abrdn: Three ways to unlock opportunity in emerging-market equity income

Emerging-market equities are increasingly exhibiting these characteristics. In this article, we explore three key developments that can help identify future opportunities.

Many dividend payers to choose from, but which are in it for the long haul?

Evidence is mounting that emerging markets (EM) are a fertile hunting ground for income, as well as capital growth. As you can see in Chart 1 below, the proportion of EM companies paying a dividend has grown significantly over the last two decades, with around 90% now doing so [1] (and more than one-third of these yielding over 3% [2]).

Chart 1: MSCI universe – companies paying dividends

The proportion of dividend payers in EM is comparable to that in developed markets (DM). However, the key for us is unearthing those companies whose dividends are sustainable over the long term. Can the business thrive and survive in both good times and bad? Does it generate healthy levels of cash flow to maintain its dividend payments (or to start payouts in the future)?

Making these judgements requires detailed fundamental analysis, but we also look at external influences. However well-run it is, a business needs to be in the right place at the right time to prosper. We’ve identified three essential cross-sector and cross-region microeconomic developments. These allow us to pinpoint the companies that are most capable of generating long-term shareholder income. 

1) Technology as a platform

Technology has helped transform EM from a group of economies dominated by commodities to something much more diversified. Many EM companies have embraced ‘leapfrog innovation’, adopting more advanced technologies, such as digital payments, to bypass the more conventional routes to growth. This has allowed them to catch up – or even surpass – DM competitors.

We’ve entered a new digital era, powered by artificial intelligence (AI), which affects everything from how we travel to the way we spend our money. What makes digital era growth such a powerful investment trend is that many key technologies are coming together at the same time. Just like a railway network requires major investment in its tracks to get trains from A to B, so this new digital economy requires technology hardware to meet its demands.

For example, generative AI models such as ChatGPT (or indeed ERNIE Bot, from Chinese technology giant Baidu), are expected to contribute US$4.4 trillion to the global economy [3]. However, this transformational innovation requires vast amounts of processing power. Indeed, the supercomputer behind ChatGPT contains more than 285,000 processor cores and 10,000 graphics cards [4].

Smarter technology in transport also comes with huge demand for additional sensors and components (see Charts 2 and 3 below). Electric vehicles need more sophisticated chips and in greater numbers than the more conventional internal combustion engine cars [5]. Autonomous vehicles require even more. Essential functions such as judging road positioning and making split-second safety decisions need large technology sets, including GPS, radar, and LIDAR.

Chart 2: Number of sensor chips required for different levels of autonomous driving

Chart 3: Number of chips per vehicle in China, 2012-2022

Technology hardware forms the building blocks for the new digital economy. Much of it’s sourced from EM. The world’s largest semiconductor foundry is Taiwan’s TSMC. It provides high-performance chips to major global brands, including Apple, NVIDIA, and Intel. Emerging Asia is also home to global players, including memory-chip manufacturer Samsung Electronics, Mediatek, a Taiwanese fabless semiconductor company, and telecommunications equipment testing specialist Sporton International. 

CASE STUDY - KASPI

Fintech company Kaspi’s super app is changing the way people in its native Kazakhstan shop and manage their finances. Its online payments, marketplace and fintech ecosystem continue to evolve and take in new areas, most recently expanding into travel services and grocery shopping. Kaspi has strong pricing power, illustrated by its elevated market share and high user engagement. The business is expanding its services and adding more premium features. We believe this should be positive for earnings, and the company can achieve a 30% compound annual growth rate over the medium term.

• Read more about this case study below

• Emerging markets income equity: taking Kazakhstan into the 21st century with Kaspi

2) Green transition

The agreement signed at COP28, the UN climate change summit, was billed as “the beginning of the end” for the fossil fuel era. While nations, companies and activists disagree over the pace of change needed to cut harmful CO2 emissions, the direction of travel points towards greener, lower-carbon energy sources. Other factors – not least Russia’s invasion of Ukraine – have forced policymakers to rethink their dependence on a handful of exporters for their energy needs.

There is already well-established scale and development of renewables in EM. These markets are also the focal point as the energy transition accelerates. Developments include expanding national power grids in India, exploring new technologies like carbon capture and storage, or adopting new fuel sources such as hydrogen. A prime example is electric-battery technology, which is essential for many aspects of the energy transition. Global demand for lithium-ion batteries is expected to grow by about 27% annually, to reach around 4,700 GWh by 2030 [6]. This is a boost for companies such as leading battery maker LG Chem.

Many of the essential materials required for greener technology, such as copper and platinum, are mined in EM countries, particularly Latin America. As Chart 4 demonstrates, demand for copper, used in solar PV (photovoltaics), wind, grid-battery storage and more, is forecast to rise from around 25,000 kilotonnes in 2022 to nearly 40,000 kt by 2050 [7]. Rising demand for these minerals will help mining companies such as copper producer Grupo Mexico, platinum producer Anglo American Platinum, and lithium miner Sociedad Quimica y Minera de Chile. 

Chart 4: Total demand for copper in the Announced Pledges Scenario

So far, investment levels significantly lag what is needed to meet ambitious net-zero emission targets. According to the most recent estimates, the cumulative investment gap to keep the global temperature rise below 1.5°C by 2050 (above pre-industrial levels) is US$150 trillion [8]. With this in mind, we expect to see continued acceleration in projects over the next few years, giving EM companies a platform to flourish.

Chart 5: Cumulative investment needs under 1.5C scenario, 2023-2050

CASE STUDY - HD KOREA SHIPPING AND OFFSHORE ENGINEERING 

Shipping accounts for 2% of global emissions, with historically more than 99% of the industry’s total energy demand coming from oil [9]. However, HD Korea Shipping and Offshore Engineering (KSOE) is taking the lead in the industry’s green transition. As one of South Korea’s largest shipbuilding firms, KSOE has used its scale advantage to ensure its balance sheet is in a fairly healthy position in terms of cash flow, despite pressure on profit margins across the industry. During a prolonged industry downturn, the firm invested heavily in research and development in new lower-emission ships. This investment has already started to show results, with the launch of an ammonia-powered vehicle that reduces CO2 emissions by up to 95%.

• Read more about this case study below

• Emerging markets income equity: can Korea's KSOE deliver sustainable dividends?

3) A new generation of consumers

Spending power is rising dramatically in EM. Nations including India and Indonesia have seen large increases in their working-age populations. Together with fewer people having to support dependents, this is a recipe for potentially greater economic growth.

While the precise definition of ‘the middle classes’ can vary, median income has increased substantially across many EM countries in recent years [10]. By one count, in 2024, 113 million people will enter the global consumer class, with 57% living in China and India [11]. 

This backdrop of consumption growth is favourable for dividend-paying companies. It stretches across several industries, including food and beverages, sportswear, electrical appliances, automotive vehicles, airports and financial products like insurance or banking. 

For us, one of the most important aspects is that consumers are expressing a preference for domestic brands over global names. This benefits some leading EM companies that have already established significant market share in their respective industries.

In China, for example, despite long-standing demand for premium imported spirits like whisky, there’s still a strong market for baijiu, a Chinese liquor made from fermenting cooked sorghum. This has boosted some of the country’s leading drinks manufacturers, such as premium spirit producer Wuliangye Yibin. Meanwhile, Midea Group, the world's largest home-appliance company, has grown its domestic range of own-brand products to dominate the markets for washing machines, air-conditioning units, and kitchen appliances.

CASE STUDY - BAJAJ HOLDINGS 

Bajaj Holdings has two subsidiaries, a scooter and three-wheeler maker (Bajaj Auto), and a consumer finance company (FinServe). The company's prospects are therefore closely linked with those of  India’s burgeoning middle class and is seeing a direct benefit from rising household incomes. Bajaj Auto has invested in making its products more durable, meaning their value tends to hold up better than those of competitors. There’s also further opportunity to grow market share at home and overseas. thanks to the company's electric vehicle offering. FinServe, with a healthy customer base, is playing a leading role in digitalisation, with new products including a personal loan app. Digitalisation is especially important in a country like India, where many of the population, particularly in rural areas, have not previously had access to formal credit. The company now offers loans and services to large sections of the country previously considered as ‘unbanked’.

• Read more about this case study below

• Emerging markets income equity: Bajaj Holdings and India’s rise as a consumer nation

The importance of cash flow

Taken together, these three microeconomic themes, which frequently overlap, help set the backdrop for well-run companies with established and loyal customer bases to sustain and grow their businesses. Alongside our ‘follow-the-cash-flow’ analysis – focusing on companies with strong balance sheets and attractive fundamentals – these themes help us stay alert to opportunities in cash-generative businesses capable of paying out sustainable and growing dividends to shareholders.

We look for companies that effectively use capital to generate a profitable income stream. This means they can invest internal funds to secure a competitive advantage over their peers, while leaving enough cash to provide attractive distributions to shareholders. We also often look for companies where we see potential for income in the future. Our balanced two-pillar approach (whereby we invest 50% in high dividend and 50% dividend growth) aims to capture the vast income and growth opportunity in EM.

The combination of high levels of income, and sufficient capital reinvestment, should result in attractive, growing dividend yields for shareholders as these businesses continue to expand over time.

Visit our Investing for Income campaign page where you can read our other case studies and find out more about our total return mindset.

The value of investments and the income from them can go down as well as up, and investors may get back less than the amount invested. Past performance is not a guide for future results.

Companies are selected for illustrative purposes only to demonstrate the investment management style described herein and not as an investment recommendation or indication of future performance. Past performance is not a guide to future results.

¹ Source: Factset, Jefferies Equities Research, January 2024

² Source: Bloomberg, October 2023

³ AI could increase corporate profits by $4.4 trillion a year, according to new research - McKinsey

⁴ Microsoft announces new supercomputer, lays out vision for future AI work - Microsoft

⁵ Source: Deloitte analysis in Global Corporate Venturing EVs drive future demand for car semiconductors, 2023 

⁶ Battery 2030: Resilient, sustainable, and circular - McKinsey

⁷ Critical Minerals Data Explorer – Data Tools - IEA

⁸ World Energy Transitions Outlook 2023: 1.5°C Pathway - IRENA

⁹ International shipping - IEA

¹⁰ Source: Haver, March 2021

^11.113 Million People Will Join the Global Middle Class in 2024 - Visual Capitalist 

Risk warning

The value of investments, and the income from them, can go down as well as up and an investor may get back less than the amount invested. Past performance is not a guide to future results.