FEM Q1 2023 Manager Letter
May 3, 2023
The strategy generated a net return of -1.2% in the quarter ending March 2023 (see below for detailed since-inception performance figures).
The strategy saw strong contributions from holdings in ASEAN (Indonesia, Malaysia, and the Philippines) and the Middle East in the quarter. However, this was more than offset by losses in the Africa portfolio. As we have written in previous letters, we have been actively reducing the strategy’s exposure to Africa (specifically Egypt and Kenya) and increasing it in ASEAN and the Middle East (Saudi Arabia and the United Arab Emirates). African economies are undergoing severe macroeconomic headwinds that have overwhelmed equity returns and exerted pressure on earnings. Conversely, ASEAN and Middle Eastern economies have been performing reasonably well, allowing us to harvest healthy USD equity returns through earnings growth and multiples expansion.
Continuing with the above theme, we decided to fully tender out the strategy’s shares in East African Breweries Ltd. (EABL) to Diageo PLC at a price of KES 192/share (compared to the KES 170/share price as of the date of this letter). While Diageo paid a premium of 35% versus the one-year average (at the time of the “intention to acquire” announcement in October 2022), the deal multiples were highly favourable to Diageo at ~14x 2023 earnings, a substantial discount to emerging and frontier market brewers. We tendered out at these low multiples because of two factors: first, there are limited incremental buyers for EABL given the macroeconomic environment and stock market illiquidity in Kenya; second, the Diageo bid presented a relatively lucrative way for us to reduce exposure to Africa, in line with our strategy. Following the deal, EABL will remain listed on the Nairobi Stock Exchange with Diageo’s ownership now up to 65%, from just over 50% pre-tender. We will continue to monitor EABL and potentially re-enter the stock once the economic environment in Kenya settles.
The strategy was very active during the quarter in both ASEAN and the Middle East. In ASEAN, we invested in CTOS, Malaysia’s leading private credit reporting agency, which holds over 70% of the country’s credit reporting market. Due to the high barriers to entry in this industry, market leaders like CTOS are likely to sustain their position as they continue to compound their data sets and create new use cases for their customers. Malaysia is a particularly underpenetrated market for credit reporting, as financial institutions still rely heavily on their internal data and the public credit bureau in their loan underwriting process. Malaysia is interesting because financial inclusion is high at around 95%, yet 65% of the population still does not have a regulated credit account. As financial sophistication grows and credit compliance requirements tighten, demand for CTOS’s services should increase significantly. CTOS’ scale and technology underpins operating income margins of ~40% while compounding operating income growth at ~20%. We have followed CTOS since it listed on the Bursa Malaysia in July 2021, but had reservations on its valuation and the previous management team, who we thought were brought on just to list the company rather than the focus on generating long-term value. When the previous CEO left the company, we went to Kuala Lumpur to meet with the new CEO, Erik Hamburger, a former executive at Experian, who articulated a growth strategy around product development, digital investments, and sales strategy that we thought, if well executed, would unlock tremendous value for shareholders. With a positive view on the company and management, it was a case of waiting for a valuation opportunity to open, which finally happened in this quarter.
The strategy also invested in Al Ansari Financial Services (AFS), a UAE-based remittance and currency exchange house. AFS is a leader in the second-largest market remittance market globally (after the U.S.). The company generates revenues from facilitating the remittance of money flow from the UAE to countries in Asia (example: Philippines), Sub-continent (India and Pakistan), and the Middle East and North Africa (Jordan and Egypt). AFS focuses primarily on small ticket remittance, a market that banks are strategically not interested in, and that fintechs have found difficult to penetrate. For context, the company reports that 67% of the remittances it facilitates are less than $400 per transaction. AFS has a robust offline network in 226 carefully selected locations across the UAE, which captures monthly remittance flows from blue-collar and underbanked white-collar workers. This offline network is supported by a strong online presence, where it has a top ranked app that processes 41% of personal digital outward remittances among exchange houses. AFS’ management have executed well, deepening the company’s competitive advantage, and translating that to operating margins of ~50%, on healthy mid-teens top line growth.
Despite the softer performance during the first quarter, we remain constructive on the strategy’s outlook. We believe the current environment is ripe for stock pickers, with valuations as attractive as they’ve been since we launched the strategy in 2018. Moreover, the economic environment is expected to deepen the competitive edge of portfolio companies in their respective markets.
As we have done in previous letters, we sign off by reminding our investors that our objective is to deliver differentiated returns that are attributed to investing skill (alpha) rather than market directionality (beta). We believe there are abundant alpha opportunities in frontier and emerging markets, which we choose to express through a concentrated but geographically diverse portfolio of companies with idiosyncratic earnings drivers and share-price catalysts. Naturally, this should result in significant deviations from global and emerging market indices in certain periods, but hopefully provide a superior risk-adjusted return profile to investors in the long term.
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Vergent Asset Management LLP