Smell the coffee

THE SIM Global team is about to experience a brief respite from its travels. As I am writing this, having recently returned from the US, UK and France with the customary delays, queues and delayed luggage, I am not sure which time zone I'm in. I think it is called "exhausted". Other team members visited India and Spain during the past month. 

In my previous column, I discussed the obstacles developed market companies face when attempting to enter developing markets. Every time I meet management of US companies I am struck by two things. Firstly, by how unbelievably good they are at playing to the pavilion.

In fact, it takes a conscious effort to refrain from being extra harsh towards CEOs whose wooing skills are lacking. Secondly, I am impressed by their ability to take action. I think Americans secretly thrive on crises. One wonders what they would do if there wasn't a war they felt they needed to be involved in.

One American company that has successfully transported its brand and model to over 50 countries is Starbucks. The $23bn global coffee market (equivalent to about a tenth of South Africa's entire gross domestic product) is still dominated by consumption outside the US and by powdered coffee, despite our image of cappuccino-guzzling, laptop-hugging Americans.

Unlike some of Starbucks' counterparts that have had to change some aspects of their menu, such as Yum and KFC, the firm has made very little change to its core business when introducing it to a new country. It has, however, found that in China, the rush hour at Starbucks locations does not consist of the morning caffeine and sugar stampede, but of a mid- to late afternoon buzz.

Liking it lean 

Not everyone needs a latte and a muffin to get going in the morning, it appears, but in China they like hanging around a coffee shop in the late afternoon. Another surprising development is that the rise in unemployment in the US has actually helped Starbucks, as many people have meetings there, or make their cup of coffee last half a day in an attempt to get out of the (heavily mortgaged) house.

The effort of lingering over coffee is reminiscent of Jean Shepherd's A Christmas Story, set in the 1940s when unemployment in the US actually reached 14.6% before dropping to 9%, more or less where it is now. The author makes the unsettling observation that you could not describe people who have stopped looking for work as really being out of work. 

Things did not always go so swimmingly for Starbucks. At the beginning of 2008, they found themselves victims of growing too fast for the sake of growing. In the few years leading up to 2008, they opened an average of 11 branches per working day!
During the past two-and-a-half years, they closed 1 000 branches and cut hundreds of millions of dollars of costs out of the business on a permanent basis. If the share price action is anything to go by, they have done the right things, as stocks are up 80%.  

Outer Mongolia

While China is embracing Starbucks and cigarettes, there are still some imbalances that could provide an opportunity. For instance, China has a quarter of the aggregate water resources per person of the rest of the world while consuming 5.5 times as much.

Agricultural land is shrinking, while the population continues to grow. One company that benefits from modernisation in farming and improved efficiency in the distribution of vegetables is Chaoda. There are many reasons why this company trades on a price earnings ratio (PE) ratio of six (compared to 26 for Starbucks).

Governance and disclosure, while improving, remain issues when investing in China. Investors generally dislike agricultural companies – so much can be outside management's control. However, Choada has vast regional diversification within China, so the chances of weather-related events (which generally vary from region to region) impacting on the entire company's earnings is reduced.

Emic and Faheem from our team have had several meetings with them in China, but the only way to get a sense of the extent of their reach is to look at a map of their operations. One of their larger divisions takes over eight hours to reach, in a four-by-four. It is literally in outer Mongolia. We took their word for it!

While there are concerns about China, the growth outlook, wage pressure and debt levels, we believe the Chinese will continue eating their vegetables. From what we see in the valuation and the potential return, we're prepared to back Chaoda. 

-  Fin24.com

*Ahern is with SIM Global, a division of Sanlam Investments which travels the world researching listed companies with potential unlocked value.