PERFORMANCE COMMENT
LO Funds – Emerging Consumer rose 1.43% during March 2014 resulting in performance of -3.8% since the start of the year and +30% since the launch of the Fund in October 2011. Over the month, the MSCI Emerging Markets Index increased by 3.08%, resulting in a 0.5% fall since the beginning of the year and a 6.6% gain since the inception of the Fund. The MSCI World Index was flat during the month, up 1.04% year to date and 46.24% since the Fund’s inception. The Fund’s underperformance during the month was mainly due to our Russian exposure, which cost us just over 50bps, and to some stock specifics reasons outlined below.
The performance during March can be divided into two halves – down sharply in the first two weeks but back up again towards the end of the month. Events in Russia have sharply impacted on our Russian portfolio. If one considers Carlsberg (5% of NAV and 40% of profits in Russia) as a Russian stock and then adds O’Key and X5, two supermarket companies which account for 3% of NAV, we have lost roughly 1% due to Russian exposure. O’Key and X5 fell more than 10% while Carlsberg was down 4%. Esprit also declined 11% during March (following very good performance last year) on the back of more or less in line earnings results. Wumart (similar to the rest of the food retail sector but with much bigger amplitude) corrected very sharply (-18%). The company, like Sun Art, and the food retail part of CRE and the whole food retail sector in China, published worse numbers than expected, since sales in the fourth quarter slowed down while simultaneously rental costs and personnel expenses rose (the same phenomenon that we have seen in the retail discretionary sector in China over the past two years). Finally, Indofood also generated poor performance (-10%) since its earnings suffered from a margin squeeze following devaluation of the rupiah while costs (especially personnel expenses) have continued to rise.
On the positive side, most of our Latin American stocks have fared comparatively well. Femsa (+9%), Arcos Dorados (+15%), Nutresa (+13%) and Lojas Renner (+12%) have all rebounded with the rest of the Latin American market. It is worth noting that Pick N Pay (+14%) has had a very good month (no earnings yet) while the rest of the food retail sector in South Africa has not performed as well.
MACRO REVIEW
Markets have been pretty volatile during March and it is worth remembering that the events in Crimea created a sharp sell-off, particularly in emerging markets and obviously in Russia. However, markets have started to recover, finishing the month on a very positive note. For the first time in four months, flows into emerging markets have turned neutral (positive in Latin America and in EEMEA). Over the last 12 months, around USD 80/100 billion has left emerging markets. As we have frequently stated in our presentations, we feel that the underperformance of emerging markets versus developed markets (33%) has been far too exaggerated and the P/E relative to developed markets (34% discount) is also far too low since it has returned to its 2008 level. The situation in the consumer sector has started to improve and for the first time in several quarters the rotation is positive with technology underperforming quite significantly.
PORTFOLIO ACTIVITY
We have been almost fully invested (94-95%) throughout the month, have no option (put spreads) exposure and have reduced our currency hedging to the minimum possible, i.e. 50% of the portfolio. However, we have decided to hedge the RMB against the USD (40% of our Chinese positions) and have reduced some currency hedging such as Real and Indian Rupee to around only 33%.
THEMATIC INSIGHT
We have had a lot of results in the last month, upon which we feel it is interesting to comment and analyze in some cases the following market action. Want Want has produced some pretty good numbers for the second half of 2013 with very decent volume growth and some price increases. Despite some input cost inflation, ebitda has gone up almost 20%. While Want Want remains an attractive asset in the Chinese staple sector the stock price has moved very little since it has been used as a defensive play during the last 20 months. Tingyi is worth explaining. Tingyi has been facing sharp competition in the noodle and beverages business from Uni-President over the last three years and investors (following catastrophic results from Uni-President) were also expecting bad numbers from Tingyi. They actually generated solid numbers in noodles and their beverages operations are back on track. The stock reaction has been fairly positive here. In the beverage business, it is worth noting the worse-than-expected results from China Foods, especially in its wines and coca cola segments, due to the anti-extravaganza campaign and severe competition respectively. Interestingly the stock has now started to rise, showing, we believe that the floor value of the Coca Cola business (2.5 HKD per share) has been reached and investors are now looking at the end of 2014 as a likely improvement for the wines activity. The same is true for Hengdeli (distributor of mid-end watches in Hong Kong and the mainland). Again, while the numbers were much worse than expected, the reaction has been fairly positive. The stock trades on less than 5x ev/ebitda, and it is likely that investors are now looking at the second part of the year for the beginning of an improvement following 12 to 18 months of decline. We are likely to strengthen our discretionary positions in China over the coming months as it seems that the bottom has been reached in terms of sales decline. The food retail sector (Sun Art, Wumart and the non-beer part of CRE) has been awful. The last quarter of the year with CPI close to zero plus non-food part of the stores (especially consumer electronics) being impacted by anti-gifting campaign has fared pretty badly. In addition, Wumart has undergone some shareholding restructuring which has negatively impacted the share price (-35% in the last three months).
We strongly believe that food retailers will, like retail discretionary, catch up in the second half of the year, as comparable basis is getting much easier and valuations are, we believe, close to their floor. The implicit valuation of CRE food retail business is now below 30% of sales while Wumart trades at 35% of sales. Our experience of the last 25 years shows that those valuations are closed to the lows. In the rest of Asia, Dairy Farm International has released numbers in line with forecasts. The story here is very similar to that of H1 with sales and margins pressure in the food retail business in Malaysia and Singapore, negative impact from forex in Indonesia, while the health and beauty products division is doing better especially in China.
The same is true for our Russian food retailers (X5 and O’Key) which have produced in line numbers. O’Key trades now close to 50% of sales for 15/20% sales growth expected in the next three years and net roce of close to 20%. This is becoming too cheap and the same is even more true for X5. In terms of Russia we still strongly believe in our position in Carlsberg. Last month the company produced better-than-expected results (similar to the third quarter). The stock has obviously been impacted by events in the Crimea and by the devaluation of the Russian ruble. However, the Russian ruble is recovering, the implicit valuation for the Russian business is less than 6x ebitda (far too low for a number one position) and competition (Anadolu Efes and Inbev) are now cutting capacity which eventually will turn very positive for Carlsberg.
Dufry (strong exposure to Latin America) has released good numbers with 4.5% comparable sales growth. Sales have suffered from BRL devaluation but the recent bounce back in BRL against USD and the World Cup should help materially here in the second half of the year. In Latam, we saw Cencosud results which were pretty weak but in line with expectations. The company is still suffering from the integration of its two acquisitions in Colombia and Brazil while the level of debt remains too high at more than 3x ebitda. However we feel that things are improving in both countries while it is likely that the company will try to find a new partner for its credit card business (worth more than USD 1 billion for 50%).
In Turkey, our new position, BIM has performed very well following incredibly strong sales and results (+20% for both). It is worth remembering that BIM produces a net of tax 70% roce.
