Cabot’s “Don’t Miss the Big Turnaround in Emerging Markets” Stocks

by Travis Johnson, Stock Gumshoe | August 31, 2016 1:49 pm

Today we’re taking a quick look at a teaser ad that went around late last week, for Cabot[1]’s Emerging Markets Investor. That’s the letter that used to be called Cabot China[2] & Emerging Markets Report, it’s changed names to reflect the relative lack of popularity of Chinese stock picking these days but is still edited by Paul Goodwin[3]… and they’re selling subscriptions by promising to reveal their top emerging markets stocks, all of which they say are “headed toward 50% gains in the next 90 days.”

They’re not alone in that sentiment, we’ve seen plenty of other folks arguing that emerging markets are ready to recover now — and it’s not just that emerging markets tend to be more commodity-focused and have benefited from some early (and uncertain) recovery in a few commodities, though that’s still the case with many of them, it’s also that there are some reasonable valuations in these markets when you compare them to the relatively pricey US stock market.

Here’s their brief big-picture sum-up from the ad:

“Cash is flooding into emerging markets again—a whopping $10 billion in just the last five months!

“This represents not only a mammoth turnaround from the $103 billion that flowed out of emerging markets over the past two years, but also signals a huge opportunity in the making.

“Three events, in particular, are driving this new boom.

– Rising commodity prices, which drives growth in emerging nations,
– Rising foreign currencies, which increases profits and cash flow, and
– Value—emerging markets stocks are cheap by U.S. standards, selling for a P/E ratio of 11 compared to 17 for U.S. stocks.”

Those are pretty reasonable assessments, though the currency issue tends to be very company-specific and country-specific — exporters, for example, enjoy having an undervalued currency because they pay their employees and buy raw materials in their weak local currency but get to sell in stronger currencies… but certainly a stronger local currency (or a weaker US dollar, since that’s what most companies measure themselves against) can be a boon to many others.

And this is not a brand new trend — emerging markets investments in general have had a good twelve months of inflow, partly because of continuing low interest rates that tend to be good for emerging markets, where incoming capital flows and capital investment from other countries are important… and the emerging market indices are now just about equal to the S&P 500 when it comes to trailing twelve month performance (it’s not a coincidence that things look a little bit better now than they did a couple weeks ago — that’s because almost all markets had a big swoon in early August last year, at one point the emerging markets ETF EEM was down 12.5% in a few weeks… that and most of the rest of the 2015 swoon that had EEM down close to 20% last year has now rolled off the “trailing twelve months” chart).

That doesn’t make up for the huge exodus from emerging markets that we saw in the years prior, but the push of new money into emerging market equities over the last two months is starting to make a dent — and the push into emerging market bonds has been even more dramatic, thanks to the global thirst for yield and the (relatively) high coupons you’ll find on sovereign and corporate bonds[4] in the emerging world.

“Emerging markets” encompasses a broad swath of economies and companies, many of which you wouldn’t really consider to be “emerging” — the largest holding in the biggest emerging markets ETF (EEM, the iShares emerging markets product) is Samsung, one of the largest and most dominant electronics manufacturing companies in the world… and fully 50% of EEM is allocated to China, South Korea[5] and Taiwan, with a big IT focus. The other top holdings these days are Alibaba, Tencent, Taiwan Semiconductor and China Mobile… all megacap companies you probably know… traditionally it used to be that financial services, telecom providers (or, as we used to call them “phone companies”) and big energy or mining companies were the largest part of most “emerging” markets, but technology globalization has really changed that dynamic (though the financial sector is still the biggest part of EEM, by a hair over IT).

Interestingly, if you go with the dividend-focused emerging markets ETFs you generally will see more commodity exposure — I’ve sometimes used the WisdomTree[6] Emerging Markets High Dividend ETF (DEM) in the past, and that has among its top holdings a number of oil[7] and mining companies from around the world… including a bunch of big Russian and Chinese energy firms.

So knowing that, knowing that huge global companies like Alibaba and Tencent and the like are big parts of the EEM index, it’s not a big surprise that it has generally done about as well as the S&P 500 over the past year… though the volatility is certainly much greater. Here are the S&P 500 (SPY) charts for this past twelve months compared to EEM:

And, to accentuate that longer-term outperformance and volatility, here’s a chart going back to the early 2000s:

So with that general introduction… what are the emerging markets stocks being hinted at by the Cabot folks now? Here are your clues:

“Our No. 1 Emerging Markets Stock is a locked-in profit opportunity that’s beginning to look a lot like pharmaceutical giant Dr. Reddy’s that handed investors 774% gains in 14 years.

“Like Dr. Reddy’s, this company is also riding a wave of profit growth but in the online commerce business. Earlier this month, the company reported a fantastic quarter—revenues rose 29%, while items sold leapt 45%, which was the fastest growth rate since 2009.”

You can ignore the “Like Dr. Reddy’s” bit, despite the fact that yes, Reddy (RDY) did have gains along those lines from trough to peak. That’s something the Cabot copywriters always throw in so they can drop a big performance number in to make you excited (this is starting to look a lot like Tesla, only in the medical supplements[8] space… this is starting to look a lot like First Solar, only in the online gambling[9] space… etc. etc. Yes, I made those examples up, but they’re similar to past ads from Cabot… and I have no idea whether Cabot even recommended RDY back in those early 2000s lows, they don’t specifically say so).

What other clues do we get about this “No. 1” stock?

“Payment volume through the company’s system surged 51% (in U.S. dollar terms) to $1.82 billion. And the firm’s delivery operation saw shipments double from the prior year. Earnings also easily topped expectations, and analysts see the bottom line reaccelerating next year.

“The stock is up 64% in the last six months and is headed for similar gains in months to come.”

So what is it? This is MercadoLibra (MELI), the Latin American online commerce giant. They went public almost exactly nine years ago, and the stock has really soared — though it’s been a pretty bumpy road, as you might imagine for a company whose biggest businesses are in Argentina[10], Brazil[11] and Mexico[12] (they try not to mention Venezuela very often these days). At $170, the stock has indeed risen more than 64% just this year — and it has roughly doubled since the last time I noticed a Cabot newsletter teasing this pick, back in 2011.

MELI is indeed enjoying solid organic growth — their payment volume did indeed rise 51% to $1.82 billion in the last quarter, sales volume did leap 45%, and they have been enjoying their best growth rate in that metric since 2009. That’s all from their last quarterly press release, which you can see here[13].

And, by all reports I’ve seen, MercadoLibre is still holding on to their market share as the dominant ecommerce provider in most of Latin America — in some places, like Mexico, Amazon.com is a pretty strong second-place ecommerce competitor, but in most countries Amazon is pretty far down the list and MELI really has most of the traffic to itself.

The company’s model is much more like eBay than it is like Amazon, with a focus on person-to-person sales, and eBay is still a substantial shareholder in MercadoLibre (they own about 18% of the shares, which has been steady for a long time). They also, like eBay with PayPal before the recent spinoff, own their own payments platform (MercadoPago), which is growing nicely as well and is also beginning (like PayPal did) to have some presence outside the MercadoLibre ecommerce platform. It’s a pretty compelling story, and Brazil and Argentina and Mexico and Colombia[14] and other countries in the region are still showing strong growth in ecommerce as internet access and credit cards get more and more penetration in those economies.

But, of course (there’s always a “but”), it’s pretty expensive. Growth like this doesn’t come cheap, particularly when a stock is loved by lots of retail investors and when they think they’re getting their hands on the next eBay or the next Amazon — analysts think that MELI will make $2.71 in earnings per share this year, which is lower than a year ago (largely because many LatAm currencies are weaker than a year ago, in addition to economic weakness in Brazil offsetting some recovery in Argentina, and probably partly because Venezuela, which used to be one of their top countries, continues to be an economic trainwreck)… but they also see growth resuming next year, with earnings of $3.44 expected (the range of estimates is wide, as you might have guessed).

If that’s true, then MELI is trading at a forward PE of about 50. That’s steep, so you’d likely have to prepare yourself for some serious volatility as the currencies of Argentina, Brazil, Mexico and others fluctuate against the US Dollar and impact the reported earnings… and as the growth rate swings pretty widely in those US$ terms, though it might well be that the underlying unit growth, user growth, and sales volumes will be enough to continue to make it a strong long-term story for those who can stomach the big swings.

That’s been the case for close to ten years now, and it’s still just a $7.5 billion company… so the risk is certainly there, but they’ve held off big competitors and built a pretty nice company that has been more resilient than I might have expected a few years ago.

And it’s worth remembering that growth at this level is pretty rare. If you do a screen for companies with similar metrics — expected long-term earnings growth of at least 25%, trailing revenue growth of better than 25%, already profitable, and with a market cap of at least $5 billion… there’s not a lot of company, only a dozen other firms make that list (if you’re curious, it’s Abiomed (ABMD)[15], Alibaba (BABA)[16], Amazon (AMZN)[17], Ctrip (CTRP)[18], Facebook (FB), Incyte (INCY), MobilEye (MBLY), Netflix (NFLX)[19], Oaktree Capital (OAK)[20], Ultimate Software (ULTI), Vipshop (VIPS) and Weibo … so mostly big tech, emerging markets, and biotech… and all expensive based on current performance, with MELI’s PE of 56 making it look pricier than BABA, VIPS and OAK, but downright cheap compared to most of the others).

I don’t own the shares, and I always find it difficult to buy stocks that are this expensive on a PE basis, but I’m trying to keep an open mind. If you’ve got an opinion to share I’m sure we’d be delighted to hear it — just toss it on the pile with a comment below.

And I’m going to leave you there for today — Cabot is hinting at two other ideas, both online gaming companies, and I want to take a little more time to look those over before I get into the details… hopefully that will make it into tomorrow’s missive, enjoy the rest of your day!

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