You pays your money and takes your choice

Thursday, 15th October 2015 14:12 - by David Harbage

The longer term belief that the world's emerging economies exhibit higher growth - and therefore merit investment - has recently been challenged by evidence of slowing economic activity in some of these markets.

In particular, by reference to the so-called BRIC countries, Brazil and Russia appear to be going backwards at the present point in time, the pace of growth in China has been slowing (albeit from an exceptionally high rate) towards 6.5% - 7% levels and only India have been maintaining pace. China is clearly the largest of these economies and her dampened demand for raw materials has been the most obvious depressant on commodity prices and the share prices of the mineral extractors (such as BHP Billiton, Glencore and Rio Tinto).

Consequently, and looking further than China, the relative strength of the US dollar has meant that the manufacture-to-export part of many of these economies has struggled; beyond such competitive pressures, authorities in such localities have had to raise interest rates to preserve parity in currency terms. As the economic cycle progressed, it was inevitable that many of these countries have seen a shift from being manufacturing-centric to being driven more by local consumption. Anyone who has recently visited the populous cities of Asia can no doubt testify to the apparent greater urbanisation - notably in higher levels of smog and other environmental damage caused by increased use of the motor car - as well as ever bigger shopping malls catering for western tastes in both 'low ticket' essential product and in luxury goods.

Today we have seen trading updates from two FTSE100 index constituents which can lay claim to be beneficiaries of rising consumer demand businesses in the world's emerging economies. (Incidentally, some commentators might suggest that China - as the world's second largest market, by reference to total output of products & services - should not fall into this category. But an assessment based on value of output per capita would suggest that there is a considerable amount of development to occur before China reaches anywhere close to the global average income per head. In any event, making accurate assessments on the quality or reliability of data from a country as large as China is also fraught with difficulty). Fund managers would have keenly awaited these numbers from Burberry and Unilever to see if the weakness evident in demand for metals has extended into consumer confidence and appetite to spend on what are typically higher cost, branded western products.

Two very different outcomes emerged: Unilever announced strong growth from emerging economies in its third quarter of trading. The maker of personal (Dove & Lux soap), food (Knorr, Hellmann's), refreshment (Magnum, Ben & Jerry's, Lipton and PG Tips) and home care (Omo, Cif, Comfort) products reported sales growth of 8.4% via 4.8% volume and 3.5% price. Within this inevitable mix of country performance, China and Turkey delivered double-digit progress - based, in part, on undemanding comparatives. Unilever has benefitted from lower commodity costs (which will have included oil, of course), as well as an overall favourable currency impact that added 2.9% to group turnover.

While Unilever remain a global business, with 30% of turnover arising in the Americas and 26% in Europe, investors have long regarded the emerging markets as the group's prime growth opportunity. With supermarkets around the world increasingly featuring branded products from such multinational giants, heavily promoted by advertising, this trend appears set to continue. (Notwithstanding the emergence of domestic discounters). Determining where 'pricing power' with the retailer resides is a perennial issue and, in this latest update, Unilever make appropriate comments surrounding management action to position its proposition further upmarket and enhance production efficiency. Today's disclosure represented a near 5% 'beat' of the City's forecasts and resulted in the shares making 4% progress to reach £29, where they stand at a 33% premium to the FTSE100 index's overall valuation. This appears sensible and deserved by reference to the company's track record of delivering steady dividend growth, recognised by a market valuation which has risen from £18 five years ago. Currently yielding 3.1% based on full year expectations, the stock offers sensible insulation to inflation and merits long term retention.

By contrast, the upmarket fashion group Burberry announced a disappointing first half year's trading update (again covering the period to 30 September 2015) relative to analysts' expectations. In what the company describe as 'an increasingly challenging environment for luxury customers', retail sales rose 2% despite opening new stores in Bahrain, Dubai, London, Moscow, Seoul, New York and Tokyo. By region, Asia Pacific - so long the traditional area of Burberry's growth - saw a 5% decline in sales, with Hong Kong being especially weak. Elsewhere, the more developed markets of Europe and North America held up reasonably well.

Burberry management are expected to continue to focus on rationalising its outlets (nine stores were closed in the past six months) as part of 'keeping a lid' on costs. The board anticipate that profits will be in-line with analysts' more recent estimates and hope that current caution on the part of its end consumers and retail outlets (who have been slow to re-stock) will prove to be short lived. Investors were disappointed with this update, perhaps belatedly appreciating that even the upper end of the consumer market is not exempt within the current crisis of confidence - exemplified by the fall in China's stock market. Eight months ago, Burberry shares stood at 1920p and even after today's 10% fall to 1250p, the stock remains on a 25% premium rating to the wider UK equity market with limited dividend support. While the company has performed well in maintaining its product as a fashion highlight (no mean feat, as mainly other clothing retailers would bear testament), this volatile stock is best suited to the brave.

As a final aside, this investor would rather procure exposure to emerging economy growth via UK listed company shares – whose accounts and management are scrutinised by domestic analysts and fund managers - than by buying individual local companies on what may well be under developed stock exchanges.

Written by David Harbage for lse.co.uk on the 15th October 2015

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.

See the share price for Unilever Group here

See the share price for Burberry here