In January, we traveled to Mexico where we visited retail, telecom, insurance, and financing companies. Some speculate that Trump will pay for the wall through taxes on remittances which would hurt retail sales, and that increased export tariffs could increase unemployment. On the other hand, Mexico’s currency seems to have significant upside potential after a 40% depreciation over the past three years, nearly half of which occurred over the past year and nearly a quarter over the past few months. Everything in the country seemed very cheap, and Mexico’s currency ranks as the 7th cheapest among 49 currencies according to the Big Mac Index.
The most interesting company we saw was a car theft insurance business. This company has been able to grow twice as fast as auto sales in general and four times the industry rate. One of the company’s competitive advantages is its decentralized model. The company’s branches are operated by entrepreneurs who are able to make faster and better decisions than centralized offices. This has enabled higher settlements and led to higher customer satisfaction and loyalty. Additionally, the company’s management has an excellent reputation in the field. Industry growth is expected to slow this year given the challenging environment, but we are considering a small stake.
The month passed quickly as we followed the results of the fund's portfolio companies and visited Egypt and South Africa. Portfolio companies – the half that has already reported – fared well, upholding 25% annual EPS growth compared to the 1% EPS rate of the broader market. Additionally, the fund's companies are inexpensive relative to the market and to their own growth rates. We do not have targets for portfolio-specific growth or valuation numbers, but this is an easy way to communicate a general theme about the fund's companies.
Our Egypt trip brought us to a leading telecom company which serves the landline data market and which won a license to build out 4G data infrastructure about six months ago. The market holds three competitors that have focused on defending their large mobile voice profit pools, and as such Egypt’s mobile phone data penetration is only 27%, one of the lowest rates in the world. The company we met does not operate in mobile voice and it can thus freely benefit from the 35% growth rate in mobile data. What makes the case even more interesting is that locals have sold shares and depressed the valuation as the company transitions to a growth company investing in infrastructure.
March was a very busy month with visits to companies in Turkey, the Philippines, and Thailand. Turkey is facing an overhang due to the coming executive presidential system referendum. While such a move would increase political uncertainty, most companies do not foresee direct impact, and the current valuations make some high-quality growth companies seem very attractive. One example we found was a steel pipe manufacturer with value-added products that made investments in automation technology which cut costs by 35%. With most of its revenues coming from exports, the company benefits from the depreciating lira providing a natural hedge against the currency weakening.
Similarly, the market has been concerned about political uncertainty in the Philippines due to President Duterte’s rhetoric. However, the Philippines remains one of the brightest spots in the emerging world, with GDP per capita of less than $3,000, growth exceeding 6%, and many great companies. One such company we identified was a low-cost airline that benefits from the growing middle class and enjoys high barriers to entry due to the congestion of the Manila airport. In addition to increasing airport efficiency, the company’s management sees opportunities in converting its high load factors into growth as it adjusts its fleet and expands to new destinations.
April took us to Southeast Asia where we visited a dozen companies in Indonesia and Malaysia. In Indonesia, we met with an internet service provider that serves one of the most underpenetrated and fastest-growing broadband markets in the world. Penetration is only at 9%, while subscriber growth is nearly 20% a year. Despite increasing competition, due to scale and first-mover advantage the company has managed to maintain its margins, which are the highest of all its global peers’ margins, as well as its 30% return on invested capital. Meanwhile, the company’s valuation doesn’t seem to adequately reflect its quality and growth.
In Malaysia, we met a food and packaging company that we have eyed for a long time but had not added due to not having met with management. We finally managed to meet the founder who told us we are the first investors he has agreed to meet in several years, mostly due to our persistence and willingness to travel to his far-flung office located hours away from Kuala Lumpur. We learned details about an exciting joint venture they are starting with a Mexican client, which will both increase margins and provide incremental growth. We believe these companies along with some others that we met will complement the portfolio well. We remain committed to scouring the globe for the most interesting investments.
We do not follow indices but it’s useful to comment on them because investors do follow them. Pakistan, long the fund's largest market, has been one of the best-performing and most interesting countries in the Frontier index. At the turn of the month, the country was upgraded to the ranks of emerging markets. For some, this is problematic as their scope becomes even smaller and a need arises to add weight to currently less exciting markets (Kuwait is nearing a third of the index). Pakistan’s weight in the fund's portfolio has slowly decreased because of increasing valuations, but for us the change itself was a non-event because we focus on promising companies and inefficient markets rather than indices. In the end, the fund's investments are placed where the most promising companies are to be found.
May brought about strong quarterly reports. Malaysian small- and medium-sized companies have done well this year as the country has bounced back from a slowdown. Dufu Technologies, a small Malaysian precision machining player, reported its first-quarter figures maintaining 100% earnings growth on LTM (last twelve months) basis. The company was able to focus on higher-margin business over time, leading to the doubling of its valuation this year alone. Naturally, not all businesses reach such heights, but we believe our focus on quality, inexpensive firms in the right locations lays the groundwork for finding such companies.
In June, we visited several companies in Monterrey, Mexico. We were highly impressed by the quality of the firms we met and also noticed some improvement in sentiment since our last trip to Mexico right after the U.S. presidential inauguration. The airport companies have interested us for a while due to their high returns on invested capital and growth rates. We were finally able to meet with one and learn about its terminal expansion and remodeling plans, as well as new terminals and highly profitable non-aeronautical projects. Airports have done well as a result of increasing conversion of long-haul bus traffic to air travel, creation of regional hubs, and increase in the number of direct flights. These companies are leveraged to the Mexican economy as they grow at 1.5 to 2x GDP. Therefore, concerns about a NAFTA renegotiation are baked into the price. Notwithstanding this, the company we met seemed cheap for its level of quality and growth.
Another fascinating company we visited was a supermarket chain which is the only retailer with a position competitive to Walmart. It has tremendous growth opportunity, as it has 70% of the sales area yet only 30% of the sales that Walmart has. In addition to completing a transformational program over the past six years, of which the company is now starting to see the fruits, it recently acquired a chain of stores focused on the middle-to-upper income segment which the firm is hoping to learn and benefit from.
Three years ago, Thailand experienced a coup. Last year, the same was attempted in Turkey. These events caused volatility in their respective exchanges, but equity valuations bounced back quickly in both cases. Some days ago, Pakistan’s prime minister was asked to step down due to alleged wrongdoing. This turbulence affected the fund, but our strategy had protected the fund as it had cut its holdings in Pakistan in half in the past year as valuations had risen. The fund still has solid investments in Pakistan and are now waiting for a bounce.
These examples were and are a case of following our strategy: focusing on long-term absolute returns by selecting companies with the best combination of quality, growth and value characteristics through a bottom-up approach. Instead of trying to beat a benchmark we focus on the best companies. As a result, the fund's country weightings do not resemble indexes. The fund has thus at times experienced short-term periods of underperformance due to country-specific factors, but the long-term performance and volatility track tell a different story.
Some of the fund's investments focus on countries investors do not like. Turkey seems to have been one of these over the past couple of years. The country has its share of political and economic troubles, but the continued depressed state also depresses equity and currency valuations, unearthing interesting opportunities. Thus, we visited Istanbul again in August and got to visit both new and old companies.
One of the most interesting targets the fund invested in two years ago was a Turkish electrical outfitter. The company was well-positioned to complete complex projects but was now also winning metro line outfitting contracts. The firm has in fact quadrupled its earnings over the last two years, and our last week’s meeting with the CEO and CFO made us believe it was still in a good position to win more business. There will be at least hundreds of kilometers more of metro lines. Many of the other companies from last week dealing with anything from detergents to air conditioning units also convinced us of their fair potential, and we are still investigating them.
Egypt has 900,000 marriages per year. Why does this matter? It matters because if you are Egyptian and getting married you are expected to move away from home, and if you don’t own a home you are viewed as incomplete. This in turn affects residential developers. Rising demand and prices have put these companies in a strong position where earnings have nearly tripled in the last year alone. We met several Egyptian developers in September and have so far invested in the most interesting one. Infrastructure, power, and export businesses seem to have strong potential as well. Overall, the country seems to be overcoming the short-term pain of a massive devaluation and reform programs.
12,000 km away, Argentina’s telecom industry is in the process of normalizing tariffs from an extremely low level which was held constant for many years due to regulation. The pricing still has significant growth potential to catch up to the rest of the region. In addition, the country still has relatively low penetration of data, though it has been growing rapidly. This month, we met a telecom company which is benefiting from these trends. Of course, Argentina has long had macro risks and is still working to combat high inflation, but it also represents additional diversification for the portfolio.
This month, we traveled to Bangladesh, Thailand and Vietnam where we met with over 20 companies. Bangladesh is the fastest-growing country in the world with an active equity market, and many of the companies we saw have incredible growth opportunities. For example, mobile phone penetration in Bangladesh is one of the lowest in the world, and given that 4G doesn’t yet exist, data usage per capita is relatively low. However, the growing consuming class and the introduction of 4G next year should significantly increase data, a high-margin business. This will greatly benefit the leading telecom provider.
Vietnam with its monsoon season was a contrast to dry Dubai. The Vietnamese market has become more expensive over the year, but we still found pockets of value in both Hanoi and Ho Chi Minh City. The country seemed to be on track to achieve its nearly 7% GDP expansion, given high growth in exports, construction and other local consumption. Vietnam has continued to benefit from manufacturing moving away from a more expensive China, while the growing middle class has continued buying homes. The fund's top holding, an industrial manufacturer, has been in a good position to benefit from both of these trends and grow faster than the market because of its favorable cost position. The company seems to be in a very healthy standing until at least 2020 when the anti-dumping steel tariffs will be revisited.
The fund invests in inexpensive companies. During the past twenty years, value has outperformed the overall emerging markets. This year, however, has been a notable exception with value underperforming growth by 25% (normal variation has ranged between 1-7%). Different themes function at different times, but such variation also creates opportunities. If, for example, value delivered without fail, the theme would cease to exist. The more immediate perspective is that value cases are now even more attractive compared to the rest of the market. In the end, it’s good to also note that chasing the flavor of the day will almost always get you there late.
We spent November searching for cheap, quality companies in Pakistan and Saudi Arabia. In Pakistan, we met with the only local PVC manufacturer. The company was inexpensive, and it was enjoying the 17% growth rate of the domestic market. Many companies in Saudi looked cheap given the macro uncertainties, so the challenge there is finding stable earnings. We like a car rental franchisee which will likely benefit from the regulations changing next year to allow women to drive. We will keep our eyes open there for any additional risks or opportunities.
December was busy, with over 30 company meetings spanning Indonesia, Thailand, Mexico, Peru, Argentina, and Chile. It was exciting to be in Chile the week of the presidential elections as we were able to get management teams’ perspectives on the two candidates, as well as talk to people on the street. The stakes felt high, as the pro-business candidate would clearly take the country in the right direction economically, while it would likely digress under the other. Despite being a very close race, we were very happy with the results and feel very optimistic about the prospects for the investments we are considering.
One of our favorite meetings during the month was with an aluminum producer in Argentina which consumes 5% of the energy in the entire country. A recent law, which requires a minimum of 8% of energy usage to come from renewable resources, has proven a surprising opportunity for the company as their renewables projects are generating very attractive returns. They plan to build more in the renewable segment than needed to meet the minimum requirements, and these projects should be able to sustain the company’s very attractive existing returns on capital. Additionally, it was interesting to learn that we were the first investors the company agreed to meet with in the past six months.
With a busy December behind us, we are already planning our next trips, and we look forward to a great 2018.