Insight Into The Frontier Markets Consumer

Via Emerging Frontiers, an interesting look at the frontier markets consumer:

Swiftarc Capital is an independent, privately held investment management firm that focuses on consumer companies in emerging & frontier markets. The firm was founded in 2010 and has two managing partners/portfolio managers; Sid Jawahar and Siamc Kamalie. In this interview with Emerging Frontiers, Siamc shares his latest research and investment outlook.

Emerging Frontiers: Siamc, since we last spoke you’ve gone on a world tour covering Africa, Europe and Asia. Specifically you were scouting in Kenya and Philippines. Catch us up on how the trip went?

Siamc: Scott, thank you for the follow-up since our last interview. The trip was brilliant! I was able to conduct further diligence on current and potential investments in both countries. In Kenya, the Fund is invested in the leading brewery and it’s appreciated significantly from when we first acquired interests in 2012. As part of my due diligence, I am always striving to criticize and test assumptions on investments regardless of price performance. For example, “Have I tried to find evidence against what I believe? Why might I be wrong? What have I overlooked? What (new) information or evidence is needed to make me change my mind?”

One of the key attractions to the Africa brewery investment thesis is the young demographics found on the continent. It is easy to process the statistical data sitting half way around the world, but when someone visits a country of 45 million people with about half of the population below the age of 19 years, only then do you truly begin to appreciate the qualitative factors that come with a young demographic profile. For example, younger consumers are potentially less brand loyal, as they are more open to trying new products and are more connected to the internet/global trends.

Consequently, their taste profiles are not always fixed. In addition, they are more price-sensitive, as they are at the beginning of their career and have less disposable income. With that, I initiated a one week analysis of “Be-The-Consumer” surveys in order to gauge alcohol consumption habits. This entailed visiting more than two dozen drinking establishments located in rural/poor, middle-class, and premium/high-end districts of Nairobi. I gathered roughly 75 different data points in order to cross-check the original investment thesis and key assumptions.After Kenya, I ventured to the Philippines, meeting over 15 companies, and performing plant operational due diligence for six of those companies. The highlight there was visiting the main distribution center for the country’s leading convenience store chain (70% market share of the convenience store segment, twice the size of its closest competitor). The company has finally established the scale where growth is easier to sustain through internally-generated cash flows. Management is thus planning a more aggressive store expansion program, aiming to double its network size (just opened the 1,000th store) over the next three years. The modern retail format remains extremely underpenetrated in the Philippines with only 22% of retail through modern channels, 3% of which is through convenience stores.

Another interesting highlight was comparing the different stages of usage and development of social media. Across the spectrum of markets, I see social media usage growing exponentially. This is particularly true in countries with young demographics such as the Philippines (median age 22), and surprisingly it also holds true in poorer countries such as Kenya (GDP per capita is $860). There is a clear trend for more and more people to get online and join the knowledge economy. As consumers connect with friends, communities, businesses, products, and governments, it empowers their decision-making. As a result, I believe that this is the most empowered generation in history. More than ever, I emphasize the intrinsic value in brands, as companies will be able to better tell their stories and build meaningful connections with consumers in ways never before seen in history.

Emerging Frontiers: I know you are a fan of breweries in Africa, as most in Asia and Latin America have already been bought out by international players. In this space what is catching your eye in Africa?

Siamc: The Africa brewery story is an attractive long-term proposition; as a result, there is an observable increased investment/rising competition between the major global brewers. Nigeria is a great example of this and has become one of the most competitive markets on the continent. However, there are still markets in Africa where you have brewers that operate like monopolies with >90% market shares. This is what excites me the most because scale is the number one factor to long-term success in the sector. The Fund is invested in these “monopoly” breweries that operate in countries like Kenya, Mozambique, Tanzania, Ivory Coast, and Zimbabwe. Given the additional macroeconomics risks in these markets, I want to own businesses that have very high recurring earnings power ensured by the competitive moats they have in scale with production, distribution and brands.

Emerging Frontiers: Given alcohol is heavily taxed, how does this affect consumers and breweries?

Siamc: Great question. Excise taxes are important sources of revenues for emerging/frontier governments. Consequently, alcoholic beverage companies work closely with governments in terms of managing increases of excises taxes. In the short term, a rise in excise taxes affects consumption volume trends negatively, but in the long-run, companies with branding power have the ability to pass on the cost to consumers.

For example, in 2013, the Philippines raised excises taxes on alcohol significantly and the local distilled spirits industry matched the increase by raising prices 12 – 16%. This difficult operating environment however also creates opportunities. For example, the Fund is invested in the leading brandy brand whose sales volume was up by approximately 4% YoY in 9M13; while the low single-digit growth may seem weak, it figures much better than the 17% and 20% decline in volumes posted by its top two competitors, during the same period. According to data from Nielsen, our brandy company’s market share expanded to 48% in 9M13 from 42% at the end of 2012. This is a classic case of “strong getting stronger” and highlights the importance of high quality / market leader investing due to of their ability to invest counter-cyclically.

Emerging Frontiers: On the topic of distillers, what do you think of the recent announcement of Suntory’s premium price offered to acquire Beam?

Siamc: As the industry has become increasingly consolidated, I am not surprised to see transaction multiples for M&A increasing significantly. If you look over the past decade, brewing/spirits transactions have occurred at a broad range of EV/EBITDA multiples with the lowest being 6.3x and the highest being 31.3x. The cost savings that have been achieved in some recent transactions have persuaded companies that a higher pre-synergy EV/EBITDA multiple is justifiable.

Further, borrowing conditions have become increasingly favorable for the beverages sector with $34.3 billion USD of debt issued since January 2012 at an average coupon of 2.7%. As a result, I believe that companies can justify higher transaction multiples and consequently have lower hurdle rates for potential transactions.

The Swiftarc Fund has interests in five breweries that on average are undervalued by 70% relative to the most recent sector EV/EBITDA transaction multiples. However, I do not expect these assets to get acquired as we have co-invested with strategic shareholders, most notably SABMiller. And although these investments are undervalued on their own merit, I think the shift in the sector’s valuation emphasizes the attractive long-term opportunity.

Emerging Frontiers: Spending time in the region, Asia feels a bit overheated now, for over the past year equities in many countries have reached record highs, currencies were remarkably strong, and in the international media the concept of the “Asian growth story” seems to have reached a feverish pitch. How are you coping with the reality that EM Asian assets are not presenting much value at present?Siamc: From a bottom-up perspective, the major Asia markets are getting more competitive at the company level and better covered by the investment community. That doesn’t mean there’s a lack of opportunities present, but only that I have to be more selective. I find the frontier Asia markets offer the most attractive valuations and have been spending more time combing through the opportunities there. For example, Pakistan, Bangladesh, and Vietnam have very attractive consumer profiles and demographics while the listed consumer companies there still trade at 50 – 75% discount to the peer group in the emerging markets. I can argue that discount is there for the “extra” country risk I take, but even when I looks at the valuation of these companies on an absolute basis, taking into account the market size/population, the under-valuation is significant.

Furthermore, I also consider a company’s ability to generate incremental higher return on invested capital, and in that regard, many of the high-quality companies in frontier markets surpass their peer group in emerging markets, making them “less risky” in the future. I find that population sizes and demographic profiles of a country are a good starting place when I compare the long-term opportunity sets across emerging and frontier markets.

Emerging Frontiers: So looking at the sub sectors in the consumer space, what’s attractive in emerging and frontier markets? Where is Swiftarc uncovering hidden value?

Siamc: I think the “trading up” opportunity in the personal and home care market is very exciting and under the radar. For example, personal care consumption take-off point is about $2,500 GDP per capita, and the main emerging markets in Southeast Asia are crossing this threshold in the next few years. For frontier markets, they are still approaching $1,000 GDP per capita, and this is an area where home care consumption takes off considering it consists of basic cleaning items.

Focusing on the global personal care market, this is the third largest consumer staple sub-sector valued at 433 billion USD in 2012, and from a value perspective, the emerging market opportunity set to “catch up” to developed markets is about 6X; when looked at from a volume perspective, emerging market consumption is already on par with developed markets. This tells me that it’s not a lack of appetite to consume these products, but a function of “trading up” the consumer. When one considers the product innovation/premium branding power in skin / hair care that’s present in developed markets, the opportunity for rising margins for companies in this space is promising.

Emerging Frontiers: Focused on the information arbitrage which exists in the emerging and frontier world, what do your travel plans this year look like to conduct boots on the ground due diligence?

Siamc: For the first quarter of 2014, I have research trips to frontier Africa and Asia. I’ll be in Nigeria, Mozambique, Zimbabwe, and South Africa for all of February. In March, I’ll be going to Bangladesh, and Vietnam. These trips will be for current and potential investments’ due diligence. I will also be meeting with private companies that may IPO this year. The capital markets in frontier markets are still in their infancy, and we want to be at the forefront of these developments. I’m excited by the potential pipeline of IPOs in these markets, because it will help address some of the challenges such as lack of listings, liquidity, and visibility.

Besides my focus on building frontier research, I also will be attending an annual consumer conference in London to meet the chiefs of large multi-national companies who already have significant emerging market businesses, such as Nestle, SAB Miller, and Diageo. This additional perspective from these global behemoths aids in building a better mosaic of the rapidly evolving emerging/frontier market consumers.

Emerging Frontiers: Wrapping up, how is the fund positioning itself to achieve alpha in the New Year? Can you share some portfolio metrics?

Siamc: The Fund’s weighted average return on equity is close to 40%, the portfolio companies have little to no debt, and should generate on average 30% earnings growth this year. The Fund is building more exposure to businesses that have no formal research coverage, and are in markets that are off the radar for most investors. Swiftarc’s competitive advantage across all emerging markets is patience and a focus on high-quality companies.

Going forward, I will be looking to supplement our investment philosophy by taking advantage of the information arbitrage that exists in frontier markets. The Fund will also be more concentrated in its top ideas to ensure we maintain our low correlation profile to the rest of the market. I look forward to sharing a few of these “off the beaten path” stories later this year.

Emerging Frontiers: Siamc, it is always great speaking with you.

Siamc: Thank you, Scott. I look forward to speaking with you again soon.

This entry was posted on Thursday, January 30th, 2014 at 10:08 am and is filed under Uncategorized.  You can follow any responses to this entry through the RSS 2.0 feed.  Both comments and pings are currently closed. 

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