The fund returned 8.5% in January, while the average emerging market index was flat. This strong performance is attributed to our stock selection: 14 of the fund's 31 companies produced returns greater than 10% (only 3 were down more than 10%), while the stock index of Malaysia where half of those winners came from was down -2%.
In early January, after a stock price pullback that wasn’t caused by any changes in highly positive fundamentals, the fund increased its position in a Malaysian property development company which is a sister company to another portfolio holding, a renewable energy contractor. The company’s chairman had purchased the obscure publicly listed business in 2019 and brought on board an experienced management team with vast business networks in Asia and the Middle East. New leadership at the helm rebranded and fully revamped the business from the get-go, strongly expanding the order book, executing new projects in Malaysia, Oman, and Qatar, and growing earnings over 100% in the last several quarters. What happened to the stock after the fund's additional investment can be described as “leapfrogging”: in just two weeks, its price rose 140%. Given that the fund's investment has performed so well so fast and is now less misunderstood by the market, the risk-return profile became less favorable, so the fund already scaled the position back.
In January we witnessed a market-wide sell-off in Vietnam, which happened after nearly six months of consistent growth. The coincidence of several factors – market’s fears that the rally is overdone, uncertainty regarding the US trade policy as it pertains to China and consequentially to Vietnam, rumors that retail investors are over-stretched on their levered equity positions, and first-in-two-months locally transmitted Covid-19 cases – led to a short-lived panic. We were not concerned: the fund's Vietnamese holdings are still cheap, high-quality, and growing strongly. For instance, the fund's 14x PE IT distributor grew earnings over 60% in Q4, while the 10x P/E financial services firm grew theirs over 800%. Now the valuations have only gotten more attractive for further position increases.
In February, we began a new project which we are calling 11 Sectors in 11 Months. For the rest of 2021, we will be on a virtual roadshow meeting hundreds of emerging market companies grouped by industry. This will enable us to effectively compare peers across dozens of markets. Instead of using the traditional GICS industry definitions, we are following the SASB Materiality Map to better understand ESG issues at an industry level.
We started the project in the Technology & Communications sector, meeting 58 companies from 14 countries. Our biggest takeaway was that the global chip shortage is even more significant than what’s widely reported in the business media.
This month the fund added another gem to the portfolio: a $300m Malaysian technology hardware business which makes frequency converters for German deep freezers used in the UK Covid vaccination program, as well as control panels for high-end Swiss coffee machines which are seeing a sales jump of 30% due to a significant increase in at-home coffee consumption. This company’s net margin of 60% and dividend yield of 5% are the highest among all Malaysian peers, its balance sheet boasts a net cash position equal to nearly 2x EBITDA, and its earnings grew 64% in the most recent quarter. At a time when most technology stocks in Malaysia trade well above 40x P/E, this growing high-quality firm’s 17x P/E is a bargain to us.
We also saw an investment thesis we made in October 2020 play out. The fund's $2b rubber company in Thailand whose stake in a medical glove subsidiary was valued 40% higher than the entire parent reported record-high earnings in February thanks to the continuous glove sales growth and the recovery in its natural rubber business boosted by the rebounding commodities cycle. Consequently, the stock nearly doubled in price in just two weeks, bridging the parent-subsidiary valuation gap and helping the fund achieve a 6.5% return for the month.
In March, we continued our 11 Sectors in 11 Months project, focusing on the Consumer Goods sector and meeting with 144 companies from 25 countries. Our prevailing observation from meetings with retailers was that those at the forefront of digitization before the pandemic accelerated market share gains from traditional brick-and-mortar firms that couldn’t quickly transition to doing business online. For manufacturers, the common theme was significant margin pressure caused by increased raw material costs resulting from the ongoing commodity boom.
This month, the fund increased its position in a $300m Indonesian wooden furniture and building materials manufacturer (with an appropriate ticker WOOD), making it the largest holding in our portfolio. This company, which derives 80% of its sales from exports to large American home retailers such as Costco and Home Depot, is benefitting from the exceptionally strong US demand for furniture and building materials thanks to the housing boom and new work-from-home culture. Together with this overwhelming demand, the severe shortage of lumber supply in the US due to the local production inefficiencies, US-China trade war tariffs, and manufacturing capacity constraints in Vietnam has driven the prices of building materials to historical highs, further benefiting the company's sales. At the same time, the firm is protected on the cost side: it sources wood from its own forests, and the global increase in shipping rates hasn't directly affected the business as it passes delivery costs on to customers. Additionally, the market is missing that the value of the company’s manufacturing land holdings has strongly appreciated due to urbanization of the surrounding area, and that the firm might also derive additional profits from using its vast forestry assets in carbon allowance trading – in an environment of rising carbon prices which are projected to triple in the next 10 years. Given such a perfect alignment of multiple tailwinds, the firm's current order book is record-high, and exceptional earnings growth is nearly certain this year.
We also witnessed yet another currency shock in Turkey as the president removed the third central bank governor in two years over his unconventional belief that higher interest rates are evil, manifesting his continued assault on central bank independence. Having studied in depth the previous currency crises in Turkey, we were prepared for such a scenario and quickly exited our modest Turkey position within a few days after the news. We plan to observe the aftermath from the sidelines.
In April, we met 134 companies from 24 countries as part of our 11 Sectors in 11 Months project, this time focusing on the Extractives & Minerals Processing sector. In almost every meeting we learned that the current global supply of commodities is extremely short due to the Covid lockdown-related supply chain disruptions. At the same time, the massive economic stimulus that followed the Covid crisis in order to revive growth catalyzed building and manufacturing activity. As a result of the roaring demand and constrained supply, the prices of raw materials such as copper, steel, and lumber have been skyrocketing, benefiting emerging markets’ commodities producers. Several CEOs we spoke with believe we are at the beginning of a new commodities supercycle.
This month, we found a company which strongly benefits from this boom in commodities: a $230m Indonesian firm named “Kapuas Prima Coal”. Due to higher commodity prices, the company expects much higher earnings this year, and is currently building two new production facilities to accommodate fast-growing demand. This firm is a great example of an undiscovered business which has been completely overlooked by investors due to market inefficiencies. The inefficiency in this case is very simple: it’s in the company’s name. Despite the moniker that makes it look like a coal mining operation, it is in fact a zinc processing business with 0% exposure to coal. The company’s management said that institutional investors wouldn’t even talk to them because of the misleading name. To our recommendation of a name change, the CEO said it would be difficult to change the name on all their licenses, and so for now they try to explain their true essence through a simple but telling ticker: ZINC.
The fund also invested in a $70m Malaysian steel producer. The market forgot about this company as well: it was unprofitable for the last few years, and the CEO hadn’t spoken to investors – instead, he was busy upgrading the plant with a new cost-saving technology and strengthening the firm’s balance sheet. The timing could not be better to have finished the turnaround now: steel prices are reaching new highs daily, and demand is extraordinary. While most steel companies’ stock prices have grown rapidly this year, this company’s stock has remained flat.
In May, we continued our 11 Sectors in 11 Months project, meeting 176 companies from 29 countries, mainly from the Infrastructure sector which includes the real estate industry. We learned that many residential developers expect significant earnings growth this year not only because many postponed 2020 projects will be recognized as revenue in 2021, but also thanks to overwhelming demand for new properties driven by a trend towards de-urbanization and record-low mortgage rates.
Being based in Dubai has proven useful to us mostly thanks to the city’s great connectivity to other emerging markets. However, this year it has provided an extra edge as we dove deep into the local housing market, which after a six-year decline of nearly 40% has seen property price growth in the last several months, a promising sign that it might have bottomed out. In fact, having experienced first-hand the plateaued dirt-cheap rental rates, we now witnessed a beginning of market recovery by touring several properties and speaking with dozens of brokers. To capture this trend in the fund's portfolio, the fund bought shares in the highest-quality listed developer in the market trading at less than 8x P/E.
The fund's positions in the Colombian glass manufacturer and Indonesian building materials and furniture manufacturer are benefiting greatly from the booming US real estate market. The glass maker – whose stock price rose 80% in May – has orders fully booked for the rest of the year and has already revised its earnings guidance upwards twice this year, and the backlog of the furniture maker continues hitting new highs every quarter.
Another trend we heard repeatedly is the acceleration of e-commerce market share gains at the expense of brick-and-mortar businesses as people did much more online shopping during the pandemic. This has severely impaired the values of many retail real estate operators and contributed to soaring values of e-commerce players. While the multiples of darlings such as the Amazon of Latin America – MercadoLibre – are far too rich for our blood (2,800x its record LTM earnings and even 14x sales), we came across a $600m Brazilian commercial real estate developer which benefits from the growth of e-commerce companies by leasing warehouses to them (it is even onboarding Amazon soon). The CEO is highly upbeat about the future prospects and expects 3-4x earnings growth this year, while the company trades at only 13x LTM P/E multiple.
In June, continuing our 11 Sectors in 11 Months project, we met with 162 companies from 24 countries, mostly from the Transportation sector. The most prevalent theme in our meetings was the supply chain constraints: due to the pre-pandemic lack of investment in global shipping capacity, the current elevated demand for goods cannot be effectively fulfilled, which results in delivery delays and skyrocketing freight rates.
We found a grossly undervalued $3b Chilean investment holding, which at 5x PE is trading at a whopping 70% discount to NAV, its steepest ever. While investors have neglected Chile due to political noise on the ground, a large part of this conglomerate’s earnings comes from abroad, insulating it from local turbulence. The market has missed not only that the holding company’s multiple listed businesses are quickly recovering from the pandemic, but also that its Q1 earnings from the red-hot shipping segment (via a 30% stake in a top-5 global container shipping firm) are already larger than the entire group’s full-year 2020 income. The CEO, one of the “Chicago Boys”, explained that they kept investing in new capacity during the challenging decade for the shipping industry that saw many competitors go bankrupt, and now they are reaping the rich harvest. We got Bloomberg to update the company’s description which failed to mention its shipping exposure and the international nature of its investments.
We also found a similar case in Turkey, albeit a 40x smaller one: this $80m investment holding trading at 8x PE is known in the market as a banking and factoring group, yet over the last few years it built a sizable shipping business. The results from shipping started to shine, with the holding’s Q1 earnings arriving 2x larger than its entire last year’s profit. The company offers a natural hedge from the chronic Turkish currency issues, given that shipping rates are set in dollars. To reflect the holding’s shipping involvement, we also got its outdated Bloomberg description fixed.
In Mexico, we met with the CEO of arguably the highest-quality low-cost airline in the world. Thanks to the pandemic, it cut expenses and has clearer skies after two of its competitors exited the market. Additionally, vaccination across the border in the US serves as a tailwind for passenger traffic as vacation-sick American tourists’ Covid revenge spending brings them to Mexican resorts. The airline has already surpassed 2019 performance metrics and its CEO is highly upbeat about future prospects.
In July, we met with 51 companies from 13 countries as part of our 11 Sectors in 11 Months project, this time focusing on the Services sector (as defined by the SASB Materiality Map) which includes hospitality and education industries that have been highly impacted by Covid shutdowns. The level of uncertainty among service-driven companies is still extremely high, and despite having met that many companies we were unable to find any with a compelling case.
The CEO of one of the education companies we met in China voiced her concerns about the rumored upcoming regulatory changes in their industry. These rumors more than materialized during the month with the government’s crackdown on for-profit education businesses. Following China’s suppression of local tech companies’ IPO activity abroad earlier this year, this sent waves of fear through the local stock market which moved sharply down, contributing heavily to the MSCI China Index’s -10% return for the first seven months of 2021.
Given that about 40% of the most widely followed emerging markets index (MSCI EM Index) is constituted by China stocks, the index has also taken a large hit, retreating to only +3% year-to-date. The fund does not have any China holdings at the moment. While we like to stay abreast of developments in China to monitor the regional risks, we prefer the markets less traveled where we find undiscovered cheap, growing, high-quality companies. As a result, the fund's performance has not been affected by the China anxiety and the fund is up 20% year-to-date.
In August, we met with 52 companies from 15 countries, continuing our 11 Sectors in 11 Months project – this time focusing on the Health Care sector. Our biggest insight was that while many pharma and biotech companies have been focusing a lot on Covid-related research and development in the past year, their intensive work on Covid can actually trigger a broader spike in medical innovation which can lead to breakthroughs in treatment methods for other diseases and conditions in the next decade.
A $40m hospital operator we met in Turkey has grown earnings over 60% per year for the past three years. Operating in underserved regions of the country which offer much larger room for growth than the wealthier cities, this company has invested a lot in expanding capacity: in the past year alone, it more than tripled the number of beds at its flagship hospital and converted an admin floor of another hospital into a surgical floor; it’s about to reap the harvest. Additionally, it recently started operating a medical school which is significantly boosting margins. The management team is highly upbeat about the future prospects, and not only because the business continues growing rapidly during the pandemic, but also because it starts seeing outsized demand as people begin to return to hospitals for all the elective treatments which had been postponed due to Covid. Trading at only 4x forward EBITDA multiple, this cheap growing business is the kind of hidden gem we look for.
During this month, the stock price of the fund's $800m digital services company in Indonesia which the fund hasf owned since spending an entire month in the country in August 2019 increased by 66% – in these trying Covid stay-at-home times, investors reassessed the company’s enormous growth potential in a country of nearly 300m people that are yet to experience the full suite of digital services such as online health advisory, food delivery, or mobile banking. Unlike many other tech businesses, this company has always made an emphasis on being profitable in every initiative that they undertake and on keeping sufficient cash reserves for potential technology or team acquisitions, and this fundamentally prudent approach is paying off.
In September, we continued our 11 Sectors in 11 Months project and met with 168 companies from 30 countries, focusing on the Financials sector. We had two major takeaways. First, we learned that nearly every bank in emerging markets is working on digital transformation from traditional branch-centered banking to a diversified tech-powered financial ecosystem. Second, at many banks deposits are growing much faster than loan books because individuals and businesses are not willing to take out loans.
A $700m UAE-listed company we found is growing its portfolio of defensive best-in-class healthcare and education businesses across the Middle East. Despite the impact of Covid, its private university is seeing record-high enrollment numbers, while all other holdings are also showing healthy growth. The previous management was unable to efficiently deploy cash and was recently replaced by a new driven team with private equity experience; in just 8 months they have already completed a 3-year turnaround plan by executing on a new streamlined strategy of exiting unprofitable legacy minority stakes and investing in majority positions to ensure greater value creation. Unlike the previous management, they are focused on what they believe the market appreciates: growing earnings and making earnings-accretive acquisitions, and they are implementing best-practice governance in their subsidiaries. With $400m cash to deploy in new high-yielding deals in the next 12-18 months, this business trading at 15x trailing normalized P/E appears overlooked.
We also found a rare case of a reverse merger whereby in order to unlock shareholder value a $400m Egyptian investment holding trading at 9x P/E is getting split into three listed entities operating in financials, real estate, and industrials. Given the current 70% holding discount and 25-40% expected 2022 earnings growth for each of the three new public companies, we are excited to watch how the market values them on a standalone basis.
The stock exchange operator in Kuwait has seen its earnings quadruple in the last three years. Its number of client accounts and trading commissions keep growing while cost-to-income ratio keeps decreasing, yet its 12x P/E is among the cheapest valuations of all EM stock exchanges. The bourse is positioned right at the very center of renewed investment interest in the Kuwait market as commodity prices climb higher and Kuwait leaves behind its EM index inclusion overhang.
In October, we met with 129 companies from 26 countries as part of our 11 Sectors in 11 Months project. This time we focused on the Resource Transformation sector, which includes electronic equipment and industrial machinery industries.
We had two significant insights from our meetings. First, we were alarmed by the state of the overwhelmed global supply chain. In nearly every meeting we heard first-hand from the CEOs that despite an exceptionally high demand for their goods they are unable to fulfill orders as their production capacity is severely constrained by a major shortage of semiconductor chips, extraordinary multi-month shipping delays, and sky-high raw material and freight costs. This profound challenge to businesses’ operational sustainability greatly limits their earnings growth and visibility. Second, we noticed a major trend of nearly every company involved in the manufacturing of electronic equipment shifting toward producing components for electric vehicles or servicing the electric vehicle infrastructure.
We met with a company that benefits from this gigantic EV trend. Based in Penang, the Silicon Valley of Malaysia, this $350m automation equipment testing and solutions provider is well-known to the fund: the fund had first invested in it six years ago and made a cumulative 570% return during the two years the fund held it. The company’s recent EV business expansion is very timely given the increase in demand for its services amid the accelerating pace of silicon carbide use in EV power management applications. The executive team has prepared well for this EV foray by hiring several hundred additional engineers in the past year as well as building a massive new facility. The EV business will further boost the company’s sales which, despite 24-week supply chain delays preventing it from fulfilling all inquiries, still reached a record-high level in the most recent quarter on the back of tremendous order volumes in the existing highly profitable smartphone, semiconductor, and medical device business lines. What makes us most excited about this company right now is actually not its future-proof growth – it’s the valuation arbitrage opportunity it presents. While the company trades at a 53x P/E multiple in its home market of Malaysia, not many investors are aware that the business is also listed on the Hong Kong Stock Exchange, where it trades at only 10x P/E.
In November, we met with 128 companies from 27 countries as part of our 11 Sectors in 11 Months project, focusing on the Food & Beverage sector. We had two main takeaways from the meetings. First, most food businesses are experiencing severe input cost pressure which is squeezing margins and thus affecting profitability. Second, many companies are still hopeful for next year’s prospects as they have already started seeing improvements in the speed at which goods move across the globe, signaling an easing of global supply chain constraints.
This month we found a $100m shrimp producer in Thailand which fell off investors’ radars after a tough Covid year made a dent in its financials, rendering its LTM P/E valuation meaningless. However, what we learned in our meeting with the CEO was that the business is alive and kicking: its production volumes have picked up and sales could potentially double next year. The company got a breath of fresh sea air from economic reopening, new overseas customer acquisitions due to lockdowns in the rival Vietnam as buyers shifted their orders to Thailand, and its new fresh produce venture in the UK with a strategy to specialize in lean foods which has already started delivering promising results. Furthermore, the firm splits freight costs with the customers, limiting its exposure to the abnormally high shipping rates. Accounting for the positive recent business momentum and management’s expectations, the forward P/E valuation of this shrimp operation becomes only 9x. That the CEO hasn’t spoken with investors in the last two years made this obscure case even more compelling.
We also discovered an overlooked $400m food company in Egypt. Due to an issue with the controlling shareholder, its financials have not been reported since Q4 2020. “Lazy” investors looking at the most recently published historical results might be extrapolating the 2020 downward trend and missing that the company has actually been recovering sales ahead of the market, implementing a cost optimization strategy which will positively impact profitability, and deleveraging. This will likely result in high net profit growth and should attract investors again, especially since the missing financial reports will finally be published in the coming months, and the controlling shareholder issue causing share price overhang may get resolved soon.
In December, we finished our 11 Sectors in 11 Months project. This month we met with 90 companies from 18 countries, focusing on the Renewable Resources & Alternative Energy sector. We had two main insights from our meetings. First, several renewable energy companies which hold carbon credits told us that in addition to benefiting from higher demand for greener electricity they also expect to profit from the rising carbon prices. Second, because of the pandemic, paper and packaging companies are experiencing a sharp pick-up in demand as consumers have replaced a lot of in-person shopping with online orders which require more packaging.
One company that stood out to us was a $1.5bn packaging paper and dissolving pulp manufacturer in South Africa. The company’s stock price has been punished harshly by fleeing investors over the past two years as it was caught by the pandemic at the worst time in its debt cycle due to significant capex spending. However, its revenues and margins are now recovering swiftly as its order volumes and selling prices are increasing due to a global shortage of paper and pulp stemming from high demand and vastly reduced capacity in the US and Europe. The company’s management was able to successfully pass on increases in energy and freight costs to consumers, and is highly upbeat about future growth prospects. Given that the main hesitation of investors is the company’s currently high debt load, the firm’s improving earnings leading to a reduction in debt should mitigate this concern in the medium term. While other paper producers we met have P/E multiples in the 15-20x range, this stock trades at only 6x forward earnings. We believe once earnings growth manifests itself consistently in the next couple of quarters this stock can rerate profoundly.
The fund returned +33.0% in 2021. In comparison, the MSCI Emerging Markets index was 4.6%. The strong absolute and relative performance amid a volatile macro backdrop stemmed from our successful stock picks made as a result of our disciplined process of investing in overlooked, cheap, high-quality companies growing in any economic environment.