Insights category - Markets economy
Markets & economy

Frontier markets: Innovative industry leaders drive returns

There are many variables to consider when investing in frontier markets, and investors need to weigh up the risks very carefully as they pursue long-term rewards. Varshan Maharaj explains why market leaders in these economies often provide more compelling investment cases, particularly when times are tough.

There have been some notable moves in frontier currencies relative to the US dollar over the past 12 months, including significant weakening of the Egyptian pound and the Nigerian naira. This follows a material decline of the Sri Lankan rupee in 2022. Companies that produce fast-moving consumer goods (FMCG) and other consumer-facing companies have to employ various strategies to combat these currency movements.

Market leaders are able to weather adverse trading conditions

Many of the companies that we hold, such as Lion Brewery in Sri Lanka and Edita Food Industries in Egypt, have leading market share and own dominant brands. This has allowed them to pass on the majority of cost increases to consumers, as evidenced by their resilient operating margins.

These companies have also grown their export revenues over the years, such that US dollars received from export sales cover a significant portion of US dollar requirements to purchase raw materials. Owning a wide portfolio of brands and producing a large range of pack sizes have been effective tools in winning market share as consumers trade down during tough economic times. Companies such as Century Pacific Food in the Philippines consistently invest in product development, allowing them to add new product offerings on an ongoing basis and grow their revenues throughout the economic cycle.

As frontier markets are still in the early stages of their economic development, there is often a long tail of smaller competitors who have higher manufacturing costs, less developed distribution systems and weaker balance sheets. Larger players tend to win market share from them when the economic climate is tough. Many of the companies we own on behalf of our clients, such as Square Pharmaceuticals and Olympic Industries in Bangladesh, also have very capable and experienced management teams who own large stakes of the businesses and whose interests are aligned with those of shareholders.  

The price you pay always matters

We are also finding some interesting ideas in Vietnam, where we are investing in a few companies with good competitive positions, that are well managed and where recent earnings declines were driven by cyclical rather than structural factors. Most importantly, these companies are trading considerably below our estimate of their intrinsic value.

Overall, there continues to be a large disparity in valuation multiples between companies in the frontier universe and comparable companies in developed markets, presenting attractive investment opportunities for patient long-term investors.

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