Corporate interest in frontier markets has been growing this year but as companies adapt to the changing nature of world markets their focus is shifting away from some of the perennial favorites.
The latest Frontier Market Sentiment Index, prepared exclusively for WSJ Frontiers by Frontier Strategy Group, presents a picture of a corporate world that is rapidly reassessing its plans for future investment in light of sharp changes in key economic and business drivers around the world.
Companies appear to be paying more attention to some countries, such as Venezuela and Argentina, that have faced considerable headwinds recently.
At the same time, former favorites such as Vietnam appear to be losing some of their luster.
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The index is based on information gathered from FSG’s roughly 200 multinational clients, which include companies such as Astra Zeneca,Johnson Controls JCI +0.35%,Danone DANOY +0.07% and Cisco CSCO +0.92%. It identifies which frontier-market countries major American and European companies are watching and measures the change in the attention they are paying to different countries. By pinpointing which countries multinationals are focusing on, the index provides insight into potential corporate investment plans.
Corporate sentiment is calculated as the percentage of companies that include a country on their watch-list. If 50 of the 200 companies are watching a particular country, the sentiment index score would be 25%.
Among the top 10 there have been some abrupt changes since the previous version ofthe index was released in January. Angola has jumped from fourteenth to fifth place, Algeria leapt into sixth place from 18th and Venezuela rocketed up from 10th to third. Vietnam tumbled from second to eighth and Nigeria, which had held the top spot since the index was launched in June 2014, has been nudged into second place by Argentina, which vaulted from fourth to first place.
Oil seems to be playing a significant part in the changes in corporate sentiment—as it has in equity market performance across the frontier markets. With global oil prices having settled at around half the level they hit in mid 2014, the frontier countries whose economies rely heavily on oil exports have seen their stock markets slump over the past eight months.
The FM Sentiment Index suggests companies are also concerned about the prospects for many of the oil-exporting frontier markets. Iraq, Saudi Arabia and Kazakhstan all saw notable declines in sentiment.
Surprisingly, though, some oil exporters made a strong showing among the 10 countries that saw the sharpest increase in attention from companies considering foreign investment. Venezuela, Ecuador, Algeria and Angola round out the top five after the highest gainer, Argentina.
Joel Whitaker, FSG’s global head of research, says conversations with FSG’s clients reveal a range of reasons for the intensity of focus on what he calls “worrisome” markets. “In the economies facing liquidity or balance of payments crises as a result of lower oil prices this may be an indicator of companies’ wishful thinking for near-term resilience or of building a business case for exit,” he says. In many cases, though, the companies involved are in industries that are less driven by oil, such as healthcare and technology, that tend to be only very indirectly driven by economic cycles, Whitaker adds.
Those companies may be looking for ways to leverage the investments they have already made in struggling frontier economies, taking advantage of lower currencies or a more welcoming investment environment to build market share in anticipation of an eventual recovery. “They have an existing footprint, they have the relationships, the established facilities and a pretty good sense of the competitive environment,” says Whitaker.
It’s not, however, a vote in favor of the macro economy, Whitaker cautions. “It’s smart companies finding smart ways to do business in those markets.”
Argentina, which saw the sharpest increase in corporate sentiment, is getting a great deal of attention from portfolio and corporate investors alike. Chad Cleaver, lead manager of Chicago-based Driehaus Capital Management’s frontier- and emerging-markets fund explains the focus on Argentina: “With the coming presidential election, there is a real prospect of reform, political change, a more-moderate government,” he says. “We don’t expect a significant acceleration of growth right away but we do see a normalization of the risk premium. We’re interested in banks and property companies that would benefit from the normalization of the cost of equity.”
Cleaver is also intensifying his focus on South Asia, a region that is experiencing a convincing increase in corporate sentiment. Sri Lanka, which was among the worst performers in January’s index as uncertainty over its presidential election peaked, is seeing interest recover. Bangladesh is also beginning to stabilize after a bout of politically driven upheaval, while Pakistan is gaining more attention as investorsand companies alike begin to recognize its market’s potential.
Southeast Asia is on the opposite tack. Myanmar, Cambodia and Laos all saw less interest from corporations. Vietnam, long a favorite among frontier investors, suffered the second-worst decline of any of the markets in the index.
FSG’s Whitaker believes Vietnam’s waning appeal is probably due to skepticism that the Trans-Pacific Partnership will ever become a reality. Companies are also tiring of a “repeating cycle of over-enthusiasm and disappointment” in Vietnam, Whitaker comments.
Jai Thampi, head of consumer electronics producer Belkin International’s international networking business, has reduced his focus on Vietnam over the past nine months. “Competition from Chinese products has compressed margins there and many smaller retailers have been forced out of business,” he says. “Overall, the sentiment toward the market is down. We’re setting our expectations very low there at the moment.”
Kazakhstan, a country whose economy is heavily dependent on oil exports, suffered the biggest decline in sentiment. Emre Tuncalp, managing partner of Washington-based risk consultant Sidar Global, says his clients have cooled noticeably toward Kazakhstan and adds that a key factor is the Central Asian nation’s dependence on Russia.
Zoran Milojevic, a director at frontier- and emerging-markets brokerage Auerbach Grayson, says last year’s 20% devaluation of Kazakhstan’s currency, the tenge, “caused the economy to come to a standstill from a GDP growth of 4% plus in 2014 to an expected 1% in 2015.” He adds that the “economy has been hit hard as cheap Russian, Ukrainian, Belarussian and Georgian products are hitting shelves and are being priced 50% cheaper then locally produced Kazakh products.”
Other worries persist for Kazakhstan, too. FSG has slashed its GDP growth forecast and projects at least three years of slow growth. “The banking sector is fragile [and the country] is facing a serious drain on reserves as it spends them to keep the tenge afloat, the group’s analysts note.
Nigeria also suffered a decline in sentiment, almost certainly prompted by uncertainty around the presidential election, which took place in late March. The decline was enough to knock Africa’s biggest economy out of the top spot it has held since the FM Sentiment Index launched in June 2014.
Kwame Dougan, head of a U.S.-based fund that invests in technology firms in West Africa, says perceptions about Nigeria have been affected by factors such as electoral uncertainty and Boko Haram. The real concerns for investors, though, are currency fluctuation and electricity shortages, he believes. “That’s what increases the cost of doing business,” he says.
Belikn’s Thampi believes the long-term prospects for Nigeria remain good. “We believe the ups and downs there are short-term noise,” he says. “It’s still on our priority list and I’m talking about making some investments there in the next year or so.”
Jim Perry, a senior vice president at spirits and wine-maker Brown-Forman BFA +1.29%, says the peaceful handover of power in Nigeria has done a great deal to ease investors’ concerns about the country: “People were surprised and impressed by how smooth the election was. [It] bodes really well for the economy,” he says.
Nigeria is already a large market for Jack Daniels, Brown-Forman’s biggest-selling brand, but Perry anticipates it will continue expanding. “We are continuing to grow our investment,” he notes.