To find the next McDonald's look to emerging markets

10/23/2009 8:30 am EST


Jim Jubak

Founder and Editor,

By 2015 one-third of companies in the Financial Times Global 500, a list that’s roughly the global equivalent of the U.S. Standard & Poor’s 500 stock index, will come from the world’s emerging markets, according to Bain & Co.

Makes sense to me. Economic growth in general is higher in the world’s developing economies, such as China, India, Brazil, and Indonesia, than in the developed economies of the United States, the euro zone, and Japan.

The growth differential is even greater when you look at just that part of the global economy that McKinsey & Co. called fast-moving consumer goods, exactly the segment of the economy that spawns the brand names that give a company the kind of broad-based popular recognition that translates into a big stock market capitalization. Compound annual growth in fast moving consumer goods in developed markets 2005-2010, according to McKinsey, will average 4% for developed economies. Germany at 3% will be slightly below average. The United States and the United Kingdom will be slightly above average at 5%.

Compound annual for fast-moving consumer goods in developing economies is forecast to be more than twice the developed world figure at 10%, according to McKinsey. China and India are forecast to show growth slightly above the developing economy average at 11% each. Indonesia is forecast at 16%.

And there’s more trending in the direction of increased representation for emerging markets among the list of the world’s biggest companies than just that big growth differential. As if that weren’t enough.

Global cash flows are moving in the same direction. Global financial assets had climbed to $167 trillion by 2006, up from $43 trillion in 1990, according to McKinsey. Emerging markets accounted for $24 trillion of 2006 total. That’s more than half the global total in 1990. Among emerging markets in 2006, China accounted for $8 trillion, “other” Asia for $11 trillion, and Eastern Europe for $3 trillion.

The flow of global financial assets toward emerging markets has still left them under-represented in the financial markets. In 2006 emerging markets accounted for 23% of global GDP but just 14% of global financial assets.

By this point your question should be, How do I get in on this trend?

It’s hard. Don’t kid yourself. Investing in emerging markets can be like walking through a mine field guided by a map with huge holes torn in it.

But I think it is possible with enough hard work and an understanding of the terrain.

First, three problems.

  • In the economy of United States often it’s who you know rather than how well you run your business that matters. (Lehman Brothers bankrupt; Bank of America (BAC) still operating; Goldman Sachs (GS) in hog heaven—need I say more.) That’s even truer in emerging markets. In Brazil the legislature is debating how much of the new oil discoveries made by Petrobras (PBR) should go to the government and, perhaps, a new national oil company. In China the government just completed reshuffling the assets of the country’s largest mobile phone companies to “increase competition.”

  • In the United States the path from private company to publicly traded company is relatively straightforward. In developing markets such as India, family controlled companies often spin off a bit of themselves to the public market giving shareholders the right to participate in ownership but leaving control effectively in family hands. China presents its own wrinkle on this in the form of state-owned companies and companies controlled by local governments or institutions such as the People’s Liberation Army.

  • In some countries, such as India and China, whole markets are effectively off limits to international investors. You may want to own shares of Bharti Airtel, for example, but unless you open an Indian brokerage account, forget it.

But there are some off-setting advantages too. Here are three.

  • Patience counts. The rise of the globes emerging financial markets and of global brands and companies from those markets is a long-term trend. You’ve got plenty of time to do your homework and still get in on the trend. This one is going to run for a while.

  • There are lots of different vehicles to use to invest in this trend. If researching and picking individual company stocks is daunting, how about buying into a bank that invests in a big chunk of the sector, like Standard Bank Group (SBGOY) of South Africa. Or how about an actively managed mutual fund such as Matthews India (MINDX) or an ETF (exchange-traded fund) such as Market Vectors Brazil Small Cap (BRF)? (For more on Jubak’s Picks Market Vectors Brazil see my post )

  • Even the extreme volatility of emerging financial markets works to the benefit of the patient investor. You’ll get lots and lots of chances to buy in cheaply as these markets crash and soar around a trend line that is climbing on average.

This last point is worth exploring in more detail.

Since we’re looking for the next McDonald’s (MCD), let’s start by looking at the history of McDonald’s share price.  In January 1970, McDonald’s traded at a split adjusted 31 cents a share. By January 1975, the stock was trading at $1.06. That’s a very tidy 3 times gain in five years.

But it wasn’t always smooth sailing. By January 1980 McDonald’s had climbed from $1.06 to … $1.06. That’s right. Five years of treading water for investors. By 1985 the stock had resumed its climb, selling for $3.17 that January.

And then McDonald’s was off to the races. $7.94 in January 1990. $16.63 in January 1995. And $40.31 in January 2000.

I see a lesson there: The biggest gains go to the investors who bought cheap. And it doesn’t matter if you didn’t catch the exact cheapness bottom. A run from 31 cents in 1970 to $40.31 in 2000 in stupendous. But I’d certainly take the profits from a move from $1.06 in 1980 to $40.31 in 2000.

Looking at the price history of a stock such as Krispy Kreme (KKD) makes the same point even though the stock’s price chart resembles McDonald’s evil twin Skippy.

Krispy Kreme went public at $11.50 a share in April 2000. It wasn’t immediately apparent as investor enthusiasm drove the price up to $44.20 by December 2001, but that initial price was too expensive. By April 2005 the stock was down to $5.92 a share. It was trading at $4.33 as a wrote this column.

Considering the risk that any stock with world-beating potential will turn out to be a dud or just a mild disappointment, investors should try to buy McDonald’s cheap instead of Krispy Kreme expensive.

Which is why I would hold off on buying any emerging market stock right now. Not because I think they’re about to crash. (Gee, I hope not. I added Market Vectors Brazil Small Cap not so long ago.) But because I think sometime in the next 12 to 18 months, once the Federal Reserve starts to talk seriously about raising interest rates, I’ll be able to get these cheaper.

If my arguments above convince you, you ought to just that time to researching potential global brands among emerging market stocks.

What stocks? Here are my five candidates for global brand potential among the emerging market universe.

  • (CTRP). The #1 online travel company in China.

  • Li & Fung (LFUGF). Convenience stores (Circle K), logistics and outsourcing giant. Recent acquisitions move the company toward branding. Maybe.

  • Ping An insurance (PNGAY). The company’s biggest competitor in China’s insurance market was American International Group (AIG).

  • United Spirits (Mumbai listing only: UNSP). One of three largest liquor companies in the world and #1 in India.

  • Jain Irrigation Systems (Mumbai listing only: 500219). A specialist in low tech but high efficiency irrigation systems.

You won’t be able to buy the two Indian stocks unless you have an Indian broker. India is gradually changing its restrictive market rules for overseas investors but movement is slow.

But there’s usually more than one way to invest in these emerging market companies. For example, you can get shares of Jain Irrigation b y buying actively managed mutual fund Matthews India.

I never said getting emerging market exposure to these potential global brand names was going to be easy. But it is, I think, worth the effort.

Full disclosure: I own shares in the iShares MSCI Brazil and Market Vectors Brazil Small Cap ETFs.

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