Investors slow to unearth hidden emerging equity gems | Reuters - Firstpost
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Investors slow to unearth hidden emerging equity gems | Reuters

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LONDON Indian airlines, Brazilian chemical producers and Turkish car makers and are just some of the emerging market firms thriving thanks to low commodity prices, and yet investors are often slow to catch on due to the asset class's dismal overall performance.

With emerging equities underperforming developed markets for five years running, investors have perhaps been too ready to lump all such stocks together - including some hidden gems buried by the landslide of selling.

In India, the valuations of some companies posting strong earnings are already high due to rapid economic growth and hopes for economic reform under Prime Minister Narendra Modi.

However, investor sentiment is near rock bottom for Brazil, which is deep in recession and political crisis, while Turkey is troubled by security and economic problems.

For all the difficulties and turmoil, some of the most shunned businesses are performing well and nowhere is this more marked than in sectors such as pulp and paper or chemicals.

Many of these companies were trampled by the stampede out of commodity-related assets last year, even though they have frequently benefited from the lower costs of raw materials and the energy used to process them.

Contrarian investors who go against the flow argue that the bombed-out valuations in some of the most sold off emerging markets such as Brazil present an opportunity to snap up cheap quality assets that will rise in value as sentiment improves.

In recent months emerging equities have tended to move in lock-step with energy prices, selling off when oil tumbled and recovering modestly when it rallied a little. Yet three-quarters of the market capitalisation of MSCI's benchmark EM equity index is down to firms in commodity importing countries.

Investors have largely punished the good companies along with the bad, pulling a net $7.5 billion from emerging equity funds in the year to March 9, data from EPFR Global shows.

"Even if companies have good earnings, no stock is safe from liquidity flows and risk-off sentiment," said Patrick Mange, head of emerging markets strategy at BNP Paribas Investment Partners.

So although the most obvious beneficiaries of cheap energy such as airlines, car manufacturers and white goods makers have posted 30-40 percent year-on-year increases in profits, their stock price performance has been mixed.

All have tended to rally immediately after reporting strong earnings but they haven't always hung on to the gains because of the broader emerging market sell off.

MODI HOPES

For Indian companies, which have been supported by investors' hopes for the Modi reforms, gains are limited by the fact that some stocks are already trading near multi-year highs.

For example, Jet Airways, India's second largest carrier, enjoyed an 8.5 percent jump in its share price after posting record quarterly net profits. But its shares now trade below five-year highs hit in January.

Similarly, car maker Maruti Suzuki and two-wheeler firm Hero MotoCorp have delivered profit rises of around 30 percent, but shares appear to have topped out after rising through 2014 and 2015.

Hitesh Jain, a senior analyst at research firm Aranca, says that much of the good news is already priced in here.

"A lot of these companies have broadly outperformed the rest of the market. Although it doesn't look as if commodity prices will increase in 2016, any further margin expansion will only come via increased volumes," he said.

This means contrarian investors are looking to less fancied markets such as Turkey and Brazil for the biggest bargains.

GUILTY BY ASSOCIATION

Brazil's materials and chemicals sectors, which suffered when investors dashed for the exit, could offer some good relative value plays, says David Purdy, a portfolio manager at Acadian Asset Management.

"There are industry groups that are somewhat guilty by association but are more fundamentally sound," Purdy said, citing pulp and paper as an example.

This is lumped in with the materials sector, but these companies have benefited from lower costs due to their high energy usage, and are closely linked to consumer staples such as toilet paper and tissues.

For example, Brazil's Fibria Celulose posted a strong quarterly profit due to resilient demand for paper products in Europe and Asia. But the stock is down over 30 percent year-to-date.

Similarly, chemicals companies have sold off as if they were oil producers, although they actually benefit from using cheap crude to make their products.

Braskem, Latin America's largest petrochemical company, posted a $39 million fourth quarter profit in February, due to a favourable exchange rate and falling crude prices. But the stock is still down about 5 percent year-to-date.

In Turkey, which faces fewer crippling economic problems than Brazil but is not as overweighted in investor portfolios as India, some companies have been able to convert strong earnings into decent share price performance.

Car maker Tofas posted a 45 percent increase in net profit for 2015, and the stock is up about 9 percent year-to-date. Meanwhile white goods maker Arcelik is up 30 percent year-to-date, following a 44 percent rise in net profits.

Julian Mayo, chief investment officer of Charlemagne Capital, says it took a while for the benefits of low oil prices to filter through to Turkish companies. This is because the lira fell 25 percent last year against the dollar, making dollar-priced commodities more expensive in Turkish currency terms.

Investors must now decide whether commodity price fluctuations and the policies of some developed market central banks, which have encouraged the flight from emerging markets, will continue to outweigh companies' fundamental performance.

"You don't want to stand in front of a high speed truck," said Mayo. "But if you believe the bulk of the selling is behind us then that will give stability to markets."

(editing by David Stamp)

This story has not been edited by Firstpost staff and is generated by auto-feed.

First Published On : Mar 17, 2016 01:00 IST

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