Back on the road
Figure 1: World Gross
Domestic Product
Bloomberg, RWC Partners as at 30 June 2021
Past performance is not a guide to the future. The price of investments and the income from them may fall as well as rise and investors may not get back the full amount invested.
For more than a year the world has been battling Covid-19 and the economic impact of the pandemic. While there is an enormous amount of work left to do across the globe, countries leading the Covid-19 exit have given us a glimpse of a return to a more normal life. For the RWC Emerging and Frontier team that means getting back on the road to visit our portfolio companies.
Huanlong Chen, one of our three China analysts, recently spent two months in Shanghai, Beijing and Hangzhou, visiting publicly listed companies, attending conferences and meeting sell-side analysts.
The resumption of international travel signals the continued global economic recovery. Our global growth forecast of 6.0% for 2021 is supported by the global vaccine rollout, expanded fiscal stimulus, business adaptations to the pandemic and the expectation of a resurgence in demand as restrictions are eased. If our forecast comes to fruition, the world economy will grow at its quickest rate in nearly 50 years.
With Huanlong back on the road, his trip reminded us that meeting management teams in person gives us insights that no amount of desktop research can ever provide. It is these on-location meetings and site visits where we can discover great companies, reveal alpha-generating ESG practices and maximise shareholder value.
Introduction
Why emerging markets now?
Upon arrival in Shanghai, Huanlong was subject to a 14-day hotel quarantine. There was then an additional 7-day community surveillance as well as stringent pre-departure pandemic control measures as authorities in China try to control the spread of the virus.
Once out of quarantine, Huanlong noted that the domestic travel recovery has gained strength. Additionally, business travel has also seen a robust recovery with current business travellers accounting for 50% of total Mar-Apr ’21 passenger traffic. There has been minimal impact arising from the infection spike in Guangzhou but the more recent sporadic Covid-19 infections have admittedly hindered the recovery momentum in August.
The Chinese Government has put in an effective system to track local movement by using a combination of ID, cell phone and spending data. For example, when checking in at a hotel or onboarding a plane, an ID is necessary which is then further verified by facial recognition (AI), while health and journey codes are also needed to show that you are Covid-free. All the data is stored in the Cloud and can be accessed nationwide. This has allowed China to manage the spread of infection effectively, resulting in a recovery of consumption.
On the ground in China
Estimated nominal GDP growth in China this year
9.5%
Global economic growth forecast for 2021
6%
Figure 2: Growth drivers in China
Figure 3: Household income growth vs nominal GDP growth
in China
Figure 4: PBOC survey on Urban Depositor Confidence
Figure 5: Retail sales in China versus US
Source: NBS; JP Morgan and RWC as at 30 June 2021
Estimates are based upon subjective assumptions about circumstances and events that may not yet have taken place and may never do so.
The recovery in consumption and services has continued to gain momentum with the normalisation of domestic travel. The earlier and more forceful rebound on the production side (exports, IP and investment) was a key element of China's post-pandemic recovery while the recovery in consumption and services lagged. Going forward, we expect consumption to recover – which should boost GDP growth in China.
The sustained rebound in consumption and services is a key pillar in the Chinese economy’s expansion this year. At this point, the recovery is still incomplete, particularly in areas affected by pandemic control efforts. Our constructive view assumes that the Chinese authorities will continue to keep the pandemic under control, and domestic activity will continue to normalise. In addition, several fundamental factors will support the consumption recovery as follows:
First, the dominant factor driving consumption in China is household income growth, which tends to move alongside nominal GDP growth (Figure 3). Our estimates of 9.5% nominal GDP growth this year reflect our views that household income will grow steadily and support a consumption recovery.
Second, labour market conditions have significantly improved, with unemployment returning to near pre-pandemic levels in March (J.P.Morgan as at 30 June 2021).
Finally, consumer confidence has continued to recover. The PBOC survey on urban depositor confidence suggests that sentiment has improved gradually since 3Q20. This suggests that there is still room for improvement, as economic growth, income growth, and consumer confidence should all be mutually reinforcing for the rest of the year.
On the ground, Huanlong experienced the pickup in consumption. He encountered long queues everywhere he went: restaurants, tourist sites, airports and train stations. He noted that capacity in modern retail & malls is recovering to pre-pandemic levels while the online economy continues to reshape their offline businesses to meet the pent-up demand.
Retail sales in China have lagged the US (see Figure 5) thus far. However, with increasing capacity and the recovery of consumer confidence, Chinese retail sales are expected to catch up in the latter half of this year while the rest of the emerging markets are seeing similar trends.
Additionally, digitalisation has become more prevalent post the pandemic as the Covid disruption spurs the need for unmanned operations and creates the opportunity for companies to accept and explore how digitalisation could help them save costs and improve efficiency. For example, restaurants in China no longer use physical menus while unmanned self-checkout machines have replaced cashiers in convenience stores.
We expect the retail industry’s business model to change in the coming decade, with traditional retail to be completely replaced by smart retail. Compared with traditional retail, smart retail can leverage AI-enabled solutions to optimise operations with newly captured information. Companies that provide these solutions within China and throughout emerging markets will likely be a significant beneficiary
Pick-up in consumption
Throughout the first half of the year, the rollout of Covid-19 vaccines was a major setback in emerging markets. Emerging market equities have fallen -1.2% so far this year, underperforming the gain recorded by developed-world stocks. The pace of vaccinations has been one of the key differentiators, with an aggressive inoculation drive and fiscal stimulus measures helping to jumpstart the US and European economies.
However, we have recently seen the rate of vaccination increasing amongst the larger emerging countries (see Figure 7). This process is expected to continue throughout the second half of 2021 and may allow emerging markets to reopen their economies faster than expected and enhance their cyclical recovery, resulting in a larger GDP growth this year.
Our analysis shows a correlation between the decline in death rates due to increased vaccination and expectations for future economic growth.
There is evidence that financial markets underperform as a result of large Covid outbreaks. For example, as deaths and cases started to rise in Brazil, Brazilian equities started to underperform the rest of the emerging markets, before starting to outperform as investors began to predict the peak in the outbreak. Based on this we expect an increase in vaccinations across emerging markets will continue to curb the increase in deaths and subsequent lockdowns. We believe this may allow for continued outperformance amongst EM countries.
In China, it was difficult for governments to convince citizens to get vaccinated at first when there were no community cases. As an incentive, local governments gave away free gifts or digital Renminbi in order to persuade the population to get vaccinated.
However, vaccinations substantially increased when new community cases broke out in the Guangdong province. The number of vaccines administered reached one billion within two months. The government set up vaccination sites all over China to facilitate the increased vaccination program, for example, there is one site right outside Shanghai railway station. An ID is the only item required to get vaccinated and the vaccines are free of charge.
Huanlong received his two shots in Shanghai due to the ease and efficiency of the vaccination programme. The record is stored in the Cloud and can be checked and verified nationwide. However, it is unclear if the vaccines that Huanlong received in Shanghai will be acknowledged worldwide at this moment.
Vaccinations
As the world continues to vaccinate its inhabitants, a recovery of travel will be a significant boost to the emerging and frontier economies that have a significant proportion of GDP from tourism. Additionally, indirect contribution from travel, which includes the impact on related industries such as food and beverage, retail and entertainment, can be double the direct contribution. We continue to see an uptick in international travel bookings, and this is expected to recover to pre-pandemic levels over the next few years.
Air travel in the Covid era remains dependent on government Covid policies. Governments are beginning to become less stringent on reopening, as vaccinations increase globally. However, as travellers plan their next trip, they will first look to destinations close to home. This trend has been apparent in China with 77% of Chinese travellers favouring domestic travel within three months after the peak of the crisis. It also appears that a similar sentiment is resounding across the world, with 71% of Americans looking at domestic locations up from 58% last year.
Additionally, we have seen significant consolidation in the travel industry as a result of the pandemic. Industry leaders have been expanding their market share at the cost of small marginal players who suffered from weak balance sheets as a result of Covid lockdowns.
Travel
In previous global recessions, emerging markets equities fell more than developed markets. They repeatedly saw their currencies underperform which also contributed to the weak performance in their equities market. However, this recession is unique as it is tied to a health crisis rather than a financial one. Emerging economies fared better in 2020 than their developed market counterparts and are expected to experience faster economic growth in 2021 (Figure 13). Emerging currencies have also performed well with the MSCI Emerging Market Currency Index experiencing highs in early June.
Notably, these countries engaged in much lower levels of fiscal and monetary stimulus than developed nations and may have avoided sowing seeds that can lead to potential future financial problems. We have identified three key themes which may benefit from the post-pandemic recovery: modern retail and malls, EM travel and technology disruption. Additionally, valuations are at attractive levels, especially relative to developed markets.
Emerging market equities continue to trade at a steep discount on a price to earnings and price to book basis relative to developed markets. On our estimates, the RWC Emerging Markets Equity Portfolio expects a weighted average return on equity of 22.9%, well above MSCI World and MSCI Emerging Markets, despite trading at 14x price to 2022 earnings. Furthermore, our weighted 5-year compound annual earnings growth estimate is 26.7%, compared to 20.1% for the MSCI Emerging Markets Index.
EM growth going forward
Vincom Retail is the largest mall developer in Vietnam with 60% market share in terms of Gross Floor Area (GFA) in Vietnam. It operates four retail format malls, which caters to unique catchment areas. The retail landlord is a good proxy to the consumption story in Vietnam. Vietnam has a growing middle class which is set to drive the next wave of consumption and enjoyed a similar success in combatting the virus as China. Its disposable income per capita is on a growth trajectory similar to the Philippines in 2004 and Thailand in 1990, thus, we believe that Vietnam can replicate these growth stories going forward.
Modern malls and retail – Vincom Retail
China’s cyber security market is expected to maintain its 20% CAGR growth given the Government’s continued investment in multi-level protection schemes. Furthermore, China’s cloud computing industry is expected to grow at a 40% CAGR (source: RWC estimates).
Sangfor is well-placed to benefit from this growth due to its strong research and development capabilities, continuous innovation and strong sales distribution. The company is the third-largest HCI (hyper-converged infrastructure) player in China and trades at a reasonable valuation considering its superior growth potential.
Technology disruption – Sangfor Technologies
2021 has clearly been a policy-heavy year in China. We remain underweight the sectors that are facing policy headwinds, including internet, property and education, as these sectors may be structurally impacted in the future. However, we don't think the regulatory issues change the attractiveness of China overall. We continue to align ourselves with government direction and look to invest in those parts of the economy which the Chinese government is promoting as essential, for example consumer, travel and green energy.
China regulatory risk
China was the first country that we managed to visit in the post-Covid
era. While China is an emphatic example of successful virus containment, there are many others. For example, India largely succeeded in its
ambitious implementation of a full lockdown of 1.4 billion people and a subsequent re-opening.
A recovery of travel, consumption and mobility in the latter half of the year will provide significant tailwinds in China going forward. We remain optimistic that these trends will be prevalent throughout the rest of the emerging markets. Furthermore, as we begin to travel again, we continue to raise awareness about environmental, social and governance (ESG) and the positive impact that strong ESG practices and standards generate for all stakeholders. We continue to fully engage in ESG practices with the companies we meet and integrate ESG data that we collect to enhance our investment decisions.
Past performance is not a guide to the future. The price of investments and the income from them may fall as well as rise and investors may not get back the full amount invested. The information shown above is for illustrative purposes only and is not intended to be, and should not be interpreted as, recommendations or advice.
Conclusion
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The team
John Malloy and James Johnstone co-manage the RWC emerging and frontier markets team. The team is composed of a further 19 analysts, economists and strategists based in Miami, London and Singapore, many of whom have worked together for over twenty years. The team joined RWC Partners in 2015 and now manages
c.$12bn for its clients. Emerging and frontier markets represent the fastest growing countries in the world. The RWC team believes the continued growth in these markets represents opportunities across a range of industries.The highly experienced and dedicated team takes an index-agnostic, opportunistic approach which allows it to explore investment opportunities that are often off the beaten track.
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EM growth company fundamentals, valuations and performance
Our constructive view for emerging market equities is backed by the global synchronised expansion, monetary and fiscal policy support and the increasing rate of vaccinations. As we continue to see a global recovery, more discretionary-related themes will likely recover due to strong secular growth via digital platforms.
Emerging markets have a unique opportunity to leapfrog traditional technological channels enabling faster and more sustainable growth. Travel should benefit from the increasing rate of vaccines being administered among emerging markets. Furthermore, less stringent Covid policies worldwide will also benefit our EM travel thematic. A recovery of consumption due to pent-up demand, robust GDP growth and increased mobility will also likely benefit modern retails and malls. The team continues to search for new themes and new ideas in our rapidly evolving universe.
Themes
Huazhu Group is a leading multi-brand hotel group in China. The company owns 12 hotel brands, including HanTing in economy hotels, Ji Hotel in mid-scale hotels and Joya in upscale hotels. As the middle class emerges in China, domestic consumers aspire to quality services. Additionally, the recovery of international travel bodes well for the hotel franchise. The company’s normalised earnings growth is estimated to be 48% 3-year CAGR, helped by industry consolidation (Bloomberg, RWC, Partners, Company Reports as at 30 June 2021).
EM Travel - Huazhu Group
Source: CEIC, J.P. Morgan and RWC Partners as at 30 June 2021
Source: CEIC, J.P. Morgan and RWC Partners as at 30 June 2021
Source: CEIC, J.P. Morgan and RWC Partners as at 30 June 2021
Source: Reuters, RWC Partners as at 22 July 2021
Source: Reuters, RWC Partners as at 22 July 2021
Source: Our World in Data, as at October 2021
Source: Bloomberg, RWC Partners as at 25 August 2021
Figure 6: MSCI EM vs MSCI World (normalised 12/31/2021), %
Figure 7: Large EM and DM total administered shots as a percentage of population
Figure 8: Change in mobility and vaccine rollout in EM
Figure 9: Change in mobility and GDP growth
Figure 10: Brazil performance during Covid outbreaks
Estimates are based upon subjective assumptions about circumstances and events that may not yet have taken place and may never do so.
Source: Bloomberg, RWC Partners, Schroders, OurWorldInData.org as at 20 July 2021
Source: WorldBank, RWC Partners as at 20 July 2021
Figure 11: Travel and tourism contribution to GDP (%), 2019
Estimates are based upon subjective assumptions about circumstances and events that may not yet have taken place and may never do so.
Source: Bloomberg, RWC Partners, as at 20 July 2021
Source: Charles Schwab, International Monetary Fund April 2021 World Economic Outlook data and forecasts as of 29 June 2021. Past performance is no guarantee of future results.
Figure 12: Emerging market economies besting developed markets in 2020 and 2021, GDP growth, %
Figure 13: MSCI EM Currency Index
Estimates are based upon subjective assumptions about circumstances and events that may not yet have taken place and may never do so.
Source: Bloomberg, RWC, Partners, Company Reports as at 30 June 2021
Source: Bloomberg, RWC, Partners, Company Reports as at 30 June 2021
Figure 14: Huazhu Group overview
Figure 15: Huazhu Group revenue per room (RevPAR) YoY
Estimates are based upon subjective assumptions about circumstances and events that may not yet have taken place and may never do so.
Source: Bloomberg, RWC, Partners, Company Reports as at 30 June 2021
Source: Bloomberg, RWC, Partners, Company Reports as at 30 June 2021
Source: Bloomberg, RWC, Partners, Company Reports as at 30 June 2021
Figure 16: Disposable income per capita (USD) in Vietnam
Figure 17: Disposable income per capita (USD) in Thailand
Figure 18: Disposable income per capita (USD) in Philippines
Estimates are based upon subjective assumptions about circumstances and events that may not yet have taken place and may never do so.
Source: Morgan Stanley, 30 September 2021
Figure 19: Network security as % of IT investment
Estimates are based upon subjective assumptions about circumstances and events that may not yet have taken place and may never do so.
Figure 2: Growth drivers in China
Figure 3: Household income growth vs nominal GDP growth
in China
Figure 4: PBOC survey on Urban Depositor Confidence
Figure 5: Retail sales in China versus US
Figure 6: MSCI EM vs MSCI World (normalised 12/31/2021), %
Figure 8: Change in mobility and vaccine rollout in EM
Figure 9: Change in mobility and GDP growth
Figure 10: Brazil performance during Covid outbreaks
Figure 7: Large EM and DM total administered shots as a percentage of population
Figure 13: MSCI EM Currency Index
Figure 12: Emerging market economies besting developed markets in 2020 and 2021, GDP growth, %
Figure 15: Huazhu Group revenue per room (RevPAR) YoY
Figure 14: Huazhu Group overview
Figure 16: Disposable income per capita (USD) in Vietnam
Figure 17: Disposable income per capita (USD) in Thailand
Figure 18: Disposable income per capita (USD) in Philippines
Back on the road
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