be a large secular tailwind for numerous corporates around the world regardless of whether they are listed inside or outside of China. Our process allows us to accurately identify these beneficiaries, and consequently benefit from their growth regardless of our view of the overall emerging market asset class.
DISCLAIMER: The information contained in this presentation is produced by K2 Asset Management Ltd (“K2”) in good faith, but does not constitute any representation or offer by K2. It is subject to change without notice, and is intended as general information only and is not complete or definitive. Please note that past performance is not a guarantee of future performance. A product disclosure statement and additional information booklet or information memorandum or general information on the funds referred to in this presentation can be obtained at www.k2am.com or by contacting K2. You should consider the product disclosure statement before making a decision to acquire an interest in the fund.