EM earnings - beware the consensus view

1 October 2018

EM EARNINGS – BEWARE THE CONSENSUS VIEW

There are signs that the asset class has become oversold, and therefore attracting bargain hunters – as indicated by recent positive flows.

Take earnings forecasts with a pinch of salt

Earnings growth has been a positive driver for emerging markets in recent years, improving flows into the asset class. Now, against a backdrop of trade conflicts and political & economic uncertainty in some quarters, earnings downgrades would appear to be giving investors pause for thought. Earnings data is, of course, hugely powerful in determining market direction, and is an important (albeit imperfect) measure of corporate health.

However, when differentiating between actual and forecast data, it pays to be mindful of the nuance lost when looking at aggregate numbers for what is a heterogeneous group of markets. Wittingly or unwittingly, sell-side analysts can help drive up correlations between countries and sectors, even though economic and corporate fundamentals may, on a closer assessment, look very different.

Falling in line with the house view

In the next few months, we expect to see the sell side downgrading their estimates further. This is, in no small measure, due to analysts trying to reflect their ‘house view’ of economic growth, taking into account the pronouncements of tariffs and counter tariffs from the US and China. These house views are subject to almost daily revisions, even for one or two year estimates.

However, these top-down adjustments don’t reflect company fundamentals and, in actual fact, ignore many of the positive prospects which are evident for emerging market companies. Opportunities which a fundamental approach to active management is best placed to identify.

For example, even in sectors such as utilities which have seen significant downgrades, there are still opportunities if investors are looking in the right places. Take China Gas for instance; the company has an ambitious multi-year growth strategy centred around expanding supply to domestic users, particularly in rural areas where customers remain reliant on coal power for heating and cooking. It plans to add over 4 million households in 2018, a growth of around 15%1.

EM EARNINGS - BEWARE THE CONSENSUS VIEW

China Gas plans to add over 4 million households in 2018, a growth of around 15%1

Revenues at the group will be driven by higher gas volumes, as both new households and existing users increase their gas consumption. In addition to volume growth the company will also benefit from one-off connection fees on newly connected homes. We expect China Gas to deliver more than 20% revenue growth in the current financial year ending March 2019. This is expected to translate to earnings growth of a similar magnitude, 20%. All this is in stark contrast of course to the earnings view for emerging markets projected by aggregate numbers2.

Long-term positives

This is not to deny the short-term challenges in some (but by no means all) emerging market countries, but we believe the impact will be limited over a longer time horizon. Current trade friction may be nerve wracking but multinational supply chains will doubtless adapt, and importantly, emerging market countries are increasingly trading among themselves.

In fact, despite all the negative headlines, there are signs that the asset class has become oversold, and therefore attracting bargain hunters – as indicated by recent positive flows.

The recent turbulence aside, it is important to remember that the fundamental drivers which make emerging markets attractive haven’t changed. These long-term growth themes, whether supportive demographics, intra-regional trade, domestic demand, or the powerful combination of technology adoption, urbanisation and services sector expansion, still provide phenomenal opportunities for investors able to look beyond the noise.

The information provided should not be considered a recommendation to purchase or sell any particular security. It should not be assumed that any of the security transactions discussed here were, or will prove to be, profitable.
1 Source: FactSet, China Gas annual report 2018.
2 Source: FactSet and Martin Currie.