FEM Q1 2021 Manager Letter
April 6, 2021
The Vergent Emerging Opportunities strategy generated net USD returns of negative 3.6% in the quarter ending March 31 2021. The strategy continues to be focused on identifying transformational growth companies in the Frontier and smaller Emerging markets. Africa and Asia today represent ~90% of invested capital and the strategy owns or has previously owned companies in CEE, CIS, and the Middle East. Thematically, we’re primarily invested in the three following areas:
- Financial inclusion and the development of the digital payments eco-system (i.e.: disruption of cash) via companies operating across a variety of sectors including in banks/microfinance, communications/media/mobile money, and software
- Rising health and wellness awareness which we express through consumer health companies selling niche FMCG and healthcare providers offering medical services to their customers
- The formalization of offline retail with a focus on the grocery and DIY category where our retailers have a large Omni-channel advantage over pure online competition as well as a scale and cost advantage over unorganized/traditional competition
Underpinning our confidence in these themes are the large addressable markets wherein our companies operate, the fragmented and weaker level of competition, and the quality of the management teams which run them (many of whom are also owners).
We highlight two such companies in this quarter’s letter.
MTN Ghana (MTNG) – the $1.8bn market cap company embodies the frontier equity story as well as any in our portfolio. MTNG is the leading telecom service provider in the West African nation of Ghana with over 24 million subscribers and a leading market share in voice (55%) and data (72%). However, what gets us excited about MTNG is “Momo”, the company’s mobile money business which is at the forefront of the digitalization of cash in the country. Similar to Mpesa in Kenya, Momo is already the winner in its market with a 98% share of all mobile money transactions and an active base of 10.2 million wallets in the country. Momo’s contribution to MTNG’s revenue has increased by ~350bps in the last two years to reach 21% in 2020. We see Momo’s growth coming from several areas including structural adoption of mobile money for peer-to-peer transfers as well as growth in value added use cases in the areas of remittances, loans and savings, and merchant services. Despite it being a $1bn+ revenue business with returns on invested capital of ~25% and an exciting fast growing fintech business, MTNG is not covered by the sell side community. This is perhaps because Ghana as a market is unclassified by MSCI and so is neither a frontier nor an emerging market by the index provider’s standards. On the buy side, many institutional investors will access MTNG via its parent company MTN Group out of South Africa, a sub-optimal way considering the multi-country operation of the parent co. This has presented us with a unique opportunity to directly own MTNG at ~5x price to earnings over the last two years. Even after a strong re-rating year-to-date, the stock is still trading below 7.5x trail 12m earnings with a dividend yield of +8%.
Unicharm Indonesia (UCID) – the $480m market cap company is the leading baby diaper and female sanitary brand in the country of ~250m people. Indonesia has one of the lowest penetration rates of baby diaper products in the world yet is expected to generate the second biggest growth in value terms in Asia Pacific after China. This is driven by demographics (over 4 million babies are born every year in Indonesia) and higher penetration rates driven by investments in innovation and distribution (UCID sells single diapers in certain retail channels to make the product affordable). UCID has nearly 47% of the baby diapers market in Indonesia which makes it almost 2x larger than its nearest competitor which puts it in a strong position to capture the growth in the market over the long term. UCID is also the market leader in sanitary female products and adult diapers which are high margin categories given competitive intensity is lower and premiumization opportunities larger (relative to baby diapers). While the top down opportunity is attractive, UCID has low operating margins compared to global peers. We attribute this mainly to the baby diaper category where consumers prioritize price over quality; consumers in Indonesia are predominantly price driven in their choices across most FMCG products and a high percentage of the target market (parents) still view baby diapers as a discretionary product. We do not foresee a change in consumer preferences in the near term in light of the impact that Covid-19 has inflicted on purchasing power. That being said, we are still expecting margins to trend upwards as the recent entry of Kimberly Clark via the acquisition of UCID’s main competitor Sofitex is likely to bring more pricing discipline to the market by way of lower promotional activity (note: the acquisition of Sofitex was done at 3x EV/Sales compared to 0.5x EV/Sales for UCID which on its own is an indication of the undervaluation present in the shares of UCID today). As the Indonesian economy reopens, we expect UCID’s general trade channel to also open up and offer another tailwind to margins over the next two years as the company earns a higher net price compared to the modern channel which is dominated by established mini market chains. We also see the development of the e-commerce channel as potentially positive for UCID’s margins as that targets a more affluent consumer base that buys more (volume) and better (quality). We’ve increased exposure to UCID over the last month having been encouraged by latest commentary from management on the competitive dynamics in the market following the entry of Kimberly Clark which we believe is a key catalyst for the thesis.
The opportunity set for the strategy continues to be attractive despite the visible underperformance relative to emerging markets. A recent FT column by Simon Edelsten brought to light a phenomenon we’ve been talking about for some time: almost 2/3rd of the MSCI EM is in three countries (China, South Korea, and Taiwan) that have “emerged” if one judges by income levels, demographics, and market efficiency to paraphrase the article. In that light, we continue to see the frontier and emerging markets in which we specialize as a truer reflection of the classic emerging market story. Translating that opportunity to returns is still about selecting the right stocks for the long term and we believe our portfolio reflects that in its current composition.
Vergent Asset Management LLP