Tapping Into Overseas Growth
By Richard Moroney
Dow Theory Forecasts
Strong global economic growth has sparked impressive gains for foreign stocks. Over the last three years, the MSCI Europe, Australasia, and Far East Index jumped 72%, more than twice the 33% gain of the S&P 500 Index.
That performance did not go unnoticed - from January 2006 through May 2007, $220 billion flowed into U.S. mutual funds that focus on foreign stocks, about 10 times the amount invested in domestic stock funds.
While most investors should not devote more than 30% to 35% of their portfolio to foreign stocks, they can tap into foreign growth indirectly, without leaving home. For the 279 S&P 500 Index components that generate at least 10% of sales overseas and provide a detailed revenue breakdown, foreign sales have risen substantially faster than U.S. sales. In the last fiscal year, the companies averaged foreign sales growth of 13.1% versus growth of 11.5% in U.S. sales. Over the last three years, foreign sales rose at an annualized rate of 15.9%, well above the U.S. growth rate of 11.2%.
Why have foreign operations delivered superior growth? There are many reasons, but two stand out:
Emerging Economies Set Pace
The European Union and Japan delivered weaker economic growth than the U.S. last year. But most of the world's major economies managed somewhat higher growth than the U.S., while the largest emerging markets were much stronger. Brazil, China, India, and Russia - which comprise 26.9% of the global economy - delivered combined growth in gross domestic product of more than 9% in 2006.
Emerging markets offer substantially higher growth rates than more-developed markets, such as the U.S., Europe, and Japan. But tapping into that growth is not easy to do, nor is it always wise. Below we briefly discuss just two of the pitfalls facing businesses that wish to expand into emerging markets:
Risk: A U.S. retailer planning a new location in Cleveland, or anywhere else in the nation, faces plenty of risks, including local acceptance of the product, supply-chain concerns, and work-force availability. To expand into a emerging foreign market, a U.S. business must take on all the risks inherent in domestic expansion, as well as concerns about the stability of the political system and currency, interest rates, transportation costs, and cultural differences.
Competition: The China and India growth stories are compelling - and by now, everybody has heard them. Hundreds of companies hungry for growth are eyeing emerging markets. The competition for land, resources, and workers will only get stiffer. Smaller emerging markets are not as congested with U.S. multinationals, and a number of countries in Africa, the Middle East, Eastern Europe, and Latin America have economies growing at double-digit rates.
The U.S. dollar has lost ground against the most influential currencies in recent years. The U.S. Dollar Index, which tracks the value of the U.S. dollar versus key foreign currencies, has been trending down for most of the last five years. During the five-year period, the index declined 25%.
In itself, a weak dollar is neither good nor bad for the company. When the dollar is cheap relative to a foreign currency, U.S. goods look cheaper to buyers using that foreign currency. Exporters and other companies that depend on spending by foreign businesses and consumers often benefit from a weak dollar, while U.S. companies that purchase raw materials or finished goods from foreign countries will have to part with more dollars.
Theoretically, a depreciating dollar should boost results for U.S. multinationals that sell in foreign markets. But these days the picture is not always that clear. Firms that purchase raw materials and produce goods in the U.S., then sell overseas, will probably benefit from the dollar's depreciation. However, many U.S. firms import raw materials from overseas for their U.S. manufacturing operations. Some both make and sell good overseas. Such companies may not benefit from the depreciation of the dollar.
One way to determine whether a U.S. company is participating in the growth of strong foreign economies is to look at the growth of its foreign sales relative to its U.S. sales growth. In our newsletter, Dow Theory Forecasts, we listed 16 Forecasts recommended stocks that appear to be taking advantage of opportunities in foreign markets. Three of them are reviewed below:
AMETEK (NYSE: AME; $40), a leading manufacturer of electrical and electro-mechanical devices, derives nearly half of its sales outside the U.S. A mix of organic and acquisition-driven revenue growth, coupled with an improved product mix that is fattening profit margins, fueled 33% per-share-profit growth last year on 27% sales growth. International sales jumped 32%, paced by a 39% gain from Asian operations.
The company seeks to expand globally throughout the acquisition of businesses with a strong foreign presence. Last year, AMETEK acquired British nanotechnology and analytical-equipment companies and a German optical-emission business. AMETEK has tripled its sales force in Europe, Asia, and the Middle East since 1999 and added offices in Russia and China in 2006. A key driver of AMETEK's expanding margins is its ongoing shift of manufacturing operations to such low-cost regions as Mexico, China, and Brazil. AMETEK has 13 manufacturing facilities in Europe, Canada, and South America and joint ventures with Asian partners in China, Japan, and Taiwan. AMETEK is a Focus List Buy.
General Electric (NYSE: GE; $38), one of the world's largest and most diversified companies, has produced 13% annualized earnings growth over the last 10 years. During that period, foreign sales rose at an annualized rate of 9.8%, versus an anemic 0.2% for U.S. operations. Not surprisingly, GE spends aggressively to expand overseas. The company's sales to China, India, and Eastern Europe have nearly tripled since 2000 to $29 billion last year, or 18% of total sales. GE anticipates sales to those three key markets will reach $50 billion by 2010.
All of GE's business units have solid growth stories. GE had more than $110 billion of infrastructure products and service revenues in its backlog at year-end 2006. GE also has another $60 billion of infrastructure financing assets generating returns. Worldwide Internet growth is allowing GE's finance segment to originate more loans online. The company expects online loan originations to exceed $15 billion by 2009. The Internet's growth is also opening up new distribution channels for NBC Universal entertainment content. GE's health-care unit, benefiting from population growth and the aging of the developed world, expects about 15% profit growth this year. Consensus estimates project per-share-profit growth of 11% in 2007 and 13% in 2008 for GE, a Long-Term Buy.
PepsiCo (NYSE: PEP; $65), leading global snack and beverage company, is benefiting from strong growth in its international operations, which represented 41% of sales and 30% of operating profits last year. International operations have delivered margin gains and balanced growth across both developed and emerging markets in recent quarters. Snack volumes rose more than 10% in the five quarters ended March, helped by particularly strong gains in Mexico, Russia, and Turkey. Beverage volume grew more than 8%, paced by strong sales in the Middle East, China, and South America.
Over the last three years, international sales rose at an annualized rate of 14.4%, versus 6.2% for U.S. sales. In the 12 months ended March, the discrepancy became more extreme, with foreign sales growth of 13.7% more than tripling the U.S. growth rate. Some of PepsiCo's brands are nearing the saturation point in the U.S., and investors should expect foreign operations to deliver most of the company's growth over the next decade.
PepsiCo is making acquisitions that expand its reach into additional countries. In June, the company agreed to acquire Sandora, the leading juice company in Ukraine, one of Europe's largest and fastest-growing beverage markets. PepsiCo, a Focus List Buy and a Long-Term Buy, seems capable of exceeding consensus per-share-profit growth targets of 11% this year and in 2008.
Editor's Note: Richard Moroney is editor of Dow Theory Forecasts, 7412 Calumet Ave., Hammond, IN 46324. 1 year, 52 issues, $279. www.DowTheory.com.
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