Manager Insight

Why Invesco's Jeff Feng favours homegrown companies over multinationals.
By Michael Ryval | 10/05/18

Many investors believe that the safest way to get exposure to emerging markets (EM) is through multinational companies rather than local companies. After all, multinationals have the virtues of strong brand recognition, capital strength and good governance, attributes that smaller, local companies may lack.

About the Author
Michael Ryval, a regular contributor to Morningstar, is a Toronto-based freelance writer who specializes in business and investing.

But Jeff Feng, a Hong Kong-based EM specialist and lead manager of the 5-star Morningstar-rated Trimark Emerging Markets Class, argues that local companies have a better grasp of consumer preferences and are uniquely positioned to serve the rapidly growing EM. In a way, his view of so-called "local champions" is summed up by the popular expression, "think global, buy local."

"In the last 10 years or so, many local champions outperformed their multinational peers. One key factor has been quick execution," says Feng, head of emerging-markets equities for Invesco Hong Kong Ltd. A native of Chengdu, China, Feng is a 21-year industry veteran who prior to joining Invesco Canada in 2009 earned an MBA from the Richard Ivey School of Business and a BA in finance from China's Xiamen University. "You don't have to wait for a response from your regional and head offices overseas. Second, local firms have a better understanding of local consumers' tastes and behaviour."

In the past couple of decades, adds Feng, local champions have developed major distribution networks outside of metropolitan centres. "They have been in these areas for a long time, and once they have more money and more human resources, it's natural for them to strengthen their distribution networks in smaller cities and rural areas. Those channels are bearing fruits for local companies."

Conversely, Feng notes that in general multinationals initially don't feel comfortable going into remote areas. "Going into these areas requires an understanding of local business practices which are certainly different from practices in developed countries. You have to speak their language and understand their mindset. It's easier to go to the larger cities and get the low-hanging fruit. But after that stage most of the growth has to come from penetration in lower-tier cities. This doesn't play well in most multinationals."

One example of local players beating multinationals at their own game is the rapid growth of Chinese car manufacturers Great Wall and Geely, both listed in Hong Kong. "Until about five years ago, multinationals (with their joint-venture partners) had a much larger market share in China than local companies. But gradually local companies improved their production quality and their engineering capability passed a certain threshold. Then they realized that people living in lower-tier cities also preferred SUVs (sport utility vehicles) to sedans. They also like certain gadgets such as rear-view cameras," says Feng. "But multinationals charge a big premium for these extra features."

Feng observes that local companies have an advantage of paying less for their talent, while multinationals have expensive teams of researchers in Europe and North America. "The cost of an engineer at home is three times that of an engineer in India or China," says Feng. "When you hire a lot of engineers who sit in an office in Silicon Valley or Western Europe, you have a cost disadvantage against local players."

Finally, Feng points out that EM companies have been able to grow more quickly because they have much better access to capital compared to two decades ago. "It's a different world," he says, adding that governance practices have also improved considerably.

Managing a portfolio with about 50 names, Feng looks for companies that have strong growth characteristics and are trading below their intrinsic values. One example is Arca Continental SAB de CV (Mexico City), a Coca-Cola bottler and licensee with operations in Mexico, Ecuador, Peru, Argentina and more recently Texas.

"In 2016, Coca-Cola Co. sold the Texas licence rights to this company because it believes Arca can do a much better job than its subsidiary," Feng says. "They have done a very good job in Mexico and are very innovative in terms of packaging and marketing." Feng adds that Arca has a highly efficient distribution network and has developed a wider range of sizes than many competitors.

Once the Texas operation is fully integrated, Arca should see a return on tangible invested capital of about 20%. Feng says the company, which trades at 18.5 times forward earnings, is seeing 10% annual top-line growth and bottom-line growth in the low teens. Currently, shares are trading at an estimated 20% discount to intrinsic value.

Another favourite is Ulker Biskuvi Sanayi AS (Istanbul), a Turkish maker of chocolate and biscuits that are sold at home, and in Egypt and Saudi Arabia. "This company has almost 80 years of history and a very extensive distribution network which covers every town and village in Turkey. Multinationals such as Nestlé, which has presence in Turkey, don't have that, because it would cost them a lot of money and time to duplicate," says Feng. "And in countries such as Egypt and Saudi Arabia the cultural challenge would be difficult for multinationals to overcome. Turkish companies tend to operate successfully in those markets because they are all Muslim."

Feng says Ulker Biskuvi trades at 16 times forward earnings, and its return on invested capital is in the high teens. However, once some acquisitions are digested the ROIC should rise to about 20%, or higher.

For investors in emerging markets, Feng admits there are worries such as the possibility of escalating trade wars between China and the U.S. "Our portfolio is almost insensitive to the effect of a trade dispute. But what does concern us is the secondary effect. The spending power of consumers in China could get hurt if the disputes become more severe and get dragged along," says Feng. "Not just Chinese companies, but South Korean and Taiwanese companies will also get hurt because of their exposure to Chinese markets. It's too early to panic. But it is worth watching closely."

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