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We have recently returned from a research trip to India, a visit we had been very excited about as we had missed in-person interactions with our holdings and interesting businesses that we have been following for a while. While our regular calls and meetings in London have allowed us to stay in close contact, a personal meeting with CEOs and managers on site cannot be substituted.

India in the Portfolio

India has been an important allocation for the Mobius Emerging Markets Fund since its inception. MEMF’s Indian holdings have contributed 40% to (gross) return as of the end of March 2023. This was almost entirely driven by stock selection. Our visit has confirmed our bullish outlook on the region, and the exciting companies diligent stock pickers can find in India.

Some Important Facts about India

India, a country of 1.4 billion people, and soon expected to be the most populous country in the world, offers a plethora of opportunities for us as long-term, quality-oriented investors. Companies have evolved, are increasingly more professionally managed, and are focused on corporate governance and sustainability efforts, which has helped in attracting domestic and foreign capital flows. Innovation is omnipresent, and India has created 100 unicorns in the last five years. Unrelenting deal activity in PE and VC also means new and innovative businesses available to invest in as public market investors. There are over 6,000 listed companies in the small- and mid-cap space.

Growing Middle Class

In India, we observe income inequality and a changing social fabric, as in most other emerging markets, but are convinced that rapid income acceleration, technological adoption and corporate spending—aided by favourable economic and fiscal policies—will keep India on a steady growth path. GDP per capita has quintupled over the last 20 years. By 2030, the Indian economy will be led by the middle class, and upward income mobility will continue to drive consumption.

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The Growth Premium

In its latest World Economic Outlook, the IMF forecast India to grow 5.9% in 2023 and 6.3% in 2024, more than any other major economy. This compares to 1.3% and 1.4% projected growth for advanced economies. The Indian economy clearly has recovered from the pandemic-related slowdown and is now on an impressive, sustained growth trajectory for the next decade. Growth will primarily come from the increase in private consumption (and we have witnessed this on the ground with busy markets and fully occupied restaurants and shopping malls) and will be fuelled by a broad-based expansion of capital expenditure by the private and public sectors.

Supportive Government Policies

We view the recent economic policies—including increased spending on infrastructure, incentives to boost certain niche manufacturing segments, focus on improving ease of doing business and fiscal measures undertaken to keep inflation in check—largely positively. Shortly before our visit, India’s government announced a raise in capital expenditure of 33% to 10 trillion rupees ($122.29 billion) in the next fiscal year to drive investments in infrastructure. We witnessed first-hand rampant construction activity across the cities we visited. The scale of expansion of the Metro (public rail transport) is mind-boggling and is being talked about by everyone we met. Further, construction of new expressways, bridges and airports continues to support the public infrastructure and we see this as a good indicator of the economic growth the country is witnessing.

Digitalising the Financial System

Another key driver of economic growth is a healthy credit cycle with multiple banks competing and lending activity again on the agenda. Our interactions with small and large banks also point to the good health of corporate credit in India which is the cornerstone of future expansion. India’s financial system has made significant progress in efficiency with technology and innovation becoming mainstream. The digital payment system UPI is basically used by every Indian and has almost replaced cash entirely (UPI enabled approximately 2,300 transactions a second in 2022). Ever-increasing smartphone penetration, combined with the government’s efforts to reduce cash transactions, has brought the majority of the population into the digital payment ecosystem. As a result, about 80% of Indians own a bank account today, a significant change from only five years ago.

China plus 1

During our visit, the world was surprised to learn about one of the largest airplane deals in recent history with Air India (the erstwhile national carrier, now owned by the Tata Group, among India’s largest conglomerates) ordering over 400 planes from Airbus and Boeing. Our visit also coincided with several global investor summits and G20 meetings and we constantly heard of the large-scale investments across diverse sectors such as manufacturing and renewable energy. India’s recovery and robust position is clearly no secret, and a term we heard everywhere was ‘China plus 1’.  Although we don’t invest directly in airlines, infrastructure or asset-heavy manufacturing companies, we have found small businesses that fit our quality criteria and are poised to benefit from these sectoral tailwinds. As part of our research, we met over 20 companies during our trip in addition to economists, local fund managers, entrepreneurs and private investors.

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Our Portfolio Holdings

The most satisfying finding from our trip was that our holdings are doing even better than we had expected. APL Apollo Tubes, one of our key holdings for over three years, had just reported its highest ever quarterly volume of 600k tons of steel tubes. The passion and the vision of the founder MD, his attention to detail and strong intent to professionalise the organisation with the right talent, continues to impress us. We are firm believers in investing in companies with good culture and this meeting with the MD reaffirmed APL’s focus on their culture—employees are considered family. During the visit to the warehouse of a distributor to APL for 10+ years we clearly saw the brand appeal and scale of distribution of APL Apollo superseding that of their peers. At a visit to one of their plants, we witnessed the highly efficient manufacturing process with >90% of energy needs met through renewable energy.

A key holding—and one of the top performers for us since inception—is Persistent Systems, a global digital engineering company that differentiates itself from the other IT companies in India by catering to a niche customer segment. Despite the macro headwinds, Persistent continues to be among the fastest growing companies and has kept up its trajectory of new deal wins. All our interactions with competitors and other investors highlighted the quality of management, the recent success in reorganisation and its ability to continue to grow in a difficult market. We remain firm believers in their long-term success and have successfully engaged with the company on various initiatives over the years.

A New Investment

We continue to find similar promoter-run businesses in India led by professional management teams and with a clear succession plan in place. One such new addition to our portfolio is CE Infosystems (MapMyIndia), a small yet exciting business that is a domestic leader in providing geospatial technology and automotive navigation solutions in India (please also see Company Spotlight above). Our interactions with the founding family—including the CEO and the heads of different businesses who have been with the company for over 10 years—highlighted the importance of culture in the organisation. Promoters have gradually transferred ownership in the form of ESOPs to key employees, even before ESOPs became common among tech companies in India. Coincidentally, CE Infosystems was celebrating its 25th anniversary on the day of our visit and were preparing for an organisation-wide cricket tournament. After our visit to their experience centre and the interactions with the team, we walked away with the feeling that they can innovate continually and combat disruption, while maintaining their sticky customer base.

Conclusion

India will remain an exciting country for us, and we will watch closely as the country is headed into elections in May 2024 during which the incumbent government needs to successfully navigate current economic headwinds for a third victory. During our trip we identified new potential investments in niche segments within financials, manufacturing and technology sectors which would benefit from the longer-term opportunities the country offers across consumer and corporate spending.

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Emerging market investors have witnessed troubled waters over the past few years: a global pandemic that had a negative impact on trade, consumption, and supply chains; increased geopolitical tensions between the US and China; a war in Europe with wide ramifications for global trade and fiscal policies resulting in rising inflation, tighter monetary policy, and appreciation of the US dollar. Furthermore, volatile commodity prices that benefitted a few countries but hurt many, and very difficult capital market conditions made it particularly difficult for emerging markets. In summary, all of this has led to very low confidence, record capital outflows, and a sell-off of the asset class. Over the last 10 years, emerging markets have delivered close to negative real returns on an annualised basis. After this prolonged period of weak performance, we now see several indicators suggesting that the tide is turning.

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Valuations at a Record Low

Investors should never lose sight of valuations. At the moment, we are witnessing record-low valuation levels in EM — the current average price-to-book value at nearly 1.5x is in the 30-year bottom quartile. The current P/E and EV/EBITDA market valuation indicates that emerging markets are trading at the largest discount to developed markets since 2008. At the same time, many emerging market currencies are currently undervalued.

Inflation and Monetary Easing

Inflation pressure in the US is moderating. Inflation declined to 6.5% in December compared with a year earlier, down from 7.1% in November. The slowing pace in inflation is a clear indicator that the Fed’s rate-hiking cycle is nearing its peak and monetary policy is expected to ease. Many emerging markets are ahead of developed markets in the hiking cycle and inflationary pressure, especially in Asia, remains contained. Developed markets saw an inflation increase from around 1% to around 7% on average, while inflation in Asia averages around 4%.

Highly Innovative Businesses in EM

Over the past 20 years, business models in emerging markets have significantly evolved. Investors can find highly innovative companies with unique business models led by excellent management teams that are still relatively undiscovered by the market, and currently most certainly under-owned. The new driver in emerging markets is technological innovation in areas including, but not limited to, factory automation, autonomous driving, renewable energy, AI or Internet of things (IoT), as well as digitalisation and modern and efficient service offerings. We are particularly interested in companies with predictable and stable recurring revenue streams and stable margins, for example in the software development industry.

Ever-growing Consumption and Faster Real Wage Accretion

a Favourable demographic dynamics and urbanisation in emerging markets remain structural tailwinds for the long term. The middle class in emerging economies is younger, increasingly more educated, and has demonstrated accelerated adoption of oechnology. The macroeconomic growth, combined with technological innovation, has yielded higher wage growth and disposable income in these countries. This in turn will result in higher spending and boost domestic consumption. For example, Taiwan and South Korea are expected to jump ahead of Japan in terms of GDP per capita in 2022–23.

Corporate Earnings Recovery

The corporate earnings recovery will be driven by the reopening in Asia. The average EPS growth forecast over three years annualised (CAGR) for the MSCI EM Index is 13% and for MEMF’s portfolio 15%.

US Dollar Rally Losing Steam

The US dollar rally is losing steam on the back of favourable inflation data, easing the pressure on emerging market currencies, debt, and monetary policy.

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Relaxation of Chinese Zero-Covid Policy

Chinese economic activity — that is, consumption, trade, and mobility of its population — has been radically weakened during “zero-Covid”. Now, for the first time in years, there are clear signs that China is relaxing its zero-Covid policy which will have a very positive impact on growth and supply chains. We must be mindful and prepare for a stony path to the recovery. Exports this year could be negatively impacted by weak demand from the EU and the US, booster rates among the elderly in China remain very low and the desire to reach herd immunity can take time. However, a post-pandemic recovery in China will not only serve as a domestic impulse, but positively affect all countries which trade with China, particularly in Asia.

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Conclusion

We have heard many differing opinions about what investors can expect from the coming year. We share the view of Neil Armstrong that, “We predict too much for the next year and yet far too little for the next ten.” And one longer-term prediction continues to hold true: a recovery is still to come. A recovery not from one bad year, but a recovery from a pandemic of an unprecedented scale,- at least in living memory. As always, markets will price this in first. We have already seen a gradual reversal of fund flows back into emerging markets.

At Mobius Capital Partners, we continue to focus on the long-term potential of our companies which are catering to growing trends like digitalisation, quality health care, factory automation, and renewable energy and on creating long-term, sustainable shareholder value for our investors.

The Week That Was in Turkey – Weathering the Perfect Storm
Carlos Hardenberg, Founding Partner & Portfolio Manager, MCP
01 November 2022

Istanbul, a city which never fails to impress with its rich history, culture and hospitality, didn’t fail to impress us this time either with its resilience in navigating challenging times. We visited Istanbul in October, and the city was still buzzing with tourists – bustling hotels, long queues for the tourist attractions and ringing cash registers at high-street retailers. Foreign currency is flowing into the country, at the markets and retailers, but what is most evident is the foreign currency investment in real estate. Istanbul, a city with 15.5 million people, appears to be bursting at its seams.

There is always more than meets the eye and the week we spent in Turkey brought us closer to reality – an economic crisis is looming in Turkey – extreme currency depreciation, high inflation and an unorthodox economic policy by the incumbent leadership that continues to cut interest rates. These aspects, combined with the political uncertainty as the country heads into elections next year, has made planning and forecasting difficult for most companies and economists we interacted with. But there are hidden gems for investors to discover.

The outcome of the 2023 elections is probably the most interesting and most discussed topic in Turkey. We met several companies across sectors including retail, technology, healthcare, energy, manufacturing, industrials and banking. We also met with politicians, pollsters, economists, and policymakers on our trip to gain insights into the trends and indicators regarding the polls, but there is still uncertainty and we walked away with a contrasting conclusion at the end of every meeting.

We wanted to assess the following:

• Macroeconomics and monetary policy in Turkey
• Health of banks and large and small corporates
• Consumer confidence
• Adaptability and outlook of our portfolio companies

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The Macro:

• Depreciating currency: The Turkish lira has depreciated over 50% against the US dollar in the last year and is now at an all-time low. Concerns over inflation, the Russia-Ukraine war and economic instability are exacerbated by skyrocketing inflation and expansionary monetary policy. Managing FX risks has been one of the biggest worries for companies this year. It was interesting to see that even small businesses such as market vendors and taxi drivers preferred being paid in US dollars or euros over lira.

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• High inflation: Recent headline inflation stands at 83%. This is the highest reported inflation rate since 1998. The real inflation across food and transport appears to be higher still, thus hurting consumers even more. This has led to an 80-100% wage increase across the board which in turn might create a wage-price spiral. Companies are resorting to wage increases to attract and retain talent as more and more employees are choosing to move to other parts of the world for careers in stable economies that pay in hard currency.
• Energy crisis: The increased oil and gas prices affecting most net importers are also hurting Turkey. The country’s energy import bill has doubled in the last year and is adding to the widening fiscal deficit. The government has increased energy imports from Russia at discounted rates and delayed payments to contain energy bills.

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• Expansionary monetary policy: The Central Bank of Turkey believes that high borrowing costs lead to high inflation and has continued to cut lending rates. The interest rates are currently at 10.5% (vs. 14% at the start of the year) and the central bank has signaled further cuts to single-digit levels until inflation reaches 5%.

Winners: Exporters are benefitting from the weak currency and the low borrowing rates which provide them with a competitive edge over their Eastern European and Asian peers.  

Losers: Banks are negatively impacted as they are unable to reduce their borrowing costs due to the requirement of buying fixed-rate government bonds. Importers, including retailers and FMCG companies with limited pricing power are hit by the depreciating currency.

We expect loosening monetary measures to continue in 2023 as Turkey heads into the elections. Lower interest rates will benefit small enterprises, which form a large proportion of the voter base. But this appears to be largely priced-in given the currency depreciation and near all-time low stock market valuations.  

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The Businesses:

• Banks: Despite the currency crisis and cutting interest rate regime, banks are in good health. They are adequately capitalised and NPL ratios are within reasonable levels. There is a desire to cap their lending activity. Banks are required to buy long-duration fixed-rate government bonds, thereby increasing their borrowing costs. FX-indexed deposit schemes that assure customers of a return equivalent to a fixed rate plus the rate of TRY depreciation are being offered to attract Turkish lira savings into the system.

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• Large corporates: We met the two largest corporates in Turkey – Sabanci and KOC Holdings – to understand their outlook and measures taken to adapt their businesses to the rapidly changing economic environment. Increasing exposure to export business, improving technological and manufacturing efficiency through foreign collaborations, and rising investments in renewable energy are just some of the key strategic priorities for large corporates. It is heartening to see the excellent presentation and reporting of Turkish companies and the growing adoption of sustainable practices and reporting
• Small and medium-sized enterprises: These form the backbone of emerging economies. In Turkey, such enterprises are generally still in good health despite the mounting challenges they face. Their balance sheets remain robust with buoyant tourism and growing exports continuing to drive demand for their products and services.

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Consumer Confidence:

It is interesting to see how consumer behavior has been adapting to sky-high inflation and macroeconomic uncertainty. We met with some of the largest retailers in Turkey who alluded to visible signs of customers downtrading (if the price of a loaf of bread increases every two weeks, who wouldn’t?) and parallel trading from corner shops to organised retailers. The recent efforts in increasing e-taxation have created a level playing field and organised retailers are able to offer products at competitive prices. But consumer discretionary spending is being affected as locals are buying less cars and houses. Although interest rates are being cut, there is a cap on LTVs that makes borrowing difficult.

Medical tourism in Turkey has become a major source of foreign currency revenue. The advanced medical technology and quality talent available at lower rates are attracting medical tourists, especially from Eastern Europe and the Middle East, for medical and cosmetic procedures. We visited a 27k sqm hospital run by a leading Turkish hospital chain specialising in stem cell treatments for medical tourists. This 160-bed tertiary care hospital looked nothing like a regular hospital. Designed by a leading Turkish architect, the interior of the hospital resembled a human cell! It also had some of the most sophisticated MRI machines and a list of accreditations from renowned medical institutions across the globe.  

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Our Portfolio:

We met with both our Turkish portfolio companies – Mavi, a leading jeans/apparel brand and Logo, an ERP solutions provider – and continue to believe in their growth.

MAVI – Mavi is a popular denim and jeans brand in Turkey founded in 1991 (we noticed people wearing their jeans and sweatshirts in the busiest neighborhoods in Istanbul). We met with the CEO, Cuneyt Yavuz and Duygu Inceoz – senior director of IR, at their offices. The headquarters are situated above a store and exude a casual atmosphere, with all employees, including the CEO and IR, wearing jeans.

Our discussions focused on rising costs and the brand’s appeal and defensibility in such circumstances. Mavi has a dominant market share in Turkey and its competitive positioning has strengthened over time. It has continued its exceptional growth even in the last year. Foreign competitors such as Zara, H&M are forced to stock limited SKUs due to currency uncertainty and given their EUR pricing strategy, they are becoming increasingly expensive for local customers. Mavi also has an edge over its local competitors due to its scale which has enabled the company to secure capacity with its suppliers at discounted rates and to manage supply chain disruptions. A lean balance sheet further helps the management to navigate the crisis.

Mavi has seen a 30-40% increase in customer traffic over the last year and continues to see real (volume) growth. Mavi leveraged its scale and low cost of production to launch adjacent brands in the US targeting new customer segments. As part of this strategy, they recently acquired a premium US brand that expands the offering beyond jeans. Mavi has very low exposure to Russia and intends to exit the market completely.

Mavi expects to grow at >100% in 2022 on the back of a very strong 2021. The core risk lies around managing operating costs and margins. The current environment is a true test of the brand’s pricing power. However, it was encouraging to see Mavi’s digital investments across marketing, pricing, and supply chain management systems. They have built an in-house system that tracks the prices of all competitors and guides their own pricing decisions. We remain confident of Mavi’s ability to weather the storm. With a strong brand, a competitive edge and strategic acquisitions, we believe, the company will continue to drive shareholder value.

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LOGO – Logo is an ERP solutions provider for mid- and small-sized enterprises across Turkey. It is a key beneficiary of the growing digitalisation and formalisation of the economy. We met with the CFO and IR in one of their sales offices with beautiful views of Istanbul. It was a Friday and we truly experienced the new flexi-working style of technology companies with a significant number of employees working remotely.

Logo is a leader in digital transformation offerings with solutions like e-ledgers, e-dispatch, e-invoice, largely web-based and transitioning to cloud offerings. It has over 120k customers across Turkey and Romania. Its products and services compete with those of SAP by offering similar features at ~50% lower prices. Recently, the Turkish government has been focusing on formalising the economy and is mandating smaller businesses to generate e-invoices. Logo continues to benefit from this and has built a strong recurring revenue base across thousands of customers. Logo continues to innovate (spending ~20% of revenues on R&D) and to release new products and to win new customers.

Logo employs over 1,300 employees and has won the ‘Best Place to Work’ accolade numerous times over the years. It is a pay leader in Turkey and has been able to attract quality talent. Macro and currency depreciation are resulting in some loss of talent to Europe, which does worry Logo’s senior management. We also see the ability to attract and retain talent as one of the key risks for Logo, but given the strong employee culture and incentives, we are confident of them navigating this well.

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