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START: Fundamentals behind our acronym

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25 November 2020

Having coined the term START for a group of five leading technology companies in the emerging market (EM) equity universe, GAM Investments’ Tim Love discusses the fundamentals behind the novel acronym and compares START to the famous US FAANG names.

We previously introduced a group of stocks which we have named START (Samsung Electronics, Tencent Holdings, Alibaba Group, Reliance Industries and Taiwan Semiconductor). These companies, in our view, share characteristics of market dominance, leadership, future growth potential and sustainability, execution capabilities as well as a compelling value proposition. We believe our original START abbreviation will become an acronym within EMs, just like FAANG (Facebook, Amazon, Apple, Netflix and Alphabet – formerly known as Google) in the US, and will adjudicate the performance of the entire EM equity asset class. Below, we look at the fundamentals behind our START acronym and highlight some facts and structural elements of Asian markets, where these companies operate, along with START versus FAANG financial metrics and ESG comparisons.

Technology in EMs

EMs are now more exposed to technology than developed market peers; in four of the last five years, the technology industry has been the best performing industry within EM equities. While we believe that market breadth in EM is likely to improve, the technology industry should continue to perform well as valuations are not stretched and growth is supported by many structural elements. Importantly, the digital universe in EM equities has become very wide and deep. In internet & direct marketing retail, publicly traded companies include not just Alibaba, but also Chinese e-commerce competitors JD.com, Pinduoduo and Meituan Dianping, an online food delivery service. In interactive media & services, Shenzhen-based Tencent is now joined by Naver Corp, operator of South Korea’s most popular search engine platform, and Kakao Corp, which offers one of the country’s most widely used messenger applications. In India, meanwhile, conglomerate Reliance Industries has become a digital giant over a span of three years through its digital unit Jio Platforms. Other EM names include Argentina’s MercadoLibre, an e-commerce platform, Indian outsourcer TCS, Infosys & HCL Technology. They are, in our view, world-class companies growing no less explosively than their US counterparts.

Chart 1: START stocks are approximately 26% of MSCI EM Index and still available at reasonable valuations

 

Chart 2: FAANG stocks are approximately 18% of S&P 500 Index

 
Source: GAM , Bloomberg, MSCI, S&P as at 4 Sep 2020. For illustrative purposes only.

EM equities at an inflection point

EM equities look to be at an inflection point after prolonged underperformance since the global financial crisis (GFC) and are appealing to investors on every metric; from value & growth to yield & quality. Many investors have favourably argued for a higher discount to the US considering EMs are full of energy and materials, while the US is more driven by technology and consumer stocks. This was a good argument in 2000 or 2010, but not so much in 2020 since the make-up of EM equities has changed dramatically in recent years. It is also worth noting the cyclical nature of the relationship between these markets over time. We are not saying EM stocks deserve a premium or a similar multiple to the S&P 500. There are other factors at play here including ESG, rule of law, governance and judicial systems, maturity and trust in the financial markets, ease of doing business and how shareholders are treated by regulators and government officials. However, things have changed drastically over the years in EMs and we believe they are well placed to outperform global equities with multiple structural stories.

Asia is on track to top 50% of global GDP by 2040 and drive 40% of the world’s consumption, representing a real shift in the world’s economic balance. Bangladesh, Vietnam, China and India are among the nations which are growing very rapidly. In e-commerce, China accounted for less than 1% of the value of worldwide transactions a decade ago; that share is now more than 40%. Despite strong internet growth during the last two decades, the Asia and Africa regions are still far behind their western counterparts and below world average. Asia was home to more than a third (119) of the world’s 331 “unicorns” (start-ups valued at more than USD 1 billion). 91 of these companies are in China, followed by India with 13, South Korea with six and Indonesia at four. By comparison, the US is home to 161 unicorns, while the UK has 16 and Germany has nine.

Given the speed and importance of the gig economy, even before the full roll out of 5G, it is important to note emerging Asia now accounts for half of the world’s internet users and a large majority of the global middle class reside in EM countries. The drivers of EM e-commerce have become stronger due to Covid-19; internet penetration in the EM world has leapt forward, powered by cheap data. In India, Jio has cut data costs by more than 90% in the last few years. Moreover, smartphones have increasingly become the main way of accessing e-commerce.

Chart 3: Internet share (world percentage)

 
Source: GAM, Internet World Stats, 2020 Year-Q2 Estimates.

Rising incomes, expanding smartphone usage and improved internet infrastructure are making EMs prime targets for US tech firms such as Google, Facebook and Amazon. If you compare Singles’ Day, a sales event initiated by Alibaba, with Black Friday and Cyber Monday, you can see how much potential the Chinese e-commerce market has for the company (Singles Day in 2019 generated USD 30 billion, more than double the sales achieved across both Black Friday and Cyber Monday). Chinese tech firms have come a long way, evolving from imitators to innovators, and are more than ready to expand. While US and Chinese firms are both keen to conquer EMs, their strategies for doing so differ markedly. US firms usually operate under the same brand and offer services very similar to those available in the US. Alibaba takes the opposite approach and invests in local companies, either buying them or taking a stake. In the past few years it has acquired a host of such companies in e-commerce, online payments and delivery, including Paytm in India, Tokopedia in Indonesia and Lazada in Singapore. Tencent has also invested in Indian start-ups in ride hailing, music streaming, e-commerce and other areas; it is estimated Tencent and Alibaba have backed more than 40% of all Asian unicorns. Among China’s competitive advantages are its strengths in payments processing and distribution. Along with banking and regulatory systems, these tend to vary greatly from one market to the next and can be highly idiosyncratic.

START versus FAANG

The FAANG stocks have outperformed START stocks year-to-date, despite gaining similar traction during the Covid-19 pandemic. Although some of this underperformance can be attributed to currency, we do not anticipate further devaluation for major economies in the foreseeable future. However, START stocks have been on a steady long-term uptrend, constantly outperforming EM growth and value in up as well as down markets, see Charts 4 and 5.

Chart 4: START versus EM growth

 

Chart 5: START versus EM value

 
Source: GAM. Bloomberg. START Universe is equal weighted for above calculations. Past performance is not an indicator of future performance and current or future trends. For illustrative purposes only.

Pre-tax earnings for the START stocks are expected to grow at a compound annual growth rate (CAGR) of 23% with substantial increase in margin (+700 bps) over period FY2020-23, according to Bloomberg consensus estimates. Free cash flow is also expected to grow strongly which will help them to further invest in value accretive businesses.

Table 1: START financial metrics

 
Source: GAM, Bloomberg Consensus estimates as on 11 September, 2020 (USD)

START versus FAANG growth comparison

Chart 6: Year-on-year adjusted net income growth (in %)

 

Chart 7: Annualised trailing price-to-earnings ratio

 
Source: Bloomberg. Aggregate US dollar adjusted net income has been considered for the above calculation.

START could command premium valuations similar to US technology stocks or even higher in the years to come. The gumption and growth potential of this universe is underappreciated, in our view, and under-priced in this unstable and volatile environment despite having structural growth appeal.

FAANG versus START: ESG

The average START ESG score (5.9) is above FAANG (5.1) and way above the average ESG score in the MSCI EM index (3.6), while the FAANG ESG score is below the average MSCI US index (5.3). START scores much stronger on social issues compared to FAANG (5.7 versus 4.4). The reason for this gap is only due to the difference in scores in labour / human capital management. Social issues is the highest weighted pillar, feeding into the ESG score (average weight across the 10 companies is 44%); this includes human capital management and data privacy and security. Unsurprisingly, START is rated below FAANG when it comes to governance, because of both poorer governance structures in place and business ethics concerns.

Chart 8: Start versus FAANG – MSCI ESG Scores

 

Chart 9: FANG + START: ESG Overall Score

  
Source: GAM, MSCI. For illustrative purposes only.

 

Chart 10: FAANG versus START – average RepRisk ratings

  
Source: RepRisk. For illustrative purposes only.

FAANG has a worse average RepRisk rating than START, both currently and historically. FAANG controversy ratings are way above their country sector average RepRisk rating. START’s controversy rating is below country sector average RepRisk rating but Samsung, Tencent and Alibaba still have high RepRisk controversy scores.

To conclude, not only is START a larger percentage of MSCI EM indices than FAANG is to the S&P 500, it is also a more liquid and consistent component of EM equity index growth. Furthermore, with year-on-year higher adjusted net income growth versus its DM equivalent FAANG, and superior ESG characteristics, we believe START offers a superior risk / return profile. Ultimately, START is a valuable component within the broader EM equity market, which we believe is at a key inflexion point in its history; namely as an enviable investment grade laggard asset class appealing to global value, growth and yield investors.

Important legal information
The information in this document is given for information purposes only and does not qualify as investment advice. The mentioned financial instruments are provided for illustrative purposes only and shall not be considered as a direct offering, investment recommendation or investment advice. The companies included are not necessarily held by any portfolio and do not represent any recommendations by the investment manager. Opinions and assessments contained in this document may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. Past performance is no indicator for the current or future development.