Investors Flock Back to Emerging Markets
As you’re doubtless (and painfully) aware, global investors headed to the exits this summer, selling off their positions in various emerging markets in response to the US Federal Reserve’s intimations of tighter monetary policy and downward adjustments to overseas growth forecasts.
But here’s the good news: At the same time, American corporate executives at small to midsize businesses (SMB) have stayed bullish on the growth fundamentals that emerging markets still offer. And in a dramatic reversal, there are now signs that investors are moving back into emerging markets investments in large numbers. This shift will only accelerate, as investors follow the lead of corporate management’s bullishness and the Fed’s announcement on Sept. 18 of continued stimulus.
A new CFO Research/High Street Partners survey of chief financial officers and other senior executives (including CEOs, presidents and controllers), released in early August, tells the story. Entitled “Pushing the Boundaries of Overseas Expansion,” the survey indicates that with growth still sluggish in certain US market sectors, executives are targeting overseas opportunities to achieve the growth they desire.
Of the 121 executives at companies with revenues between $50 million and $1 billion, nearly two-thirds (65 percent) reported they expect to expand their international initiatives in the coming year. Three-quarters (75 percent) of the respondents are interested in overseas business primarily to increase revenues or gain customers, rather than reduce costs.
Even more—83 percent—expect international markets either will be among the top priorities for their companies over the next three years (66 percent) or at least will become more important than they are now (17 percent). And in three years, 95 percent of respondents expect to have customers in at least two foreign countries.
What’s particularly telling of the survey is that SMB companies typically are more sensitive to changes in the economic cycle than larger firms. The fact that they are planning major international expansions over the next three years suggests an implicit forecast on when they expect robust US economic growth to return. Below, we profile various companies that have announced international expansion plans in the last couple of months.
The majority of executives surveyed expressed greater comfort with operating in developed economies similar to their own, asserting that Europe and Australia are on a par with North America in ease of conducting business. However, a majority of respondents, 57 percent, indicated that entering new markets in emerging economies would be moderately important or critical for them in the next three years, given the higher growth trajectories.
The emerging markets these executives consider a top or moderate priority is Eastern Europe, Japan, Latin America and Asia (ex-China). The executives regard the aforementioned markets as generally easier to do business in than Africa, China, Middle East and India, which nonetheless are also a focus of their expansion efforts.
The Forecast for Global Growth
What took many market experts by surprise when this summer’s sell off took place is that emerging market growth forecast adjustments had not changed one inescapable fact—they remain significantly higher than developed economies’ growth forecasts, which are still recovering from balance sheet recessions.
This dynamic is probably what’s driving interest in international expansion by US companies. Emerging market countries are forecast to outpace developed economies by more than one full percentage point until at least 2025 and by several percentage points when looking at certain individual country comparisons.
A recent Conference Board report titled, “Global Economic Outlook 2013, September 2013 update,” predicts the US and other advanced economies will gain some ground in closing their output gaps. As the report states: “This development should allow the US to average 2.3 percent annual growth during 2013-2018 before falling to 2.0 percent in 2019-2025.”
Overall, growth in developing and emerging economies is projected to drop from 5.5 percent in 2012 to 5 percent in 2013, with growth falling in China from 7.8 to 7.5 percent and in India from 5.5 to 4.2 percent. From 2019-2025, emerging and developing countries are projected to grow at 3.3 percent (see Chart A).
Chart A: Long-Term Country Growth Projections
Source: Conference Board
Meanwhile, investors seeking high yields in emerging markets are starting to pile back into the sector. As Chart B shows (see below), the iShares MSCI Emerging Markets Index (NYSE ARCA: EEM) has been at a 3-month high.
It’s likely that investors now recognize that Fed tapering is not likely to lead to meaningful increases in Treasury yields as compared to what can be found overseas, as reflected by their return to emerging markets. And on Sept. 18, the Fed unexpectedly refrained from reducing the $85 billion pace of monthly bond buying, which will only continue to put downward pressure on rates over the intermediate term.
The Fed explained its decision saying it needs to see more evidence of improvement in the US economy. The Fed has expressed concern about the continued weakness in the labor market and how rising rates could stifle the recovery.
Furthermore, the withdrawal of Lawrence Summers in mid-September as a candidate to be the next Fed chief has been interpreted by the market to mean the central bank will be less aggressive in slowing monetary stimulus.
The top candidate for the Fed chief post, Janet Yellen, is expected to hold short-term rates lower for longer if she succeeds Ben S. Bernanke in January. The US 5-year yield fell seven basis points, or 0.07 percentage point, to 1.62 percent on the news. The yield on the benchmark 10-year note dropped two basis points to 2.86 percent, after falling as much as 11 basis points the same day.
Chart B: Emerging Markets Investors are on the Comeback
Created with Y Charts
US Corporate Expansion Plans
It has been long observed that the location of new hotels and restaurants are usually the frontline of any developing neighborhood or region that is starting to grow, whether in the US or internationally. Such initiatives have usually been followed by large infrastructure and increased business investment.
That’s why it’s significant where some of America’s best-known hoteliers and restaurateurs are locating their establishments to capture emerging market growth.
Ritz-Carlton Hotels, owned by Marriot Corp (NYSE: MAR), announced plans in early September to open new hotels in Asia, the Middle East, Latin America, and Eastern Europe. Over the next 2-3 years, Ritz-Carltons are slated to open in the cities of Chengdu and Tianjin in China; Aruba, Venezuela and Cabo San Lucas in Mexico; as well as Herzliya, Israel and Almaty, Kazakhstan, to name a few.
Other Ritz-Carlton locations are planned in Oman, Muscat; Bali, Indonesia; Ho Chi Minh, Vietnam; Tunis, Tunisia and Haikou, China. Given that Ritz-Carlton is a high-end luxury brand, its choices are likely be indicative of where the firm sees significant increases in wealth and purchasing power, and where other business investment is likely to follow.
Marriott announced second-quarter 2013 earnings of $179 million, a 25 percent increase compared to second quarter 2012. Diluted earnings per share (EPS) totaled $0.57, a 36 percent increase from diluted EPS in the year-ago quarter. On May 1, 2013, the company forecasted second quarter diluted EPS of $0.55 to $0.59. Marriot Corp is a buy up to 48.
Darden Restaurants (NYSE: DRI), is the world’s largest full-service restaurant company, owning and operating more than 2,000 restaurants. In February, the firm announced it had entered into an area development agreement with International Meal Company (Bovespa: IMCH3) to develop and operate 57 restaurants under Darden’s Red Lobster, Olive Garden and LongHorn Steakhouse brands in Brazil, Colombia, the Dominican Republic and Panama.
This announcement was followed in July by yet more Latin American development deals with local partners in Guatemala, El Salvador, Honduras, Nicaragua, Costa Rica and Peru. Already present in Mexico and Puerto Rico, Darden with these new agreements will operate in 12 markets throughout Latin America.
Darden reported third-quarter EPS for fiscal 2013 of $1.01, missing analysts’ consensus estimate of $1.04 by $0.03. The company generated revenue of $2.3 billion in the quarter, compared to the consensus estimate of $2.27 billion. During the same quarter in the prior year, the company posted $1.15 in EPS. The company’s quarterly revenue was up 11.1 percent on a year-over-year basis.
Present headwinds in front of earnings reflect a still difficult US retail environment and expenses from developing new growth opportunities overseas. However, analysts predict that Darden will post $2.98 in EPS for the full fiscal year. Darden Restaurants is a buy up to 50.
In late August, Yum! Brands (NYSE: YUM), which operates KFC and Pizza Hut, announced a major expansion in its Yum! Restaurants International (YRI) division. At their recent annual investor day, company officials expressed confidence that YRI could eventually produce annual profit growth of at least 10 percent, and they detailed the 14,000-plus-unit division’s plans to double its annual net openings over the next five years. They also reaffirmed plans to shift the bulk of the company’s expansion to emerging markets, notably Russia and Africa.
Some analysts have noted that Yum is targeting $1 billion in annual operating profit from YRI by 2015, which would be roughly a 10-percent compound annual growth rate for the nearly $675 million in profit YRI generated in fiscal 2011.
Emerging markets should grow about 15 percent over this timeframe, with developed markets growing about 6 percent, analysts predicted. Yum! management also has a bullish outlook on other emerging markets such as the so-called CIVETS countries of Columbia, Indonesia, Vietnam, Egypt, Turkey and South Africa, as well as Brazil, the Philippines and Thailand. Yum! Brands is a buy up to 75.
But here’s the good news: At the same time, American corporate executives at small to midsize businesses (SMB) have stayed bullish on the growth fundamentals that emerging markets still offer. And in a dramatic reversal, there are now signs that investors are moving back into emerging markets investments in large numbers. This shift will only accelerate, as investors follow the lead of corporate management’s bullishness and the Fed’s announcement on Sept. 18 of continued stimulus.
A new CFO Research/High Street Partners survey of chief financial officers and other senior executives (including CEOs, presidents and controllers), released in early August, tells the story. Entitled “Pushing the Boundaries of Overseas Expansion,” the survey indicates that with growth still sluggish in certain US market sectors, executives are targeting overseas opportunities to achieve the growth they desire.
Of the 121 executives at companies with revenues between $50 million and $1 billion, nearly two-thirds (65 percent) reported they expect to expand their international initiatives in the coming year. Three-quarters (75 percent) of the respondents are interested in overseas business primarily to increase revenues or gain customers, rather than reduce costs.
Even more—83 percent—expect international markets either will be among the top priorities for their companies over the next three years (66 percent) or at least will become more important than they are now (17 percent). And in three years, 95 percent of respondents expect to have customers in at least two foreign countries.
What’s particularly telling of the survey is that SMB companies typically are more sensitive to changes in the economic cycle than larger firms. The fact that they are planning major international expansions over the next three years suggests an implicit forecast on when they expect robust US economic growth to return. Below, we profile various companies that have announced international expansion plans in the last couple of months.
The majority of executives surveyed expressed greater comfort with operating in developed economies similar to their own, asserting that Europe and Australia are on a par with North America in ease of conducting business. However, a majority of respondents, 57 percent, indicated that entering new markets in emerging economies would be moderately important or critical for them in the next three years, given the higher growth trajectories.
The emerging markets these executives consider a top or moderate priority is Eastern Europe, Japan, Latin America and Asia (ex-China). The executives regard the aforementioned markets as generally easier to do business in than Africa, China, Middle East and India, which nonetheless are also a focus of their expansion efforts.
The Forecast for Global Growth
What took many market experts by surprise when this summer’s sell off took place is that emerging market growth forecast adjustments had not changed one inescapable fact—they remain significantly higher than developed economies’ growth forecasts, which are still recovering from balance sheet recessions.
This dynamic is probably what’s driving interest in international expansion by US companies. Emerging market countries are forecast to outpace developed economies by more than one full percentage point until at least 2025 and by several percentage points when looking at certain individual country comparisons.
A recent Conference Board report titled, “Global Economic Outlook 2013, September 2013 update,” predicts the US and other advanced economies will gain some ground in closing their output gaps. As the report states: “This development should allow the US to average 2.3 percent annual growth during 2013-2018 before falling to 2.0 percent in 2019-2025.”
Overall, growth in developing and emerging economies is projected to drop from 5.5 percent in 2012 to 5 percent in 2013, with growth falling in China from 7.8 to 7.5 percent and in India from 5.5 to 4.2 percent. From 2019-2025, emerging and developing countries are projected to grow at 3.3 percent (see Chart A).
Chart A: Long-Term Country Growth Projections
Source: Conference Board
Meanwhile, investors seeking high yields in emerging markets are starting to pile back into the sector. As Chart B shows (see below), the iShares MSCI Emerging Markets Index (NYSE ARCA: EEM) has been at a 3-month high.
It’s likely that investors now recognize that Fed tapering is not likely to lead to meaningful increases in Treasury yields as compared to what can be found overseas, as reflected by their return to emerging markets. And on Sept. 18, the Fed unexpectedly refrained from reducing the $85 billion pace of monthly bond buying, which will only continue to put downward pressure on rates over the intermediate term.
The Fed explained its decision saying it needs to see more evidence of improvement in the US economy. The Fed has expressed concern about the continued weakness in the labor market and how rising rates could stifle the recovery.
Furthermore, the withdrawal of Lawrence Summers in mid-September as a candidate to be the next Fed chief has been interpreted by the market to mean the central bank will be less aggressive in slowing monetary stimulus.
The top candidate for the Fed chief post, Janet Yellen, is expected to hold short-term rates lower for longer if she succeeds Ben S. Bernanke in January. The US 5-year yield fell seven basis points, or 0.07 percentage point, to 1.62 percent on the news. The yield on the benchmark 10-year note dropped two basis points to 2.86 percent, after falling as much as 11 basis points the same day.
Chart B: Emerging Markets Investors are on the Comeback
Created with Y Charts
US Corporate Expansion Plans
It has been long observed that the location of new hotels and restaurants are usually the frontline of any developing neighborhood or region that is starting to grow, whether in the US or internationally. Such initiatives have usually been followed by large infrastructure and increased business investment.
That’s why it’s significant where some of America’s best-known hoteliers and restaurateurs are locating their establishments to capture emerging market growth.
Ritz-Carlton Hotels, owned by Marriot Corp (NYSE: MAR), announced plans in early September to open new hotels in Asia, the Middle East, Latin America, and Eastern Europe. Over the next 2-3 years, Ritz-Carltons are slated to open in the cities of Chengdu and Tianjin in China; Aruba, Venezuela and Cabo San Lucas in Mexico; as well as Herzliya, Israel and Almaty, Kazakhstan, to name a few.
Other Ritz-Carlton locations are planned in Oman, Muscat; Bali, Indonesia; Ho Chi Minh, Vietnam; Tunis, Tunisia and Haikou, China. Given that Ritz-Carlton is a high-end luxury brand, its choices are likely be indicative of where the firm sees significant increases in wealth and purchasing power, and where other business investment is likely to follow.
Marriott announced second-quarter 2013 earnings of $179 million, a 25 percent increase compared to second quarter 2012. Diluted earnings per share (EPS) totaled $0.57, a 36 percent increase from diluted EPS in the year-ago quarter. On May 1, 2013, the company forecasted second quarter diluted EPS of $0.55 to $0.59. Marriot Corp is a buy up to 48.
Darden Restaurants (NYSE: DRI), is the world’s largest full-service restaurant company, owning and operating more than 2,000 restaurants. In February, the firm announced it had entered into an area development agreement with International Meal Company (Bovespa: IMCH3) to develop and operate 57 restaurants under Darden’s Red Lobster, Olive Garden and LongHorn Steakhouse brands in Brazil, Colombia, the Dominican Republic and Panama.
This announcement was followed in July by yet more Latin American development deals with local partners in Guatemala, El Salvador, Honduras, Nicaragua, Costa Rica and Peru. Already present in Mexico and Puerto Rico, Darden with these new agreements will operate in 12 markets throughout Latin America.
Darden reported third-quarter EPS for fiscal 2013 of $1.01, missing analysts’ consensus estimate of $1.04 by $0.03. The company generated revenue of $2.3 billion in the quarter, compared to the consensus estimate of $2.27 billion. During the same quarter in the prior year, the company posted $1.15 in EPS. The company’s quarterly revenue was up 11.1 percent on a year-over-year basis.
Present headwinds in front of earnings reflect a still difficult US retail environment and expenses from developing new growth opportunities overseas. However, analysts predict that Darden will post $2.98 in EPS for the full fiscal year. Darden Restaurants is a buy up to 50.
In late August, Yum! Brands (NYSE: YUM), which operates KFC and Pizza Hut, announced a major expansion in its Yum! Restaurants International (YRI) division. At their recent annual investor day, company officials expressed confidence that YRI could eventually produce annual profit growth of at least 10 percent, and they detailed the 14,000-plus-unit division’s plans to double its annual net openings over the next five years. They also reaffirmed plans to shift the bulk of the company’s expansion to emerging markets, notably Russia and Africa.
Some analysts have noted that Yum is targeting $1 billion in annual operating profit from YRI by 2015, which would be roughly a 10-percent compound annual growth rate for the nearly $675 million in profit YRI generated in fiscal 2011.
Emerging markets should grow about 15 percent over this timeframe, with developed markets growing about 6 percent, analysts predicted. Yum! management also has a bullish outlook on other emerging markets such as the so-called CIVETS countries of Columbia, Indonesia, Vietnam, Egypt, Turkey and South Africa, as well as Brazil, the Philippines and Thailand. Yum! Brands is a buy up to 75.
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