The next billion consumers

The faded fields of gold

Emerging markets are headed for their sixth straight year of declining growth rates, driven by a slowdown in China and contraction in Russia and Brazil, according to figures released by the International Monetary Fund (IMF) in April. Output is expected to fall to 4.3 per cent, from 4.6 per cent last year. By contrast, growth is expected to pick up in the world’s advanced economies, rising 2.4 per cent this year, from a meagre 1.8 per cent in 2014, nudging global growth up by 3.5 per cent in 2015, from 3.4 per cent last year. The IMF says this data has put a real dampener on expectations for a medium-term recovery in the developing world.

What a contrast to the turn of the millennium. Between 2000 and 2009, output per person in the emerging world almost doubled. The average annual rate of growth over that decade was 7.6 per cent, 4.5 percentage points higher than the rate seen in rich countries, according to The Economist. People’s living standards increased and the gap in terms of income between prosperous nations and poorer countries narrowed quickly. Now, that gap is widening again. The Economist reckons it could take well over 100 years for emerging economies to reach rich world levels of income per head.

History suggests that catch-up will be a long, difficult grind, built on slow improvement. The past 15 years have changed perceptions regarding just what is possible, but they also deceived people into thinking broad convergence is the natural way of things. “It looks like the world is now being reminded that catching up is hard to do,” opines the magazine.

So what stunted development? Well, some economists argue that the 2000-09 bubble was just that – an anomaly – created by a perfect storm of lower interest rates, rapidly rising commodity prices – which benefited many emerging economies reliant on natural resource exports – and a huge surge in global trade as technology allowed for tight supply chains, high-tech logistics and instant communication, making production in the Far East a very real and extremely cheap possibility. When the economic crisis set in, that trade eased as consumption waned, sending commodity prices tumbling. Capital flowed out of emerging markets, and the announcement that the US Federal Reserve would begin tapering quantitative easing sent many emerging markets currencies spiralling downwards. Fresh expectations that the Fed may soon raise interest rates has added to these currency woes.

“Tapering by the Fed was a catalyst for a reversal in investor sentiment in emerging markets, especially the conviction that higher risks were justified by higher expected returns,” says accountancy firm PricewaterhouseCoopers. “As the Fed wound down this tide of liquidity, currencies fell and interest rates rose and growth slowed.” Meanwhile, this downturn has coincided with a period of political and social turmoil in many parts of the developing world, namely the Middle East, Russia, Ukraine and north Africa.

The big squeeze

According to Morgan Stanley, the emerging world’s troubles are not as bad as in 1997-98. But the exposure of rich-world companies is far higher now than it was back then. Last year, European companies made one-third of their sales in the developing world, almost triple the level in 1997. For big, listed American companies the total has doubled, to about one-fifth (The Economist, 8 March 2014). Lower growth, and by extension weaker consumer demand, in the emerging world has therefore hit many multinationals hard.

The prospect of a continuation of this trend in the medium term is certainly a worry. Take Unilever, which generates 57 per cent of revenue from emerging markets. The food and personal care giant once enjoyed quarter after quarter of double-digit revenue growth in emerging markets. Today, it’s a different picture altogether. Unilever’s emerging markets category hasn’t reported double-digit sales growth since the second quarter of 2013, when growth stood at 10 per cent. The latest update this year shows that it has fallen to just 5 per cent. Luxury fashion house Burberry (BRBL) has huge exposure to the Chinese consumer. Here, demand has fallen due partly to the slowdown in the economy but also due to a government crackdown on lavish gift-giving. Political upheaval in Hong Kong, a key shopping destination for many Chinese shoppers, is seriously impacting sales. Drinks giant Diageo relies on wealthy Chinese consumers’ penchant for expensive whisky, as well as South Americans’ taste for spirits and beer. In both regions, Diageo is reporting painful declines in volumes and sales on the back of much lower demand. At the half-year stage in December, chief executive Ivan Menezes said the group was reviewing its investment priorities in Asia to “improve returns and support long-term growth”.

An index run by index provider Stoxx of western companies with high emerging markets exposures offers a good picture of this trend. As the chart to the right shows, the index has significantly lagged behind the S&P 500, the FTSE 250 and the FTSE All-Share since 2012. The FTSE 100 and Australian ASX 200, with high exposure to mining and emerging markets, have tracked its performance closely.

On top of softer demand from consumers, currency depreciation in many emerging markets has dealt a further blow to companies who report in US dollars or sterling, by taking a huge bite out of paper profits. For example, last year Unilever reported a 6 per cent decline in sales, which reflected a negative currency impact of 8.9 per cent. Personal care maker PZ Cussons (PZC), which has big operations in Africa, said its operating profit last year would have been 18 per cent higher had it not been for the impact of adverse exchange rates. Luxury goods brand Burberry has suffered similar setbacks, as have Diageo and brewer SABMiller (SAB). The latter recently reported a dip in earnings in the year to March as the strength of the US dollar – its reporting currency – cancelled out growth in emerging markets.

IMF global growth projections April 2015

The tide is turning

Given these problems, it would be logical to assume that many chief executives are now turning their focus away from the Brics and the Mints and towards the developed world. An article in Reuters cited research from consultancy firm Accenture which suggested that 60 per cent of the chief executives surveyed were looking to change course.

But before you write off the potential of the world’s poorest nations, remember this: demographics are still on the side of the developing world. Young working-age, and growing, populations coupled with huge scope for wage growth and consumption is a potential gold mine for consumer goods companies. And as a bloc, emerging markets are still outpacing growth in the developed world. For example, China is expected to grow at the slowest rate this year since 1990. But the country’s GDP rate is still 6.8 per cent, a far cry from the 14 per cent growth rate in 2007, but a huge jump from the miserly figures in Europe, including the UK, one of the developed world’s fastest growing economies. Moreover, while the Brics contribution to global growth will fall for the second year in a row, they will still account for a third of the total.

Mexico and Turkey are among a handful of emerging markets expected to deliver high productivity and job growth. PwC senior economist Richard Boxshall says there are more jobs now in the seven biggest emerging markets countries than at the end of 2007. Productivity in China, for example, is 60 per cent higher today than in 2008, thanks to a process of up-skilling. What that means is that although China’s workforce might be shrinking, workers are moving from low-cost manufacturing to higher-skilled occupations. “This shift could also help China avoid falling into the middle income trap and put its future economic expansion on a more sustainable footing,” says Mr Boxshall. In the long term, therefore, consumer goods companies should still set their sights on emerging markets consumers.

Analysts at PwC agree: “We still believe that most emerging markets have economic fundamentals in terms of the labour force growth and potential for capital investment and productivity improvement for solid economic long-term growth. But it will be a bumpy ride.” Indeed, PwC predicts that economic growth in sub-Saharan Africa (SSA), for example, will outpace goal growth for the 15th year in a row this year. It also expects the GDP of the SSA’s four largest economies in terms of purchasing power parity – Nigeria, South Africa, Angola and Ethiopia – to overtake the economic output of Italy in 2015. “For businesses, this is a further sign of the potential of SSA as a region in which to invest,” they say. That’s good news not just for companies such as Cussons, but also brewer SABMiller and Nichols (NICL), with substantial operations in Africa.

Cherry-picking

The difference, however, between now and the situation 15 years ago is that it’s no longer enough for company executives to simply ride the wave of emerging markets momentum. The vastly differing growth prospects across the emerging markets bloc (see table on page 24) shows how cherry-picking the right regions with the right products will be vital for consumer goods businesses. Brazil and Russia, for example, are contracting, while India is taking off, fuelled by low oil prices and a business-friendly government, which will boost GDP growth, ease pressure on India’s high current account deficit and bring down inflation.

Beverage maker Nichols is big in the Middle East and operates in 30 African countries. While sales are buoyant and steady, they can be lumpy. “We are not seeing high double-digit growth as in the years gone by, but that was not sustainable,” says finance director Tim Croston. “And it does contrast to the UK market, where overall sales are flat and volumes are declining in the wider soft drinks market. Emerging markets are not dead, they are a good source of growth in the years to come. It’s no longer a blanket call, it’s about picking where the growth opportunities lie.”

Brandon Leigh, finance director at PZ Cussons, home to the Imperial Leather soap brand, agrees we’re unlikely to revert to the heady days of the early 2000s, but that it doesn’t matter, and frankly, those rates of growth could never be sustained in the long term.

He still believes emerging markets offer the best long-term growth opportunities for consumer goods companies, such as Cussons, which generate over half of total sales in emerging markets.

“The story now is much less about the general global themes and much more about specific markets, factors affecting those markets and what product categories you’re selling in those markets,” he explains. “If you take one of ours, Nigeria, there are very specific factors affecting the economy, social unrest in the north, the Ebola outbreak and currency devaluation. But the outlook now, post election, is looking positive. In these markets, you have to have a business that is entrenched and can survive slower years. Emerging markets are key to future growth, but it’s about taking positions and all stakeholders must understand that, by definition, emerging markets are volatile, so you have to play the long-term game.”

It hasn’t been plain sailing for Cussons. Nigeria’s currency was hit with a 25 per cent devaluation last year and consumers there still face price inflation. In Indonesia, another big market for Cussons, GDP growth has slowed from double digits to 6 per cent. Still, Mr Leigh points out that this level of growth outpaces that of Cussons’ developed world markets. “Emerging markets are still growing ahead of developed markets, and prospects remain as attractive as ever. The issues many emerging economies have faced in recent years just re-emphasised that in the short term to medium term there is always going to be volatility and that will never go away. That is why we like to have a balance. I don’t think we will be rethinking our emerging markets strategy. These are still key markets.”

The general consensus now, is that the developed world will grow in the low single digits in the long to medium term, with Asia in the high single digits and Africa will serve up at least low double-digit growth.

There are also signs that consumer goods companies’ emerging markets exposure could become a benefit once more. Car dealership Inchcape (INCH) is a big beneficiary of emerging markets consumers and just reported a set of bumper results, driven by its higher-margin distribution business in what it calls “fast growing” emerging markets. SABMiller is also in fine fettle having just unveiled strong underlying sales growth, of 6 per cent. Consumer confidence appears to be ticking up in parts of the developing world (see page 26), too. Even currency swings will reverse in their favour at some point: first-quarter sales at Unilever were actually helped by a 10 per cent currency tailwind. Turnover increased 12.3 per cent to €12.8bn (£9.2bn), helped by a positive currency impact of 10.6 per cent. Compare that with the same period last year when the effect was the opposite.

Of course, it won’t be smooth sailing this year. Commodity producing countries, such as Brazil, will have a tough time due to low prices, while social and political unrest in many parts of the world looks unlikely to abate any time soon. But as the research has shown, writing off emerging markets would be folly as these are the markets that offer the best long-term growth potential. Consumer goods companies that pick the right regions, with the right strategies in place, will be the ones to ultimately win out.

Six emerging markets consumer stars

SIX EMERGING MARKETS STARS