Global Emerging Markets Sustainability

Centre Testing International provides inspection and certification services for industrial and consumer products across China, ensuring product quality and safety standards. The franchise benefits from being one of the first movers in the country, and continues to take share in a fragmented market as scrutiny rises on health, environmental and product standards. The balance between long-term family stewards and a professional manager who spent decades at one of the world’s leading inspection and certification services firms helped us build conviction in the quality of people here as well.

We also initiated a position in Midea, China’s dominant domestic home appliances manufacturer. Midea is taking the cash flows from this business, and reinvesting behind expanding into attractive growth areas like digital building automation, integrated energy management and industrial robots.

The third new position was a re-initiation in Samsung Electronics (South Korea: Information Technology). We have long admired the strength of the Samsung Electronics franchise, along with the ability they have shown to evolve. We believe current valuations do not reflect a recovery in the memory market, or the investments that Samsung Electronics continues to make behind long-term growth. The business continues to have an impressive ability to generate cash, and a solid balance sheet.

Finally we initiated a new position RBL Bank (India: Financials), a private bank in the midst of a turnaround. The bank lost its way through aggressive growth leading to high non-performing loans (NPLs). As a measure of abundant caution India’s central bank stepped in to change management and solidify the foundations of the bank. We believe new management is putting in place the right systems to build a quality credit culture with a focus on lower risk assets funded mostly by deposits. A successful turnaround could yield attractive returns for shareholders.

Regional (Mexico: Financials) was the first of the new positions we initiated. The founding owner-managers, the Rivero Santos family, continue to act as stewards here, and have a history of delivering steady, conservative growth. Regional is focused on lending to Mexican small and medium-sized enterprises (SMEs), maintaining long relationships and steadily deepening access to credit across the country. The combination of conservative stewards, history of profitable lending, and runway for growth led us to initiate a position in the bank at reasonable valuations.

Secondly, we initiated a position in AirTAC International (Taiwan: Industrial), the second largest pneumatic equipment provider in China. AirTAC has consistently strengthened its competitive positioning in the country, gaining market share in a consolidating industry. Barriers to entry in this business are high, with clients looking for customised solutions delivered in short spans of time. The founder and long-term managers remain stewards of the business, continuing to reinvest in the growth of the franchise and preserve the strength of the balance sheet in a cyclical industry.

Milkyway Chemical Supply Chain Service (China: Industrials) was the final company we initiated a position in this quarter. Milkyway is a third-party logistics provider focused on the safe and reliable transport of chemicals across the country. Founder Yin He Chen continues to grow the business with a focus on quality of customer relationships over price-led volume growth, which has led to enduring, sticky relationships with key customers. This is a business where cost of failure is high in dealing with hazardous chemicals, and reputation matters, so Chen’s focus on quality has led to Milkyway gaining market share in a fragmented industry.

Globant (Argentina: Information Technology) is an IT services company that primarily serves US corporates in their digital transformation projects. Globant’s co-founders remain at the helm of the company, and the franchise continues to focus on strengthening their deep relationships with existing clients. We have met Globant a few times since 2016 and, recently, valuations have come down to very reasonable levels with concerns around potential spending slowdowns if there is a recession in the US. While we have no predictions of the macroeconomic environment, these IT service businesses have proven resilient through past cycles. When the short-term concerns of markets gives us opportunities to accumulate shares in great companies at reasonable prices, we will certainly do so.

We also continued to add to some high-quality companies where valuations have become more reasonable in the face of some of these nearer term concerns, including EPAM Systems (US: Information Technology) and Aavas Financiers (India: Financials). Similar to Globant, IT services provider EPAM remains a resilient business with long-term client relationships that they continue to invest behind. Equally, Aavas Financiers, a rural Indian mortgage provider has spent the last decade setting up the foundations for their growth and, with low leverage on the balance sheet, has a great runway to continue expanding over the years ahead.

During the course of this quarter, the investment team also travelled to Mumbai and Bangalore to meet with the management teams of some of our largest Indian holdings and spend time finding new ideas. Trips such as these continue to help us reiterate the quality of the businesses we own on behalf of clients and the people managing them, as well as helping us to build conviction in smaller positions. Our conviction in our holdings in India continues to remain high in the context of the growth opportunities these companies have available to them in the decade ahead.

As ever, we continue to focus on bottom-up analysis of the fundamental quality of stewards, franchises, and financials and the sustainable growth tailwinds these businesses might enjoy. We believe this remains the best way to continue protecting and growing clients’ capital in emerging markets.

We sold out of a small holding in robotics company Estun Automation (China: Industrials). Nothing significant has changed in our view of the quality of the company. However, we felt that after some share-price strength, which has taken valuations towards extremes, the opportunities for attractive returns have diminished significantly and there are now more attractive alternatives available.

We also exited MediaTek (Taiwan: Information Technology), a Taiwanese chip designer with earnings primarily driven by smartphone demand in China. As consumer sentiment has returned with the re-opening of that country, the share price has performed well. We feel there are likely companies with better earnings-growth profiles within the semiconductor sector that we would rather own for the long term.

In particular, during the quarter we have initiated a position in German semiconductor supplier Infineon Technologies (Germany: Information Technology). Long held in our Worldwide strategy, the majority of the company’s sales are to emerging markets in Asia. Infineon specialises in chips that control power supply, with 2.5x the market share of the #2 competitor¹. This gives the company great exposure to rapidly growing end markets, like renewable energy, smart grids and electric vehicles.

In making the switch from MediaTek to Infineon, we feel we have exchanged a company primarily exposed to more saturated consumer technology to one primarily exposed to more quickly growing industrial end markets. Given extremely similar valuations, and that it seems more likely that Infineon can deliver sustained earnings growth over the long term, this felt like an upgrade in likely future returns.

In the case of Natura (Brazil: Consumer Staples), we felt that the investment case had changed considerably from our initial thesis. During the last short while, a difficult economic environment has exposed some weaknesses in the franchise, the balance sheet has deteriorated, and the company has changed senior leadership. Exiting a position and realising a significant loss is never a pleasant experience, but it is usually best to avoid sunk-cost fallacy and anchoring biases, and to focus on quality. After much discussion, we decided the company faces a tough road ahead and that we have better ideas at attractive prices today.