Re-emerging Markets - Lazard Asset Management
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Lazard Insights
Re-emerging Markets
Thomas C. Boyle, Director, Portfolio Manager/Analyst
The supply-chain economies of Asia get emerging market investors’
Summary attention, and the commodity economies get the (often negative)
headlines. But investors with a narrow focus may be overlooking
• Behind the headlines, some of the world’s
biggest commodity-driven emerging markets a very good thing. It pays to look behind the headlines, where
are “getting it.” They’re cleaning up corporate compelling value stories have been unfolding.
governance, advancing shareholder interests,
and inviting private investment. Renaissance in Russia
• Even though emerging markets earnings
growth is expected to top that of developed Foremost among those stories is Russia’s turnaround, a tale of great
markets in 2020, emerging market shares progress with the possibility of a long runway still ahead. Coming
trade at a steep discount to developed market out of the oil price collapse in 2014, the MSCI Russia Index has
valuations.
soundly outperformed both the broader MSCI Emerging Markets
• Russia, which had the world’s best-performing (EM) Index and the MSCI All Country World Index in four of the
stock market in 2019, is the first beneficiary of
this emerging trend.
last five years (Exhibit 1). Russian returns compounded at better
than twice the rate of the rest of the emerging markets as a whole
• We believe Brazil may be next.
over the period and one-and-a-half times the MSCI USA Index in
dollar terms. Last year to top it all, Russia’s stock market returned
Lazard Insights is an ongoing series designed to share value-
added insights from Lazard’s thought leaders around the more than any other.
world and is not specific to any Lazard product or service.
This paper is published in conjunction with a presentation Perhaps the most extraordinary feature of the Russian market’s
featuring the author. The original recording can be accessed extraordinary performance is the fact that after all those gains
via www.lazardassetmanagement.com/insights. it still trades at a substantial discount to the EM index. Since
bouncing off a recent low in 2018, MSCI Russia has outperformed
MSCI EM by a good 50%. Yet by almost every conventional
valuation measure—price-to-earnings, forward price-to-earnings,
and price-to-book value—the former trails the latter by a large
margin. In one measure alone does the Russian market command a
premium: dividend yield (Exhibit 2). And therein hangs the tale.
2
Exhibit 1
Getting the EM Act Together
World Champion Ironically, given the common perception of state-owned enterprises
Index Returns 2015 − 2019 (SOEs) as politically driven bureaucratic boondoggles, Russian
(%) SOEs, primarily in the energy and financials sectors, have led the
60 MSCI Russia MSCI EM MSCI USA
way. The government, counting on SOEs as a funding source,
has consistently pressured them to raise their dividend payouts.
40
Privately held companies in the hard commodity sectors, energy and
20 materials, have followed suit, forgoing limited capital expenditure
prospects in a soft pricing environment to reward their shareholders.
0
Russia spotlights the value trends we have seen building in the
-20 emerging markets over the past several years—trends we believe
2015 2016 2017 2018 2019
will soon start to pay off elsewhere in the emerging markets.
Cumulative Index Returns Despite the fact that companies in the emerging world trade at
(100 = 2014)
250
a substantial valuation discount to those in developed markets,
MSCI Russia MSCI EM MSCI USA consensus projections call for emerging market corporate earnings
200 to accelerate past developed markets in 2020, thanks in large
part to the emerging markets' long-term GDP growth premium
150
widening out this year (Exhibit 3).
100
50 Exhibit 3
2014 2015 2016 2017 2018 2019
Anatomy of a Bargain
As of 31 December 2019
The EM GDP Growth Premium Is Expected to Widen …a
Note: Characteristics shown are calculated on a 1-year trailing basis.
(%)
Source: Lazard, MSCI EM Real GDP Growth
5
4
3
2
Exhibit 2 1
DM Real GDP Growth
Russia on Sale 0
2015 2017 2019E 2021E 2023E
Forward Dividend 2016 2018 2020E 2022E
P/E (x) P/E (x) P/BV (x) Yield (%)
… Powering EM Earnings …b
Russia 6.11 6.65 0.96 6.95 (%)
Emerging Markets 14.64 12.21 1.65 2.72 30
S&P 500 Index MSCI EM Index
20
As of 31 January 2020
Source: Lazard, MSCI 10
0
-10
Russian corporate governance since the global financial crisis 2016 2017 2018 2019E 2020E
has undergone a quiet revolution, at least in terms of financial … While Leaving EM Valuations Trailing Behind c
ROE (%) P/E Premium/Discount
productivity. Coming out of the crisis, the MSCI Russia payout 20 25
ratio, the portion of net earnings returned to shareholders, usually MSCI EM Index ROE [LHS] MSCI World Index ROE [LHS]
EM Valuation Discount to DM [RHS]
in the form of dividends, had bottomed at 15%. It subsequently 15 0
rose above 30% and has recently topped 50%. The enhanced
payout ratio translates to a dividend yield (dividends as a 10 -25
percentage of share price) that has topped 8% and still comes close
to 7%—about a percentage point higher than the global high yield
5 -50
bond index—despite the ongoing rally in Russian stocks.1 To put 2005 2007 2009 2011 2013 2015 2017 2019
2004 2006 2008 2010 2012 2014 2016 2018
this surge in context, the dividend yield has increased five-fold in As of 31 December 2019
a Characteristics shown are calculated on a 1-year trailing basis.
the past decade, more than in any other emerging market and well Source: Lazard, MSCI
above the index’s 47% increase. b Calendar year EPS estimates for 2019 were calculated on 31 December 2019.
Source: FactSet Market Aggregates
c Characteristics shown are calculated on a trailing 1-year basis.
Source: Lazard, MSCI3
The Federal Reserve added a tailwind to emerging market returns
Exhibit 4
in 2019 by cutting US interest rates, which in turn helped High Tax, Red Tape
emerging markets currencies strengthen. The Fed tailwind has
(Taxes as % of GDP)
dissipated in the worldwide flight to the safety of the dollar 50
occasioned by the outbreak of the COVID-19 virus in China. We 40
don’t anticipate the outbreak will disrupt the emerging market 30
resurgence over the long term, however. Indeed, we think it more 20
likely that the Chinese government’s effort to restart its economy 10
could trigger a V-shaped recovery throughout the emerging world 0
Brazil Russia India China South United Argentina France
in the second and third quarters. Africa States
Brazil Prepares for Takeoff As of 31 October 2019
Source: Brazilian Federal Tax Bureau “Carga Tributáriano Brasil 2017” (for Brazil,
United States, South Africa, Argentina, and France); Heritage Foundation 2015
Of all the large emerging markets, Brazil looks to us the one best Macroeconomic data (for Russia, India, and China)
positioned to stage a Russia-style turnaround. Over the last two
years, the country has reined in its notoriously rampant inflation Number of hours per year incurred in the preparation, filing,
and payment of taxes (medium-sized businesses)
and eased rates, slashing interest on its 10-year bond from 14% to
4%, about the same rate as inflation, which has fallen from double United Kingdom 114
digits. GDP growth, which had hovered around 1% since Brazil China 138
Russia 159
emerged from a sharp recession in 2016, has risen above 2%.
United States 175
Politics in this instance has abetted economics. The election of a South Africa 210
new president in 2018 brought in an administration determined India 262
to deploy market-based solutions to tackle an economy top-heavy ...
Brazil 1,591
with government payrolls and transfer payments. In the first
nine months of last year, 23% of the federal budget went to 189 countries surveyed: World average 234 hours
cover salaries twice as high in some instances as compensation for Source: PayingTax2018 – World Bank & PwC
equivalent positions in the private sector. Social security benefits
ate up another 44% of the budget. 2
The results of the administration’s efforts at reform so far have
Potential Payoff
been highly encouraging. In October, the Brazilian senate Yet Brazil’s potential looms even larger than its problems. It is
approved a pension reform, capping decades-long efforts. The the world’s tenth-largest economy and home to 200 million
reform, which lifted retirement ages by nine years, may save up to consumers. It exports more of five basic commodities than any other
$200 billion in the next 10 years. As impressive as that number is, country: coffee, soybeans, sugar, oranges, and chicken; it comes
even more impressive is the expression of national will that made in second in another five: beef, corn, cotton, iron, and beverages.3
the reform happen. The bill made it pretty much intact through a To capitalize further on these assets, the government has stepped
congress of 26 different parties. up a privatization drive launched originally in 2016 to address
the government’s budget deficits. In a further iteration under the
In the new year, the congress is applying the pension-generated
new administration, it wants to induce the private sector to take
momentum to an even tougher nut to crack: tax reform. A
a lead role in the nation’s development. Over the course of last
burdensome and byzantine tax regime has weighed down the
year, the administration auctioned off some $28 billion of state
private sector. In 2018, according to the most recent data, taxes
assets, ranging from the lottery to portions of the crown jewel in
consumed better than 32% of GDP, compared to 26% in the
the government portfolio, the Petrobras oil company (Exhibit 5).
United States and about 20% in both Russia and China, two
It aims to realize another $35 billion in privatization auctions
developing markets of a scale comparable to Brazil. And not only
this year and ultimately to raise $100 billion for infrastructure
do Brazilians lose more of their earnings to taxes, they work harder
projects. In an implicit recognition of the role of foreign capital
to file them than citizens almost anywhere else. It took on average
in realizing its goal, it has advanced a bill through the congress
11 times longer in 2018 to prepare taxes in, say, São Paolo than in
designed to strengthen Brazil’s application for membership in the
Chicago (Exhibit 4).
Organisation for Economic Co-operation and Development by
formally guaranteeing the central bank’s independence.4
Perhaps the most significant implication of the revitalized
Exhibit 5
privatization drive for investors—and, for that matter, for the Taking Brazil Private
global economy—is the commitment to tap private capital to
Successful Divestments
help upgrade the transportation infrastructure across the world’s
IRB Stock Issuance (reinsurance)
fifth-largest nation by land mass—an infrastructure so deficient Petrobras Stock Issuance (oil & gas)
that Brazil has managed to become a commodities powerhouse Petrobras’ Pasadena (refinery)
Petrobras’ TAG (gas transportation)
28
almost in spite of itself. It costs roughly four to eight times more Petrobras’ BR Distribuidora (petrol stations)
per ton/kilometer to ship goods by rail in Brazil than it does in the Petrobras’ Paraguay (petrol stations) $
Petrobras’ Liquigas (gas distribution)
United States (Exhibit 6). It costs about the same to grow a ton Railways and Ports
Billion
of soybeans in Illinois as it does in Brazil’s Mato Grosso state, and Airports
Lotex (lottery)
it costs about the same to ship that ton to China from Santos or Banco do Brasil (stock issuance
from New Orleans to a port in China, but it costs $120 to truck Oil auctions and Petrobras’ (oil fields)
Neonergia’s IPO (electric power)
that ton from Mato Grosso to Santos and $25 to haul it by barge
from Illinois to New Orleans (Exhibit 7). As of Second Quarter 2019
Source: Ministry of the Economy and BNDES
The Next Emerging Surge
In Russia’s recent accomplishments and the initiatives that Brazil is
Exhibit 6
undertaking, we can identify in two commodity-based economies
High Price to Pay
much of the reformist, market-based energy that powered the
Railroad Tariffs
Asian supply-chain economies in the last decade. In objectively
(Cents per ton/km, US$)
assessing the opportunities this energy generates, we think it pays 20
to filter out the headlines and focus on the fundamentals. In many
15
of the commodity economies, they’ve deteriorated to such an
extent that even modest steps to improve capital productivity and 10
corporate governance, boosted by accommodative interest rates,
5
can reap exceptional and enduring rewards.
0
Our view explains our Brazil conviction, in particular. The Ferrovia T. Perurail Northfolk KCSM Canadian Union
Cristina (Peru) South (US) (Mexico) Pacific Pacific (US)
government’s ambition to bring Brazil’s infrastructure into the (Brazil) (Canada)
21st century and its drive to attract private capital gives the As of 2015
nation its best opportunity in generations to realize its potential as Source: AAR, GMexico Transportes, International Transport Forum, OCDE
breadbasket to a growing, healthier, and more prosperous global
population. And its determination to realize its ambition with
private capital makes Brazil one of the most compelling stories in Exhibit 7
the emerging markets today. Logistics Costs in Brazil vs. US
Shipping Soybeans to China
New
Illinois Orleans
US$25/Ton US$46 /Ton
China
Mato Santos
Grosso
US$120/Ton US$45/Ton
As of 31 December 2019
Source: Morgan Stanley5
This content represents the views of the author(s), and its conclusions may vary from those held elsewhere within Lazard Asset Management.
Lazard is committed to giving our investment professionals the autonomy to develop their own investment views, which are informed by a
robust exchange of ideas throughout the firm.
Notes
1 As of 30 January 2020
2 As of 30 October 2019. Source: Secretaria do Tesouro Nacional
3 As of 2018. Source: IGBE, IMF, Brazil’s Ministry of Infrastructure
Important Information
Published on 26 February 2020
Mention of these securities should not be considered a recommendation or solicitation to purchase or sell the securities. It should not be assumed that any investment in these securities was, or
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that any securities referenced herein are currently held in the portfolio or that securities sold have not been repurchased. The securities mentioned may not represent the entire portfolio.
The MSCI Emerging Markets Index is a free-float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets. The MSCI
Emerging Markets Index consists of 26 emerging markets country indices: Argentina, Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia,
Mexico, Pakistan, Peru, Philippines, Poland, Qatar, Russia, Saudi Arabia, South Africa, Taiwan, Thailand, Turkey, and United Arab Emirates. The index is unmanaged and has no fees. One cannot
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