Global relapse: EM consumer may disappoint

But a series of profit warnings and signs of belt tightening among emerging consumers have darkened the horizon.

Danish brewer Carlsberg cut its outlook last week,citing weakness in Russian sales,and Brazilian supermarket chain Hypermarcas trimmed 2011 profit estimates. India’s top car maker Maruti Suzuki expects single-digit sales growth in 2011 versus 25 percent last year,as Indian car sales fell in July for the first time in 2-1/2 years.

There is still a strong secular case for the EM consumer but in the world we live in,everyone is thinking of what will happen next week,not next decade,said Mark Donovan,CEO of Robeco Investment Management. If we get into a phase when global growth slows materially or even contracts,exposure to the EM consumer isn’t going to bail you out.

Sales of cars,property and consumer goods were easing even before this month as higher interest rates began to bite in many emerging economies including China,India and Brazil. But any recession in the United States and the euro zone would hit developing countries even harder as an inevitable slump in emerging economies’ exports would hurt domestic consumer morale.

Many reckon the outlook is gloomier than in 2008 when governments,both advanced and emerging,pumped vast amounts of cash into their economies to shore up domestic demand.

We are looking at a prolonged period of slow US growth which cannot be fixed this time with a quick dose of stimulus,said John-Paul Smith,head of emerging equity strategy at Deutsche Bank. Chinese wage growth will come under pressure,that will have a multiplier effect and slow consumer demand.

Emerging households today are far more leveraged than in 2008,RBC Capital Markets said in a note. Government deficits are bigger and trade surpluses overall are smaller,it said,concluding EM policymakers have fewer bullets to spend now.

CAUTION CREEPING IN

Until now,faith in the EM consumer has paid off — Thomson Reuters data shows that a basket of euro zone stocks with a high degree of foreign exposure outperformed a portfolio of domestic-focused stocks by 14 percent in the past year.

Consumer discretionary stocks such as cars and tech firms,have fallen 6 percent this year,while broader emerging equities are down 15 percent.

No surprise really,given Chinese minimum wages rose 24 percent in 2010 and many emerging economies are running almost full employment. Compare that with the United States where 58 percent of the working-age population is employed full-time,and wage growth is stagnant,and it is easy to understand why investors are reluctant to abandon the bet on the EM consumer.

In terms of outlook … the EM consumer is very well positioned relative to the developed markets consumer. It is clear the latter is in for a very long period of retrenchment that could be anything between five and 20 years,said Julian Mayo who manages $3.3 billion at Charlemagne Capital.

Consumer discretionaries remain the top play for emerging funds,a Bank of America/Merrill Lynch monthly survey shows.

But as the data flow from emerging markets turns sour and growth forecasts are cut for big consumer nations such as India and Brazil,some caution is creeping in.

Funds have cut overweights on EM consumer stocks by a quarter since January,BoA/ML data shows. And consumer stocks’ outperformance to the broader market has stalled in the August stock market selloff — they have done just as badly.

RICH VALUATIONS

Overall,however,consumer stock valuations do not yet reflect the darker economic outlook,making them vulnerable if the global equities rout continues.

Smith of Deutsche Bank says that valuations of consumer-focused EM companies,unlike other sectors,have barely budged.

Energy and utility stocks are valued near November 2008 troughs of 1.2 on a price-to-book basis,he noted,but consumer discretionary stocks,despite data such as falling car sales,are trading at 2.3 times book — 40 percent above 2008 lows.

Price-to-book is a measure that compares stock prices with the value of the company on its balance sheet. According to Smith it is a more accurate valuation gauge in the current environment than the more common price-forward earnings ratio.

The energy sector is pricing in a pretty bad scenario but people are expecting the EM consumer to hold,he said. It’s a crowded trade and will suffer if we have any further big price declines.