BoA Merrill seeks fresh angle to tap EM consumption

Given recent price performance and valuations of emerging market consumer companies, the bank has identified 22 large-cap stocks in the US and Europe with leverage to the EM consumer.

Bank of America Merrill Lynch has named 22 large-cap stocks in the US and Europe with strong sales into emerging markets as a means to tap into the latter’s rollicking consumption story.

Private consumption in large emerging markets (EM) has grown almost 20% per year for the past two decades, and the bank is convinced this is only the beginning of a consumer credit cycle.

Its economics team has forecast that EM imports will increase nearly 13% in 2011, driven by rising domestic demand for global goods and materials.

But viable opportunities to invest into the EM theme have become harder to find. Liquidity is limited, with the market cap of consumer companies in the US, Europe and Japan nine times that of their EM peers.

There is also recent price performance to take into consideration. EM consumer staples and discretionary stocks advanced 27.6% and 29.5%, respectively, in 2010 on the back of record inflows.

Investors poured more than $84 billion of new money into high-growth emerging markets, and withdrew nearly $15 billion from developed market (DM) equity funds.

“While we remain bullish on EM over the medium term, we recognise that strength of 2010 investment flows will be difficult to replicate,” says the firm in a research note.

As investors recognised the potential for EM consumer growth, the valuations of EM consumer companies have become less compelling.

An influx of new funds has seen EM consumer staples and EM consumer discretionaries trade at premiums to their five-year historic average on both price-to-earnings and price-to-book measurements.

By contrast, BoA Merrill points out that DM consumer sectors are trading at a discount to their long-term historic P/Es and only a slight premium to their historic P/Bs.

So the bank screened consumer companies in the US, Europe and Japan with market caps greater than $10 billion for exposure to EM sales, excluding those with less than 30% of their sales into EM in the last reported fiscal year.

It has identified 22 large-cap DM companies in eight countries that met its criteria, although none of these was from Japan. It includes two tobacco firms in the top five by EM sales, British American and Philip Morris; three packaged foods and meats firms in Mead Johnson, Unilever and Danone; and four brewers in the top 12, namely SAB Miller, Carlsberg, InBev and Heineken.

The average 12-month forward P/E for the 20 stocks is about 15.9 times, a significant discount to the historic average P/E for either DM consumer discretionary (19.1x) or DM consumer staples (17.1x).

“These reasonable valuations, combined with healthy leverage to the EM consumer, make the stocks in our screen more attractive investment options, in our view,” the report read.

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