A positive of the covid recovery in major developing economies (particularly India), which has seen them roar back to life, has been the normalisation of results for non-tech businesses which experienced a choppy pandemic as emerging market consumers stayed at home and some had to dig into their savings to survive.
India’s leading apparel retailer Trent, for example, has been (again) knocking it out of the park after reporting standalone sales growth of 61% in the most recent quarter. Away from retail, boring old Nestlé India with its stable of packaged food brands is up another 17% having started the year with sales and earnings growth of 21% and 27% respectively.
Categories such as basic apparel and groceries, packaged food and confectionery would simply not offer strong organic growth categories in developed markets. Hence, the move into tech businesses – some profitable, most not – have been the new shiny things that growth investors have been attracted to in these markets.
Assembling a group of developed world businesses comparable to our offline retail exposure is probably impossible to achieve without appearing to cherry-pick. But there are rough benchmarks which can be used as a guide – for example the S&P 500 Consumer Staples index, which per Bloomberg consensus will grow at half the rate (7%) of our ‘stuff’ businesses in the next three years. Remember, in this comparison, the current inflation differential between the developed and emerging world: that 7% figure is, allowing for foreign revenues at S&P 500 businesses, probably lightly negative on an inflation-adjusted basis, vs. high single-digit in the case of an Asian company.
The S&P 500 Consumer Discretionary index, perhaps a better benchmark for our offline retail exposure, is growing at a similarly underwhelming 6% rate. Short-term valuations for the developed market group are somewhat lower than our portfolio (21x FY23 earnings for staples; 29x for discretionary), but as the EM-DM growth differential returns, the chances of rapidly bridging this short-term multiples gap appear stronger than they have done in some time.
In emerging markets, we think it would be foolish to ignore the relentless digital transformation underway in these markets, but thankfully we get to be more selective and only pick what we believe are the ‘real’ ones. For us this means digital businesses that are grounded in tangible, physical infrastructure which confer important competitive advantage in the digital sales channel: such as JD.com’s end-to-end control of its own logistics platform; Meituan’s access to 4 million delivery riders; or IndiaMart’s feet-on-street sales force helping to kick-start the digitalisation of its customer base. From a financial metrics perspective these companies that consistently generate high levels of operating cash flow and invest it wisely in building stronger moats.
By this broader definition, all our holdings, whether digital or analogue, are ‘real businesses’ but sadly the market in a panic mode does not differentiate, and despite our highly selective approach to these companies, we spent much of 2021 and 2022 experiencing the sharp end of the volatility in sentiment towards the technology sector.
It is worth briefly indulging a temporary anti-digital prejudice, to re-emphasise the fact that in developing countries, one does not always need to seek exposure to younger, less proven sectors in order to achieve attractive levels of earnings growth. Every sector has its risks, however, in offline retail execution risk is heightened but here there is the potential for multiple growth tailwinds – overall consumption per capita growth is amplified by the forces of market consolidation and formalisation, further reinforced on the bottom line by operating leverage.
In all respects, our view is that our digital holdings are ‘real world’ businesses, solving real world problems, which happen to interact with their customers primarily via an online sales channel. And these businesses have delivered real earnings throughout our ownership and the future looks attractive they have borne the brunt of sentiment downturns against their sector which may indeed repeat.
In developed markets, the choice is most typically one of either dependability or growth. In emerging markets, we aim to find both.
