09/09/96 IN EMERGING MARKETS, IT PAYS TO BE PICKY (int'l edition)

IN EMERGING MARKETS, IT PAYS TO BE PICKY (int'l edition)
Value investors have to work hard to find the real bargains
Don Reed waxes nostalgic when he talks about the Sixties. But it's not Flower Power or the Summer of Love that brings a wistful tone to his voice. It's reminiscing about how Sir John Templeton, a trailblazer of global investing when most U.S. money managers stuck to America's ``Nifty Fifty'' blue-chip stocks, forayed abroad and discovered Japan. Although its economy was growing an average 10% a year, the overall price-earnings multiple on the Tokyo stock market hovered at an amazingly low three. ``There's nothing like that today,'' sighs Reed, who as president of Templeton Investment Counsel Inc. also manages more than $4 billion worldwide.
Value investors these days must work hard to find true bargains in emerging markets. The universe of stocks in the fast-changing economies of Latin America, Asia, and Central Europe is regularly picked over by even conservative investors who want to diversify their portfolios. For example, says director James Diack of Stamford-based InterSec Research Corp., U.S. pension funds at the end of 1995 allocated 13% of their international equity holdings to markets such as Mexico, compared with 3.4% only five years ago. As more institutions take positions in emerging-market stocks, it's tougher to be a pioneer.
So without a Japan of the Nineties, how do global investors find the sleeper stocks in developing economies? Instead of relying on the simplest ratio analysis--measuring a company's share price against its current or potential earnings--experts seek out special situations or deconstruct assets. ``Emerging markets are still a great long-term story,'' says Jan van Eck, executive vice-president of investment management firm Van Eck Global. ``But there are fewer pockets of tremendous undervaluation. You have to be a more careful investor.''
The great long-term story, of course, is the classic argument for buying into emerging markets. This time-honored thesis holds that developing economies will continue to grow at least twice as fast as those of the U.S. and other mature markets and that their expansion will translate into corporate profits and stock prices that also deliver more punch. The trend is hardly new. According to Boston-based Pioneering Management Corp. statistics, over the 50 years through 1995, emerging-market equities showed average annual returns of 16.5%, compared with 12.4% for the Standard & Poor's 500-stock index and 11.8% for the EAFE index.
That growth argument still rings true. Over the next 18 months, predicts Mark H. Madden, who manages Pioneer's $78 million Emerging Markets Fund and its $30 million India Fund, GNP will expand around 3% in the U.S., 2% to 2.5% in Europe, and 3% or 3.5% in Japan vs. 6% to 10% in most emerging nations. In some, such as Korea, a growing middle class is boosting the fortunes of consumer goods makers and the banks that roll out charge cards. In others, privatization of state-owned service providers, from phone companies to electric utilities, promises improved efficiency and profits.
BREAKING RECORDS. Such scenarios look all the more compelling stacked up against a U.S. economy that is widely expected to slow by early next year--and a Dow Jones industrial average that keeps breaking records anyway. ``Most people admit the U.S. market is stretched,'' says Madden. ``And earnings are probably slowing at this point into the [business] cycle.''
But some emerging equity markets are stretched, too. Speculators drove Russian stocks up by more than 150% in the first half of 1996, correctly betting that Boris Yeltsin would win the presidential election--despite an economy that is still struggling to pull out of a crippling recession. And although the Mexican bolsa has rebounded more than 20% this year, thanks to continuing optimism that seemed justified by 7.2% GNP growth in the second quarter, Mexico still has a long way to go before economic recovery takes firm root.
That's why value investors are being super-picky in emerging markets. Take Amit Wadhwaney, who will manage Carl Marks & Co.'s new Global Value Fund, a private limited partnership dedicated to bargain-hunting. Right now, Wadhwaney is poring over Indian financial companies, which got hammered by a credit crunch last year. He expects a ``huge runup for those that really have a purpose in life.''
His pick: Shipping Credit Investment Corp. of India, whose clean balance sheet attracts Wadhwaney as much as its price. Traditionally a lender to midcap Indian industrial companies, SCICI is moving into infrastructure finance. Wadhwaney notes that its ratio of nonperforming loans to assets is only 2%, compared with 18% for the average Indian bank. And at 91 cents, he calls the stock ``wildly cheap,'' as book value is $1.20. SCICI also pays a dividend of 28 cents per share.
GATT GAINS. Wadhwaney's search for hidden value includes competitive companies that are active in rapidly changing markets. In New Zealand, for instance, he is bullish on two farming stocks that he believes are plays on wrenching changes in global trade regulations. ``Agricultural companies in New Zealand will be incredible beneficiaries of GATT,'' says Wadhwaney. He explains that as farm subsidies and quotas are abolished in other countries, especially in Europe, New Zealand farmers will gain a significant edge because they have been operating without such safety nets since the mid-1980s.
One is Tasman Agriculture Ltd., the biggest dairy farmer in Australia and New Zealand. Wadhwaney says that at 83 cents, Tasman is trading at a 20%-25% discount to its asset-liquidation value. He also likes Wrightson Ltd., a farm-service company that provides farmers with everything from seeds to insurance to product distribution. The stock pays a dividend and at 77 cents is trading at only eight times earnings per share.
Madden agrees that markets where reforms are taking hold can offer exciting opportunities. For example, although Brazil's political leadership so far has a stop-go record on privatization, pension reform, and other needed changes, Madden favors several Brazilian companies poised to reap rewards when the government ``gets it right,'' as he says. His picks include Acesita and Usiminas, both high-quality, well-integrated steelmakers whose American depository receipts are trading at just under $5 and $10.49, respectively.
Madden is also loading up on the stocks of Korean banks, such as Commercial Bank of Korea Ltd. and Korea First Bank, even though both are trading near their 12-month highs. Where does the value come in? ``The net interest margins of Korean banks are 1.5%, the lowest in the world,'' says Madden. He expects these margins to shoot up dramatically as banks move into the lucrative consumer-lending business. As Korea's per capita income grows, commercial banks that provide mortgages, credit cards, and auto loans should see their profitability skyrocket.
In some cases an entire region can seem like a screaming buy. Henrik Strabo, who manages the $300 million Twentieth Century International Emerging Growth Fund, says Central Europe is ``dirt cheap vs. Asia and Latin America.'' Stocks he favors include Egis Pharmaceuticals Ltd., a Hungarian generic drugmaker, and Poland's Elektrim, which makes infrastructure equipment. And Carl Marks's Wadhwaney says his ``favorite market anywhere'' is violence-torn Sri Lanka, which he calls ``a wonderful repository of value.'' To invest there, he cites two offshore closed-end funds: Regent Sri Lanka and Sri Lanka Growth Fund.
You don't need to go that far afield, however. Templeton's Reed maintains a ``bargain list'' of 125 to 225 stocks that he updates continually. To make the cut, shares must trade at a fraction of projected earnings in five years. Both Telefonos de Mexico and Telebras, the giant phone utilities of Mexico and Brazil whose ADRs are already well-known to U.S. investors, satisfy the criteria. Further proof that value can lurk in unexpected places--even right under your nose.
By Joan Warner in New York