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Emerging Markets May Offer the Most Potential for the World's Largest Consumer-Focused Companies

Prepared in collaboration with the World Economic Forum

Empowering Public-Private Collaboration in Infrastructure National Infrastructure Acceleration (NIA) approach

S&P Global Ratings

COP24 Special Edition Shining A Light On Climate Finance

S&P Dow Jones Indices

Considering the Risk from Future Carbon Prices

S&P Global Ratings

Global Economic Outlook 2019 Autumn Is Coming


Emerging Markets May Offer the Most Potential for the World's Largest Consumer-Focused Companies

A ggregate consumption growth in emerging markets is poised to pick up again, after the decline in commodity prices in 2014-2015 helped cause it to slow down. With these markets presenting ripe opportunities for consumer-oriented companies, conventional wisdom would suggest that companies in these regions would stand to gain the most. But S&P Global Ratings believes large, multinational players are better-positioned to prosper more than their smaller competitors.

Overview

  • Aggregate emerging market consumption will expand more quickly than that of advanced economies, and emerging markets will account for an increasing share of global consumption.
  • Large multinationals with strong brands, innovation, well-developed infrastructure and deep pockets are in the best position to capitalize.
  • Developing economies provide opportunities for long-term growth, particularly China, India, and Brazil; and different consumer-focused sectors stand to benefit in different ways.
  • To minimize risk, companies will employ partnerships (joint ventures, franchises) rather than outright acquisitions.
  • Successful execution of developing market expansion can help boost sales growth, better leverage cost structures, and diversify geographically, but we don't expect this to translate into positive rating actions in the near term.

To be sure, developed economies will remain important markets because of their established populations, comparatively large middle classes, and relative stability of demand. But many developed nations also have low growth prospects for consumer-oriented companies. Consider that, in terms of purchasing power parity (which adjusts for currency fluctuations), advanced economies accounted for about 65% of global GDP in 1990 but just 42% in 2015; China and other emerging markets accounted for the other 58%.

In this light, it's no surprise that companies that have the size and scope to do so have targeted countries and regions where the middle class is ascending and the political climate is fairly stable. And while we don't expect these opportunities will translate into positive ratings actions for borrowers in the near future, successful developing market expansion will boost their sales growth, leverage cost structures, and diversify their exposure to local economic cycles over the longer term.

Pockets Of Potential

Even with 2016 shaping up to be another soft year for the global economy, consumption spending remains resilient in many parts of the world. In the U.S., solid consumer fundamentals, helped by stronger income gains, continue to foster moderate consumption growth. Europe is obviously on shakier footing because of the economic hit and uncertainty from Brexit. (In the aftermath of the vote, we reduced our growth forecasts for the region. However, we do not see the U.K. falling into a full-fledged recession nor the eurozone recovery stalling.

But brighter news may be coming out of emerging markets. Consumption spending in Asia-Pacific as a whole looks set to expand at the fastest rates globally in the next couple of years, boosted by growth in China and India. Although China's consumption has decelerated (along with the overall economy), consumption spending in what is now the world's second biggest economy is still expanding at a rapid pace and looks to be contributing 4 to 5 percentage points to growth. And India's economy is growing faster than China's. We expect budget reform, as well as technological innovation, will drive consumption growth in rural areas and broaden what has been a very urban story to date.

Latin America's economies have been suffering from the commodity downturn and elevated political uncertainty but there are signs that they are stabilizing. Brazil--the biggest economy in the region and the eighth-largest national economy in the world--could turn a corner next year, and we see it reaching the bottom of its sharp consumption spending decline this year, helped by moderating inflation and prospects for monetary easing.

All in all, we forecast emerging market consumption growth will again outpace the developed world in 2017 (see chart 1).

 

This is not to say that consumption spending is poised to revert to the very high growth rates seen at the start of the decade, or that vulnerabilities have dissipated. In fact, we see China's planned rebalancing toward an economy based on consumption and services progressing only modestly in the next five years, and it's not without challenges. The Brexit vote also highlights emerging markets' continued vulnerabilities to financial market volatility, weakening capital flows and currencies, and geopolitical developments.

Encouraging Economic Evolution

Emerging markets' consumption growth slowed markedly last year to about the same rate as in advanced economies (see chart 2) as low commodity prices and weak global trade took their toll. Still, they have accounted for a steadily growing share of global consumption--now representing almost one-third global consumption spending, up from less than one-fifth in 2000 (see chart 3).

 

 

This trend won't continue without some broader economic evolution, in our view, and the extent of developing economies' success will be highly dependent on implementing reform. For example, China must reduce its overcapacity and curtail debt growth, while India needs to increase private investments and exports. Brazil must resolve its public debt burden, attract foreign investments, and ease its current political and fiscal uncertainty. More broadly, commodity exporters need to cut public spending and diversify their revenue bases.

At any rate, we expect consumer-oriented companies to look to emerging markets as a major growth area over the longer term. Developing economies generally have faster-growing and younger populations, incomes that are rising at a faster pace than in advanced nations, and higher savings rates--which can indicate, though not guarantee, an increase in future spending (see chart 4 and 5). For example, China, India, and Indonesia rank first, second, and fourth, respectively, in population size (and collectively have almost 40% of the world's people), and their high savings rates augur well for consumer-oriented companies (especially as incomes rise).

 

 

Who Stands To Benefit

With per capita consumption in emerging markets still considerably below that in advanced economies, there's significant room for those regions to catch up (see chart 6). Different consumer-focused sectors stand to benefit in different ways.

 

Consumer Products
Developing economies will likely play a large role in the growth of consumer products companies, given the positive outlook for most of these markets long term, and the secular and demographic challenges facing the industry in more advanced economies. In light of our projection for low-single-digit organic sales growth in the next three to five years in developed markets (where modest economic growth, changing tastes--especially among Millennials--and aging populations will weigh on revenues), we believe consumer product companies will continue to invest in emerging markets.

Demand for branded good should grow along with the number of middle-class consumers, particularly in China, where consumers have shown a preference for premium-branded products. Demand for basic items such as diapers and meat products will also likely increase as income levels rise.

Geographic diversity will help companies generate more consistent profitability, as periods of economic weakness in one region can be offset by economic strength in another. A good example is Colgate-Palmolive Co., one of the most geographically diverse companies and one that reports consistently solid operating performance. Moreover, the compound annual growth rate of Colgate's organic sales has exceeded 5% from 2009 to 2015, largely due to its presence in emerging markets. Developed markets have been growing at a low-single-digit rate.

The biggest European consumer product companies--Unilever PLC, Reckitt Benckiser Group PLC, Danone, and Nestle S.A.--also posted solid results in 2015, despite tough macroeconomic conditions facing them in developed markets.

Other consumer products companies that will likely benefit from growth in emerging markets are multinationals Procter & Gamble Co., baby-formula maker Mead Johnson Nutrition Co., food and beverage conglomerate Mondelez International Inc., International Flavors & Fragrances Inc., PepsiCo Inc., The Coca-Cola Co., food-ingredients manufacturer Ingredion Inc., personal-care products maker Kimberly-Clark Corp., NIKE Inc., home-appliance giant Whirlpool Corp., and beauty-products makers The Estee Lauder Cos. Inc. and L'Oreal S.A.

However, operating in developing markets doesn't come without risks, like currency volatility and geopolitical risks (including election outcomes). Therefore, we expect companies to enter markets slowly or through a joint venture, and to diversify manufacturing and debt denomination. The sharp rise in the dollar last year resulted in U.S.-based multinational corporations reporting lower operating profits, though no ratings were affected as many consumer-products companies reduced share repurchases to maintain stable credit metrics.

 

Retail
Successful retailing is a local business first and foremost. In developing markets there is much more opportunity for new store growth than in the U.S., for instance, where we think excess retail space is undergoing a steady rationalization. Accordingly, we think the large retailers will continue to invest in emerging markets.

There are several large rated U.S. retailers for which developing economies are an important growth story, including Wal-Mart Stores Inc., Starbucks Corp., and McDonald's Corp. But the majority of rated U.S. retailers are U.S.-centric, with the most common international exposure being Canada.

Likewise, French retailers such as Carrefour S.A., Auchan Holding, and Casino Guichard - Perrachon & Cie S.A. are primarily Western European focused, but with a large and increasing presence in China, Russia, and other emerging markets. Auchan, through its joint venture Sun Art, is focused on expanding its presence in China, and their emerging markets operations provide significant revenue and earnings stability.

Not all retail concepts travel successfully. Success requires a not-always-simple adaptation of products and menus to local markets. Failure lurks in the inability meet local preferences, supply chain complexities, legal and regulatory risks, and foreign exchange transaction and translation impacts. Still, developing markets have long-term appeal for large retailers with the resources to adapt, given the prospects for higher growth in population and income than in more mature markets.

Retailers have certain advantages in tapping emerging market growth that other sectors don't have. First, e-commerce provides a means to support, if not replace, traditional brick-and-mortar market expansion. Second, restaurant retailers have the ability to grow by franchising, a much less capital-intensive alternative to opening company-owned stores.

One success is McDonalds. It already generates the majority of revenue outside the U.S., with about 25% in high-growth markets (including China)--although not all high-growth markets are developing markets; some are simply developed markets that are underrepresented.

Another retailer with deep exposure to emerging markets, particularly China, is restaurant operator Yum! Brands Inc. The company is separating its China division into an independent company while Yum! Brands remains a "pure play" franchisor. We generally view a higher mix of franchising as a positive.

But not all retailers feel the lure of distant geographies. The world's largest company by revenue, Wal-Mart gets about 74% of its revenues from the U.S. Its largest developing markets (by square footage) are Mexico, followed by China. Still, the company is taking measured steps into the developing world: it recently announced the formation of a strategic alliance with JD.com Inc., reported to be China's largest e-commerce company by revenue, to serve online customers in that country. Partnering with an established local player is often a successful risk mitigating strategy for local market entry.

Media and entertainment
Essentially all global media companies operate in emerging markets despite the regulatory and protectionist risks they pose. And while most don't break out exactly where their exposure is, both Viacom Inc. and Twenty-First Century Fox Inc. have rapidly growing businesses in India, and Time Warner Inc. and Discovery Communications Inc. have significant investments in Latin America, for example. We expect entertainment companies will look to expand their presence in developing areas through a combination of organic growth and acquisitions.

This expansion won't come without potential hurdles. Under some regimes, foreign companies are barred from owning a majority stake in a domestic media company. In fact, in some countries--Russia, for example--foreign companies have had to sell their networks to domestic owners. Additionally, the censorship of content remains a problem in certain parts of the world, and some areas cap the amount of international content that can be shown. China, for instance, strictly limits the number of international films allowed to exhibit in the country.

Film is already a global industry, and the rise of the middle class in developing economies has meant substantial growth in international box office receipts--in some cases, international revenues account for as much as 70% of total gross box office for a particular film. We see television as a more significant growth driver for U.S. media companies, not just for content produced at home but content produced in local markets as well. The rise of Netflix Inc. and other providers of so-called over-the-top (OTT) content--which gives consumers access over the Internet without authentication through a cable or satellite TV subscription--has also been a boon to U.S. media companies because these OTT operators compete to purchase content against the local broadcasters, which results in higher prices for that content.

Leisure and gaming
Leisure and gaming companies have long had a large exposure to emerging markets, and that exposure is only growing thanks to the rising middle class in China and expanding transportation alternatives that make it easier for those customers to travel. Last year, Chinese visitors to casinos in Macau accounted for 60% of Wynn Resorts Ltd. revenues, 58% of Las Vegas Sands Corp. (LVS), and 24% of MGM Resorts International (MGM). Because the Macau gaming market has a limited number of licenses, we don't expect any new companies to expand into this market. However, most of the license holders in the Macau market are expanding operations through construction on the Cotai Strip that target mass-market customers, and we expect these projects to increase the percentage of revenue that Wynn, LVS, and MGM earn in this market. The main risks they face relate to government regulations, such as visa restrictions and tighter scrutiny of the movement of money, which can weigh significantly on visitations and revenues.

Cruise companies are also expanding into China and adding ships there, although revenues from China still constitute a relatively small percentage (less than 10%) overall. We expect cruise companies will also benefit from a rising middle class in that country and increased outbound tourism among Chinese citizens. The extent of the growth in the market will depend in part on infrastructure developments that allow ships to travel to more ports, as well as the increased length of vacations so that cruise companies are able to offer more varied itineraries.

Globally diversified lodging companies such as Marriott International Inc., Hilton Worldwide Holdings Inc., Starwood Hotels & Resorts Worldwide Inc. (soon to merge with Marriott), Four Seasons Holdings Inc., and Wyndham Worldwide Corp. have presences in emerging markets in Asia-Pacific and Latin America, with the percentage of rooms (and, therefore, revenues) in the 10%-20% range. One of the risks these companies face is sustaining developer relationships to grow a steady pipeline of rooms. Also, political and terrorism risks exist, although most of these companies have are geographically diversified enough to mitigate much of this risk.

Airlines
All of the large "network" carriers that we rate--including American Airlines Inc., Air Canada, British Airways PLC, Delta Air Lines Inc., Deutsche Lufthansa AG, Qantas Airways Ltd., and United Continental Holdings Inc.--have at least a moderate presence in emerging markets and stand to gain from growing air traffic. But dynamics in the industry that differ from those in other industries mean that domestic air carriers in developing countries may be better able to take advantage of increased appetite for travel as economies develop and middle classes in those regions expand.

Chinese airlines are increasing their services within--and into and out of--the country. Right now, there are more than 40 airports being built in China, and the country's aviation authorities are actively promoting growth. Meanwhile, Middle Eastern airlines such as Emirates and Etihad are increasing their capacity on a global basis. In fact, the International Air Transport Association (IATA) recently forecast the largest growth potential for 2016 to be in Asia-Pacific (8.5%) and the Middle East (11.2%).

Growth through acquisitions faces obstacles as well, as many national ownership rules make cross-border deals less likely. Still, it's not unusual for a carrier to have a minority equity stake in a partner airline. And developing countries' home airlines are often expanding aggressively and may have local government backing.

Expansion by Chinese airlines has increased capacity and competition, but the aggressive addition of capacity has run ahead of traffic demand and trimmed fares on those (still very profitable) routes for U.S. airlines. Most passengers on U.S.-China routes are Chinese, and airlines in China are seeking to increase their share (currently a minority) of traffic between the two countries.

Autos
As with airlines, auto industry dynamics suggest that, as vehicle markets around the world emerge and mature, local manufacturers may benefit as much as--if not more than--large, global car makers. That said, the companies that can most take advantage of developing markets are major original equipment manufacturers (or OEMs, which make parts and systems for manufacturers) and Tier 1 global suppliers (the direct suppliers to OEMs). Consolidation can help global Tier 1 players to grow fast, especially in the emerging market. And OEMs must continue to set up production in low-cost countries to remain competitive. Among the risks these companies face are cyclicality in the demand for light vehicles, the possible resurgence of raw material price volatility, unsteady or declining consumer confidence, and tariffs that add to costs.

We see passenger-vehicle sales growing 5%-6% in China this year as increasingly affluent consumers seek greater mobility and convenience. However, sales of commercial vehicles look set remain flat or grow only in the low-single digits as industrial activity slumps. And next year could be a tough one, as the effects of some policy incentives, such as a cut in the sales tax on small-engine passenger vehicles in China, expire by the end of this year. Still, such policy incentives provide a strong indication that the automotive industry could remain a high priority for the Chinese authorities, especially if further softness in the economy appears likely to stifle demand for vehicles. We expect most of the economic growth and increased automotive demand to come from the Tier 2 and Tier 3 cities in the lower‐income central and eastern provinces where, currently, vehicle ownership levels are low. We expect similar trends for the Indian market, where mass urbanization will likely lead to a rise in vehicle ownership.

Chinese auto manufacturers are making progress on product development, brand recognition, and product diversity and quality--though they lag behind their global rivals. As it stands, the country's automakers continue to depend on foreign partners for technology advancement and product designs, despite substantial investments in research and development.

Still, there are a handful of Chinese automakers that we think could break into the ranks of global players in the next decade, including SAIC Motor Corporation Limited, Dongfeng Motor Group Co. Ltd., Chongqing Changan Automobile Co. Ltd., Beijing Automotive Group Co. Ltd., Great Wall Motor Co., and Zhejiang Geely Holding Group. However, consumer confidence and brand awareness will take a long time to build, and we think it will take another five to eight years for one or more Chinese automakers to become a global brand.

Writer: Joe Maguire



Empowering Public-Private Collaboration in Infrastructure National Infrastructure Acceleration (NIA) approach

Executive summary

Infrastructure is a key economic and social driver of sustained growth and acts as a true enabler of a country’s competitiveness. Yet new infrastructure development remains insufficient and ineffective, and many investors continue to be discouraged by a general lack of information, the absence of bankable deals and risky policy environments. Enhanced public-private collaboration and understanding are therefore required more than ever, as stretched government budgets and increasing infrastructure needs conspire to widen the infrastructure financing gap.

There is no silver bullet for addressing the many facets of this global challenge; however, in a world where there is no shortage of capital, pursuing the right collaborations and frameworks may offer a potential solution. In this context, the National Infrastructure Acceleration (NIA) model proposes an innovative approach to a sustained country dialogue to address infrastructure development and investment.

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NIA facilitates interaction between the private sector and governments, thereby contributing to improving countries’ investment climates, deepening local capital markets and ultimately accelerating the development of infrastructure pipelines.

To achieve this, the NIA initiative convenes national multistakeholder working groups, recognized and endorsed by the national governments concerned. These working groups represent a standing, multistakeholder platform designed to facilitate interaction between its members, the goal of which is to identify actionable solutions to advance infrastructure development and financing. They also provide a space to address policy questions and initiate collaborative projects among members.

This report describes a standardized NIA Implementation Roadmap created by the World Economic Forum in close cooperation with S&P Global. By defining a series of activities that have proven to be effective in implementing NIA successfully at a country level, the Forum aspires to expand its reach and further the adoption of the model in additional countries, municipalities and regions around the world.

This publication is intended to serve as a blueprint for policy-makers, private entities and multilateral development banks (MDBs) that want to introduce a sustainable model for public-private collaboration in their respective countries or jurisdictions.

Read the Full Report
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COP24 Special Edition Shining A Light On Climate Finance

Highlights

− Green loans are evolving, with the Climate Bond Initiative forecasting nearly $1 trillion in green bond issuance by 2020.

− Despite the uptick in green bond and loan issuance, the market still remains relatively small, especially compared to the universe of assets comprising CLO 2.0 transactions.

− In our view, a green CLO market has large growth potential, boosted by regulatory initiatives and emerging interest from both issuers and investors in 2018.

− We built a hypothetical rating scenario for a green CLO to compare and contrast the underlying portfolio and structure with a typical European CLO 2.0 transaction.

− Our hypothetical green CLO analysis showed that green loans may have different fundamental characteristics to corporate loans, such as lower asset yields, higher credit quality, and higher recovery rates assumptions.

The global collateralized loan obligation (CLO) market has experienced a rebirth (2010 in the U.S. and 2013 in Europe). New issuance continues to increase due to investor familiarity with the product, as well as low historical default rates. While a market for green assets, such as green loans and bonds has been established for a while, although still of a relative size, a sustainable securitization market is still in its infancy. Considering the challenge in financing the amounts, S&P Global Ratings expects green CLOs to play a role in increasing the private sector presence in the sustainable finance market.

Following the Paris Agreement that came into force in November 2016, 184 parties have ratified the action plan to limit global warming. For this purpose, developed nations have pledged to provide $100 billion (about €87 billion) annually until 2025. As part of this deal the EU has committed to decrease carbon emissions by 40% by 2030. In March 2018 the European Commission (EC) proposed the creation of environmental, social, and corporate governance 'taxonomy', regulating sustainable finance product disclosures, as well as introducing the 'green supporting factor' in the EU prudential rules for banks and insurance companies.

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Considering the Risk from Future Carbon Prices

Along with the advent of the 2015 Paris Climate Agreement has come a growing understanding of the structural changes required across the global economy to shift to low- (or zero-) carbon, sustainable business practices.

The increasing regulation of carbon emissions through taxes, emissions trading schemes, and fossil fuel extraction fees is expected to feature prominently in global efforts to address climate change. Carbon prices are already implemented in 40 countries and 20 cities and regions. Average carbon prices could increase more than sevenfold to USD 120 per metric ton by 2030, as regulations aim to limit the average global temperature increase to 2 degrees Celsius, in accordance with the Paris Agreement.

S&P Dow Jones Indices launched the S&P Carbon Price Risk Adjusted Indices to embed future carbon price risk into today’s index constituents.

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Global Economic Outlook 2019 Autumn Is Coming

Highlights

- The direction for the global economy in 2019 is clear: GDP growth will slow, led by the U.S., which will likely see the rate of expansion fall to around 2% by the end of next year. Chinese growth will moderate. Europe's growth will remain relatively low and stable.

- We see the risks around our baseline on the downside. These include worries about the entrenchment and expansion of the U.S.- China dispute, as well as market turbulence related to the path of interest rate normalization by the U.S. Federal Reserve. Brexit and Italy's fiscal woes may have an impact, but remain regional risks for the most part.

- All is not lost! Policy makers across the major economies can seize the opportunity to shed shibboleths and undertake bold (non-monetary) policy actions to mitigate the slowdown.

- We expect the path of growth and policy normalization next year and beyond to be orderly for the most part; more an arrival of autumn than a coming of winter. This global slowdown is both necessary and healthy. It's not the beginning of another global financial crisis.

Dec. 11 2018 — The outlook for the global economy in 2019 is straight forward: GDP growth will slow in aggregate and in most major countries. The U.S. will lead the trend, as fiscal stimulus will wane and monetary policy normalization will continue, with both weighing on growth. China's expansion will continue to moderate despite a pause in corporate deleveraging, and we expect further policy easing as ongoing trade tensions and the effects on both business and investor confidence continue to bite. European growth will trundle along, weighed down by concerns about Brexit, Italy's budget, and Germany's new leadership ahead of a reshuffling of the European governance. Across emerging markets, tech and oil exporting economies may struggle in relative terms.

Moreover, the risks to this outlook are on the downside, driven in large part by two scenarios. First, the U.S.-China entanglement (it's not just about trade and never was) may worsen and broaden before it gets better. The pause in tariff escalation by Presidents Trump and Xi following the recent G-20 meeting in Buenos Aires was welcome, but much work lies ahead. Second, as our just-completed Credit Conditions Committee agreed, with the cycle turning, the possibility of surprises on the credit front is rising as well. These include debt affordability as well as access to financing.

Despite this gloom, we are not jumping on the crisis band wagon. In broad terms, we see the slowing of global growth as both necessary and healthy. We expect the process to be reasonably orderly, with recent bouts of market turbulence a reminder that slowdowns are not always smooth. It need not be the case that winter is coming, but the global synchronized upturn of 2017 has clearly passed, and we are entering the autumn of the long expansion that followed the global financial crisis.

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