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A SIGN outside the lift in an upmarket shopping centre in Sao Paolo reads:
"Attention: Check if the elevator is here before entering". Jacobus and I took a few uncertain looks at each other before taking the stairs.
It is inconceivable to imagine investing without assumptions. We assume an outlook for inflation, for rational management action (although many of us have given up on that), and for a range of outcomes when it come to earnings. And when we approach the doors to an elevator, we assume that the elevator has actually arrived.
With assumptions, the trick is to work out if there is a grain or a lump of truth in it.
And not to confuse them with preconceived ideas. I find it ironic that my mother's reluctance to attend a soccer match with me, due to a fear of British soccer hooligans is mirrored by the fear of many Britons of a soccer blood bath in South Africa, fuelled by newspaper headlines in the UK.
Many people have had to review their assumptions about emerging market risk and developed market safety over the past few years, and again in the past few weeks. Investing in emerging markets is certainly not without risk, but a blanket assumption that there is safety in focusing only on the major developed markets has surely been tested.
Once you have taken the decision to go and look for investments in emerging markets, the danger of working off unfounded assumptions escalates.
For example, we may underestimate the growth in cellphone sales, or we may overestimate the success of retail businesses requiring consumers to become mallrats, as is the case in America.
Take Natura in Brazil, for instance. They are the leading manufacturers of skincare, sunblock, cosmetics and hair care products. While only listed for six years, they have adopted the direct sales model for almost 40 years.
Sales overtook that of Avon in 2006, with their one million plus sales consultants capitalising on the growth in disposable income as well as the sense of community which makes the direct selling model so successful. We asked management whether online sales posed a threat to their model and the response was that the consultants actually use the internet to purchase in bulk and place their orders.
The end consumer, however, likes the fact that the experience is a personal and tactile one. About 71% of orders are placed via the internet – but not necessarily by the end consumer.
In fact, according to management, the internet triggers relationships, and social networks provide their consultants the opportunity to interact with their customers.
Another interesting fact is that their attempts to manufacture locally in their markets as far as possible, is driven in no small part by the fact that their largest export ingredient is…water! Natura has been discovered by the investing world though, and is trading at a price earnings ratio (PER) in the 20's.
Given that their return on equity (RoE) easily gets to over 70% (must be all that water) perhaps some investors don't mind the higher rating.
Printing works
Another Brazilian company that pushes the boundaries of assumptions is called American Banknote. If you could think of a boring company, this is probably it.
Their business includes the manufacturing of credit cards, printing services - they print cheque books (does anyone even use them anymore?) and drivers licence ID cards.
We asked management about cheque book printing. While it is a small part of their business, it is a profitable one and one could easily have assumed that it should be a dying one. What they have found, however, is that post dated cheques still make up an important form of credit extension for the purchase of, for example, TV sets for people who do not have access to credit.
Credit card penetration is still low in Brazil (and growing) at 50%, around a fifth of the US and Japan. It is not only their governments that have a debt problem. The average American or Japanese has five times as many credit cards as the average Brazilian. Of course, one should be careful to assume that this means a five fold increase is on the cards – let's hope they remain a bit more sensible in Brazil.
This company spans the technology spectrum from printing cheques and credit cards, and drivers licenses to more advanced products. Licenses are part of a growing market as Brazil grows and the planned 6 800km of new roads (and investment in 32 000km of repairs) should also encourage people to get their own transport once they can afford it.
The total spending program on infrastructure for 2007 to 2010 in Brazil was recently increased to $281bn. To put that into perspective, the planned spend on road and rail improvement leading up to the World Cup in SA was R3.5bn (about $0,5 billion).
At the high tech end of the spectrum they also manufacture the chips for contact-less payment wrist watches and RFID wristbands (radio frequency identification). These are used in hospitals, malls, theme parks and at events, enabling wearers to pay for goods, or enter a hotel room without a key.
This company is trading at a PER of around nine, a price to book of 1.8 and and RoE in the twenties.
Both of these companies are examples of how one should always question your assumption about the way and the rate at which emerging market consumers adapt the behaviours of their developed counterparts.
- Fin24.com
Anet Ahern is head of research for global best ideas fund at SIM Global.
