Adrian Ciocoi of Riedel Research -
The financial crisis and the consequent 40%-plus dive on average on most of the world's stock markets has caused sell-side research departments of several global firms, to shrink (Citigroup), to close or get transferred (Bear Stearns and Lehman Brothers), or to be sold (Merrill Lynch).
If this trend extends to buy-side research, the situation won't be too favourable for the sell-side research business. While I was in Manhattan in September, I learned of several hedge funds that were halving their fees for those clients who wouldn't withdraw their money for a determined timeframe. I heard also that Hedgeworld was predicting that the number of hedge funds could halve in 2009. It's possible this trend will continue and hedge funds will cut or even give up fees altogether in order to retain capital and survive. But all this can only translate into a reduction of demand for research, and only those producing high-quality research will stay in business. As always in the research industry, the only thing constant is change.
When I was still in business school in 1996, investors relied almost exclusively on detailed fundamental company analysis produced by investment banks and brokerage firms. However, in the past few years, beginning with the US and continuing in other regions of the world, Regulation Fair Disclosure and Sarbanes-Oxley legislation have reduced the value of investment bank research, as sell-side analysts have less and less access to company management (or rather the management currently has to say the same story to all). The reduction of confidential information in sell-side research has prompted many buy-side investors to bring a great deal of their analytical needs in-house. In turn, this has changed the type of research that buy-side investors have found most valuable.
Currently, I find that many buy-side investors (and particularly hedge-funds) desire from us information that's not widely distributed to other investors, but it's "hidden" information that's of importance to the overall company valuation. This is what unique insights really means. We accomplish this through our on-the-ground local and native analysts in their respective emerging markets and consider our local presence of utmost importance to being able to pick up those unique insights. I constantly encourage our research analysts to produce quality research that is proactive, insightful and non-consensus. Overall, we aim to produce research that is distinctive enough for the buy side to be willing to pay for it.
Time to invest
Producing such research for emerging markets is essential for investors today, as investments into these regions makes more, not less, sense following the crisis.
The numbers speak for themselves. The table below shows the comparative performance of representative indices in some of the main emerging markets. It can be seen the indices in Central and Eastern Europe and Middle East/Africa fell on average by 44.9% and 23% in the year to date. The average performance of selected indices in developed markets shows a negative 37.4% year to date. We estimate the rebound will be higher for some of the emerging markets (due to various stats), hence our conviction to invest (or continue to invest) in the emerging markets.
I am still recommending selective investments in emerging markets. Not because Riedel Research is covering them, but because of their growth outlook. In the "Emerging Europe & Beyond" department, which I oversee, we currently recommend investments in defensive sectors in large-cap, high-quality companies that exhibit strong cash flows and balance sheets, high dividends, coupled with flexible capital expenditure commitments.
We concluded the most attractive defensive sectors in "Emerging Europe & Beyond" are:
• Telecommunications - we favour telecoms especially because of a stabilizing price competition, and attractive dividends yields, although this sector is still exposed to regulatory debates.
• Food and Beverage - we have seen input cost pressures easing on many food items, although the food sector continues to be expensive though.
• Healthcare - especially the pharmaceutical sector has attractive dividend yields and cash flows but as in the case of telecoms, the risks are in the regulatory hurdles.
In telecoms, for instance, we learned of the results of a recent survey (completed during August) done on a statistically significant sample of European-based telecom customers. The survey showed consumer spending on telecom firms was not influenced by the economic slowdown. Therefore, it could be inferred the telecom sector was less sensitive to the economic swings, making it a truly defensive industry sector. Whilst there are a number of risks facing operators (regulation, competition, consumer credit), so far at least the economy has been a "third- or fourth-order effect." In our view, during an economic slowdown consumers may delay the upgrade of handsets and shift to cheaper tariff plans, but won't stop using their mobiles to which a large fraction of the populace are well and truly addicted.
We have been positive for a long while on the telecom sector in the Gulf Cooperation Council due to: attractive demographics/young population, sector liberalization, high-growth GDP/capita and the valuations. In their desire to differentiate away from oil and gas, the GCC states have been making significant financial investments in emerging markets and in the developed world. We've listed here deals valued at $1bn or more, and it can be seen the great majority, ie. 8 deals (highlighted in blue and shown on the map), were in the telecom business.
Our four picks in the telecom sector:
• Vodafone, 6% dividend yield, 8.8x 2008 P/E. Vodafone is a leading global mobile operator with stakes in strong businesses across Europe, North America, Africa and Asia. In July, the company increased its weighting in emerging markets through acquisitions in Turkey and India. A strong balance sheet affords further opportunities to acquire high growth assets, particularly in Africa. In August, Vodafone's African portfolio (Kenya, Egypt, S.A. and indirectly Tanzania, DRC, Mozambique) was increased by the addition of Ghana.
• Turk Telecom, 12% div. yield, 6.5x 2008 P/E. Turk Telecom is Turkey's dominant fixed-line operator, and a new comer (IPO in May 2008) on the Istanbul Stock Exchange. The company has exposure to different segments within the sector: PSTN, ADSL and GSM
• National Mobile Telecomm Company, 4% div. yield, 10.7x 2008 P/E. This company also called "Wataniya" is Kuwait's second mobile operator, and operated in five countries in North Africa (Algeria and Tunisia), Gulf (Saudi Arabia, and Kuwait) and in Maldives. This geographic footprint offers Wataniya a diversified exposure to several wireless markets in various stages of development, all with favorable demographics and strong growth prospects. Wataniya operates in markets characterized by a young and growing population with a total footprint of 75 mn people of which 50% is less then 25 years old. This young population should be the growth engine of Wataniya.
• Telecomunikacja Polska, 10% div. yield, 12.0x 2008 P/E. This is the leading operator in most of the telecom segments in Poland (fixed-line and mobile telephony as well as broadband) TPSA has a focus on two main strategic directions: strengthening the position in current core business and at the same time looking carefully for new opportunities to invest more in adjacent business sectors.
Adrian Ciocoi is head of research for "Emerging Europe & Beyond" at Riedel Research
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