BRIC Inflation Imperils Consumer Stocks as Food Rises

Emerging-market consumer companies are valued at the most expensive levels on record just as surging food and energy costs curb household spending from Sao Paulo to Shanghai.

Shares in the MSCI Emerging Markets Consumer Discretionary Index traded at a 15-year high of 2.6 times net assets last week, data compiled by Bloomberg show. Wynn Macau Ltd., owned by billionaire Stephen Wynn’s casino company, fetched a record 28 times forecast profit. Mahindra & Mahindra Ltd., India’s biggest sport-utility vehicle maker, has a price-to-book ratio 53 percent higher than global peers, while Brazil’s Cia. Hering, producer of Hering brand apparel, commands a 15 percent premium.

Economic growth and supply shortages sent a United Nations gauge of food prices to a record last month, cutting the buying power of 2.8 billion people in Brazil, Russia, India and China who spend 19 percent of their income on groceries, compared with 6 percent in the U.S., Euromonitor International data show. Consumer shares were the second-worst performers among 10 industries in periods of rising inflation since 2001, according to Morgan Stanley.

“Inflation has really thrown a curve ball,” Jacob De Tusch-Lec, who helps oversee about $17 billion as a London-based money manager at Artemis Investment Management, said in a Jan. 14 telephone interview. “With food prices and energy prices being so high — and it’s a big portion of consumer spending in Asia — that could put a bit of a stop to that story.”

Rising Borrowing Costs

The MSCI emerging-market consumer index surged 36 percent during the past year, the best performance among 20 industry gauges worldwide, as investors lifted holdings to their biggest “overweight” position, data compiled by MSCI Inc. and Bank of America Corp. show. Profit at hotels, carmakers and retailers may get squeezed as input costs including oil rise faster than retail prices, according to Morgan Stanley.

Consumer shares are “over-owned” and will probably trail the broader market, Jonathan Garner, the New York-based bank’s chief Asia and emerging-markets strategist, wrote in a Jan. 14 research report.

Rising benchmark interest rates will also increase company borrowing costs, Emil Wolter, a Royal Bank of Scotland Group Plc equity strategist who has an “underweight” rating on Asian consumer shares, said in a Jan. 18 e-mail.

Inflation Accelerates

The extra yield investors demand to own the debt of developing-nation retailers over U.S. Treasuries has climbed 148 basis points, or 1.48 percentage points, during the past year to 434 basis points, the highest level among seven industries, according to JPMorgan Chase & Co.’s CEMBI+ Indexes.

The jump in China’s inflation to the fastest pace since 2008 has prompted the central bank to raise its benchmark lending rate twice since October and lift banks’ reserve requirements four times in about two months. India’s central bank Governor Duvvuri Subbarao said on Jan. 17 in Mumbai that the country is facing a “surge” in inflation, fueling concern he may increase borrowing costs at a policy meeting today.

Futures traders in Brazil have boosted bets on higher interest rates after the heaviest rainfall in 44 years threatened to curb food production. Russian consumer prices rose 8.8 percent in the 12 months to December, the most in a year, prompting Bank Rossii Chairman Sergey Ignatiev to say last month he may lift borrowing costs in the first quarter.

Low Rates

The U.S. Federal Reserve will probably keep its benchmark lending rate at a record low, near zero through at least the fourth quarter, according to the median forecast of 77 economists compiled by Bloomberg.

Emerging markets are “where the risks lie at this point, because those economies are farther along in the overheating stage, and you’re starting to see tightening,” Michael Aronstein, president of Marketfield Asset Management in New York whose Marketfield Fund beat 94 percent of peers the past year, said in a Jan. 14 interview with Bloomberg Radio.

Surging Chinese demand and Russia’s worst drought in a half-century sent an index of 55 food commodities tracked by the UN to a 25 percent gain last year. Rising milk and flour costs triggered protests in Algeria this month that left three people dead and 420 injured. Tunisian President Zine El Abidine Ben Ali was forced to hand over power to his prime minister on Jan. 14 and leave the country after failing to end a month of protests by promising lower prices for bread and sugar.

Still Bullish

McDonald’s Corp., the world’s biggest restaurant chain, will probably raise prices this year to offset rising ingredients costs, Chief Financial Officer Peter Bensen said on a conference call with analysts. Meat prices may climb as much as 3.5 percent this year, according to the U.S. Department of Agriculture.

Inflation in seven of the 10 biggest developing nations accelerated during the most recent month that government data were available, fueled by a rally in oil prices to above $85 a barrel.

Many professional money managers are still bullish on emerging-market consumer discretionary stocks, with a net 50 percent saying they hold more shares in the group than are represented in benchmark indexes. The ratio is the biggest proportion of any industry in developing countries, the U.S., Japan or Europe, according to a Bank of America survey of managers with $562 billion of assets that was published Jan. 18.

Premium Valuations

Consumer purchases in the so-called BRIC countries may climb by more than $500 billion a year, according to Goldman Sachs Asset Management Chairman Jim O’Neill. Spending in the four countries was about $4 trillion in 2009, Goldman’s data show. Companies that sell to emerging-market shoppers are some of the best investments “of our lifetime,” O’Neill, who created the BRIC acronym in 2001, said on Bloomberg Television last month.

“We’ve found a lot of profitable investments in consumer- oriented stocks — in consumer goods and retailing,” Mattias Westman, who helps oversee about $4.7 billion as a founding partner of Prosperity Capital Management in London, said in a Jan. 6 interview on Bloomberg Television. “There you have really good growth.”

The MSCI emerging-market consumer discretionary index is valued at a 22 percent premium to the same industry gauge for developed markets, compared with an average discount of 29 percent since the start of 1996, according to price-to-book ratios compiled by Bloomberg.

‘Losing Luster’

Mahindra & Mahindra of Mumbai trades at a 98 percent premium to Dearborn, Michigan-based Ford Motor Co., the second- largest U.S. carmaker, price-earnings ratios show. Hering, based in Blumenau, Brazil, is 81 percent more expensive than New York- based Phillips-Van Heusen Corp., the apparel company that owns the Calvin Klein brand.

Wynn Macau shares trade at HK$19.98, or within 1 percent of the average 12-month share-price estimate of 18 analysts compiled by Bloomberg. The company, which listed in Hong Kong in October 2009, was named a “top sell” on Jan. 13 by RBS’s Wolter.

Revenue at companies in the MSCI emerging-market consumer index will probably decline 6.4 percent this year, analysts’ projections compiled by Bloomberg on Jan. 19 show. Profit margins are poised to fall from the widest levels since at least 2000 as inflation pushes up costs faster than companies are able to pass them along to consumers, according to Morgan Stanley’s Garner.

Russia’s index of producer prices rose 16.7 percent in December, almost double the rate for consumer prices, government data show.

“The consumer discretionary space is clearly losing its luster,” said Wolter, the head of regional strategy for Asian equities at RBS in Singapore. “Given its valuation premium, we expect sectoral weakness to persist.”