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Season 2, Episode 11, Transcribed: Bargain Hunting in Frontier Markets, With Hedi Ben Mlouka of FIM Partners

Last updated on February 15, 2022

Moderator 0:02
Welcome to the Contrarian Investor Podcast. We give voice to those who challenge the prevailing sentiment in global financial markets. This podcast is for informational purposes only. Nothing on this podcast should be taken as investment advice. Guests were not compensated for the appearance, nor do they supply payment in order to appear. Individuals on this podcast may hold positions in the securities that are discussed. Listeners are urged to educate themselves and make their own decisions. Now, here’s your host, Mr. Nathaniel E. Baker.

Nathaniel E. Baker 0:36
My guest on today’s podcast is Hedi Ben Mlouka of FIM Partners. Now Hedi has been investing in frontier markets for quite a long time. And in fact, he has one of the oldest funds focused on this sector. It is of course a very interesting time in Investing. And in economics, as we all know, the Coronavirus has wreaked havoc on the economy. frontier markets, as we may know are a little bit less tied in to the major economies of the world. There are some typical emerging markets, like China and India. So, one could think that maybe this asset class is a bit better protected from events like the Coronavirus, but that is not the case according to Hedi. He tells us why this asset class is actually particularly vulnerable. And in fact, he goes into further details and tells us specifically which countries are at greater risk. But that doesn’t mean that there aren’t still compelling opportunities for investors to put capital to work. Before I roll the tape on this conversation, I want to remind you of an event that I am hosting on April 20, the first ever contrarian investor virtual conference. This will be held on a via web conference. I’m hosting this in partnership with value walk. And we actually just moved the time to 8am. So it’ll we’ll be recording this and hosting this at 8am on Monday, April 20. And I’m very excited because there are several hedge fund managers that have signed on and a couple of them have promised to present ideas that they haven’t previously shared. And I fully expect these ideas to move markets when they are discussed. And that’s why we moved this to the start of the day before The market open. To find out more about this event, you can go to contrarian slash event, contrarian slash event. And it’s all over my social media feed as well at pod contrarian on Twitter. So all that out of the way, let’s roll the tape on this conversation. Here you go.

Hedi Ben Mlouka 3:25
I’m the CEO and founder of FIM Partners. In a nutshell, FIM Partners is one of the leading frontier investors. We’ve been in existence since 2000, the end of 2008. And we’ve been investing in what we call high growth markets or frontier market by our own definition, which is basically the small emerging markets in Asia. I’m talking about Pakistan, Philippines, Bangladesh, and all of the MENA region. So that goes from the GCC countries Saudi Kuwait, Qatar, UAE, Oman, North Africa and also parts of sub Saharan Africa and I’m thinking in Nigeria and and a few other larger countries in the large countries in Africa. We are mostly in equity firm. So we basically we focus on public equities, in these markets that I just mentioned to you and we are also managing money on behalf of very large institutions globally. So from university endowments, pensions, sovereigns, because I sovereign, these are long term investors in the frontier markets. So they like obviously the opportunity said they like the growth profile, but also the fact that these economies are less integrated within the global economies and therefore offer an opportunity set which are to some extent different from what they would find in larger emerging markets, such as China in India etc. Our my approach to investing has always been to, to, to think as a business owner. And not to think like a minority, passive shareholder in any of the companies we invest in. So always want to create a very strong relationship with the management, sometimes even board members, but also understand the ecosystem of all of the companies we invest in. So, always privilege going into visiting the companies we invest in meeting, speaking to their suppliers, to their clients, to the competitors, even in the private space, etc. And that’s how I build the business. And that’s why I think we’ve been very successful investing in these in these markets. So I’ve been doing this myself for the last 20 years almost before FMI. I worked for Merrill Lynch in London, responsible for central Eastern Europe, Middle East and Africa.

Nathaniel E. Baker 5:59
So you’ve been doing doing this for a while. So if the firm started in 2008, I think, obviously, with everything that’s going on in the world now, one of the interesting questions is whether this is a good time to be investing in frontier markets. You mentioned the fact that these these markets are less tied to the global economy and the global supply chain than others, especially, you know, traditional emerging markets like China, etc. Nevertheless, there has been a lot of selling in risk assets over the past month or two. And so I’d be curious about that. What do you think about that? And as far as the timing of this?

Hedi Ben Mlouka 6:44
Yeah, no, obviously, that’s a question and something that myself on the team work on to understand the impact on the economy that we’re investing in. And also the policy response that we’ve seen in many of the markets. We have Investing. But let me let me start by saying the following. I think the first part of the equation is how prepared the economies that I’m talking about for an event like the one that we live in when I’m talking about obviously COVID-19 spread. Okay? And can they respond as aggressively as you have seen in the US and Europe from fiscal, also monetary policy perspective? And I think the short answer to that is no. Okay. So you coming into the crisis with balance sheets that are weaker, and with policymaking tools, which are less effective, and I’ll explain myself a little bit here, okay. So, when you go into the frontier market, the balance sheet of the government, the macro level, are not as strong as obviously the US or UT in Europe and therefore, the fiscal stimulus cannot be of the same size even on a relative basis and the reality also be monetary or fiscal, the effectiveness of these tools is lower Why? Because for instance, the the size of the pearl economy of the black market is obviously much larger in frontier market, right. So, can you actually impact that part of the economy? Will your policies vary very difficult to do, okay. You also have a large portion of the population which is not necessarily financially included and therefore, no bank accounts and they’re not living in urban areas, for example, okay. And if that is the case, again, it’s very difficult to reach out to this population, even if you had the means To do so, okay. And then when it comes to fighting the virus itself, you face many more challenges that you would in the US I think the compliance with a confinement, you will expect it to be much lower. First of all, in many of these countries family live together, which is not going to be helpful in this type of situation. And I think a much bigger challenge in many of the economies we invest in is that many workers are receive daily wages, okay. And so you cutting them off from that daily revenue is, is a big big issue and you’ve seen seen even in larger emerging markets in India with Modi’s decision to to impose a lockdown in cities etc. But that’s going to be also the case in many frontier market. So I think the impact of the virus could be Eventually larger from healthcare perspective. And the policy response to it can most probably will be weaker, especially in the fragile economies, right? So, with that context, I need to build a scenario for what’s going to happen the developer. And I then extrapolate to understand what’s going to happen in the frontier work. Okay. So in the develop work, I think anybody who’s expecting a V shaped scenario, I think does not realize what’s going on. Okay. It’s not going to happen. It’s not going to happen because people underestimate how interconnected The world has become. And therefore, we’re going to have to go with the lowest denominator. And I had very interesting conversation with one of the CEOs of the companies we invested in who is in the logistic, one of the major logistic player And he explained Look, it’s good that China is going back to work. But actually I don’t have demand anymore before that you had the West with demand but a couple of months ago China cannot could not meet that demand right. And now is the opposite China can meet that can produce but actually there is no demand and and beyond that there is no airfreight, how do I move merchandise from one place to another, right? And is basically I’m saying that globalization is going to have you’re going to see the downside of globalization essentially today, and therefore the recovery cannot be reshaped no matter what. So you need to think more with the with a U shaped my mindset. So to me, you need to write off 2019. Okay, you cannot focus too much on predicting what earnings are going to be in 2019 and your best But this is exactly what I’m doing is I’m thinking, look, I need to look at the businesses I own in my in my portfolio and start to think, how solid are these balance sheets? Can they withstand a prolonged period of in this recovery, And to me, that’s at least at the very earliest, q4 of this year, and potentially normalization in 2021. So it’s a balance sheet work that you need to do now and not don’t focus too much on earnings short term, because they’re not meaningful, okay? And they’re going to be very volatile. And they may be even scary with short term, focus more on the balance sheet, and then think, will for each business, you own your portfolio and I’m talking now about the frontier markets. Will they recover fully from this or will they recover partially and are they likely to be beaten industry will compete with or permanently be disrupted? Exactly. This is the basically the framework under which I am, I am working working on the frontier market. But just to answer your question on how impactful these frontier markets will be, I think the impact is going to be high. Okay. And I think the policy response will, will unfortunately be weakened because the means are not the same. And also the enforcement and the possibility of channeling into the real economy will be also very, very much more challenging, but that way.

Nathaniel E. Baker 13:35
Yeah, I must say, it doesn’t really sound like you’re making the case for investing in anything right now. Right? It seems like a good a good strategy would be to hold cash and to wait for these opportunities to emerge. Right? If I if I extrapolate what you’re saying a little further,

Hedi Ben Mlouka 13:51
actually, I’m not exactly saying that I’m just okay. I’m saying something different. Okay. I’m saying that you cannot underestimate the impact, but also what you need to see what In the price, okay? Because today, you have corrections of 30 40% in many of the markets that we invest in, and this correction at this point in time is indiscriminate. Okay, what’s happening? People want to raise cash, as you say globally, especially for something which is risky or perceived to be risky. I want to get out of that, right? That’s what what the move has been so far. And you get a lot of redemption going to em funds. And these when these redemption take place, the managers sell again indiscriminately, they are not in a position in the short term to think oh, this is this is good value, this is less than good value, this business is going to be impacted. So you have a dislocation, let’s say that you see in the credit market, you have exactly the same thing in our market. There is no discrimination was up and this nothing new since 2008. You’ve seen in any sell off. First step is I sell and raise cash as much as I can wherever I can. Okay? And that’s where you opportunities because if you’re not in that position and you can afford to start stock picking and thinking business by business, what is impacted what is not impacted? That’s your that’s your strategy starting today and that’s what we exactly are doing today.

Nathaniel E. Baker 15:25
Okay, interesting. So then the follow on from that is where are these opportunities do you think and why so that I think that would be an interesting thing for you to talk about, like where exactly in these frontier markets do you think it’s a good place to cash to work?

Hedi Ben Mlouka 15:40
Okay, so at the macro level, we start with a macro and then industries and dances okay. So at the macro level, you beyond what has happened, as in COVID-19 pandemic, you also have two major shifts right? You have oil price, dropping From 60 $65, all the way to 26 $27. I’m talking about the brand with a small recovery today. And what it means for many of the countries that we invest in. Some of them are commodity commodity importers. I’m thinking of Pakistan, Egypt, our beneficiary of lower oil price, although Egypt to a lesser extent, and others such as Saudi, Kuwait, and Nigeria are obviously rely heavily on revenues from oil prices. Okay. So my view on oil is the following. I think oil prices would recover down the line. And I don’t think what Saudi and Russia did with increasing production was, or Saudi, I should, I should say, is emotional and thought of type of policy. It is not true. I think it’s an Really well thought of decision. And I certainly think it is the right decision for them, because people forget that what Saudi should be solving for and each solving for is to maximize its revenues over the next 10 1520 years is not to maximize price in the short term. What has happened in 2015? Is that since 2015, initially Saudi want to decrease production, but then they realized they do not have the the bandwidth or the the flexibility from a fiscal perspective to do so. So they started defending, in my opinion, opinion wrongly, price on oil price in the short term to try to maximize revenues in the short term, but at the expense of market share. So what happened? shale oil production goes up, everybody’s production goes up, and Saudi keeps retreating and losing market share thing. And this junction, they did realize that is not a strategy that can work medium long term, especially that Russia, rightly so decided not to play ball anymore in terms of giving up market share to the US. So I think the Saudi strategy is a two step strategy. First step is signaling. We can produce more and we can take the pain shorter if nobody wants to take the pain with us. Okay, we will do it and we’re doing it. And number two is bringing the new equilibrium in OPEC plus, but potentially, I think now that for example, US production cannot free right anymore. There may be also a partner in this, you know, I know that sounds a little bit of a stretch given the current situation, but it can happen, okay, where you have a new equilibrium where all We’ll recover to 50 to $60. And we’re maybe a little bit of us production goes away. And then you know, Russia and Saudi and other OPEC members basically reduce a little bit their production and we get to medium to long term equilibrium, which is much more efficient and better globally, okay. And the reason I have very high conviction that on oil prices recovering because I do not think there is a single player, including the US itself, that does not want higher oil prices. And when we have today, forget about the demand shock that we’re seeing today. This is short term, it will go away eventually. But I think what we need to focus on is medium term supply. And I think the US wants higher oil price. Because it wants to be relatively independent from an energy perspective. Okay, it’s not about just okay. So, so my view is look, oil price weakness in the short term, recovery medium term. So for oil exporting, Such as Nigeria, Saudi Kuwait. What we’re seeing today is a negative impact. There’s no doubt about it, because you see, Saudi, for example, oil at $25 will bleed $75 billion in terms of its full reserves by the end of this year, okay, so it’s a big impact when you think of reserves of $420 billion. So I think these countries will, depending on the size of their sovereign, or their reserves, will be impacted more than obviously oil importers. So I’m thinking the most vulnerable guys are Nigeria because they’re not prepared at all. They already struggling. Oman could be another one. I think Saudi would put it in the middle because they do have significant reserves so they can defend it in the short term, but definitely not in the medium term. It will have an impact medium term the fiscal spending so that we need to be aware of when When understanding government spending and also fiscal policies and how it can impact businesses etc but the beneficiaries as I say the other Pakistan’s and the and the other importers in the frontier space so that gives you a little bit where you should be positioning yourself okay, so I think frontier Asia is probably preferred place followed by Mena and I would be negative on on Sub Saharan Africa today, okay, that’s, that’s a bit okay, macro layout when it comes to businesses now, okay. You need to go to focus on balance sheet. So today I stay away from businesses which are leveraged, that cannot have easily access to funds. And I would stay away also from sectors such as hospitality He ideation for obvious reasons because I don’t think they I think the probability of Vshape scenario is extremely low if not nil. And therefore, you know, recovery down the line is meaningless for them because they’ll be gone by something shareholder value would have the business may survive because they will get recapitalized said they will always be, you know, buyers or investors in airlines. But I think as a shareholder today, you may go to zero before that happens, okay. And I think go for government support will not go to shareholder you will go to employees and to the company to survive and to carry on as a going concern. Banks as well I am concerned and as a sector I would avoid, because if you look at policies across the frontier markets and also globally, if you think of it Yes, the central banks are stepping in to provide liquidity, but they asking the banks to bear partially the costs of funding the economy and asking them to extend loans giving interest rate, holidays etc, which means that they will impact the profitability and there is no doubt about the fact that certain businesses and SMEs which are not prepared for this type of shock, they will disappear and the banks will will suffer from that you will see the cost of risk going up you will see that NPS rise over time and low interest rate environment is not good for banks in general as you know, nim compression so I think it’s a perfect storm for bank so you need to stay away as much as possible. From bank I’m talking on the equity side the creditor is a bit different. The businesses we are keeping and we like are businesses that may get impacted short term, they may even having a couple of losing quarters or even the write off for the year, but we know will recover eventually in 2021 and beyond so you see health care, education, retail, consumer staples is probably the most resilient and probably be up this year. But even consumer discretionary, I think they will be impacted dramatically this year, but I believe he will recover for as long as we have a strong balance sheet. So these are the businesses that we like today. And if you ask me, What am I investing today, in right? I’m investing The second category of businesses which I think are businesses you want and in the economies that I think are the most resilient and I’m looking for stocks that have still been impacted but by the indiscriminate sell off, so at this point in time, I am in the beginning of the investment curve. So I want to go for the most resilient in the best economy and at very interesting valuation, this window over this window will close very, very quickly started closing, by the way. Really? Yeah, it started closing okay. People started slowly not to sell everything indiscriminately. They try to do more research and understand what’s the impact on the business etc. And slowly I would move that risk curve as also uncertainty, dissipate and have a much clearer idea on where the company is going to happen, etc. So that’s a little bit how we’re approaching. Okay.

Nathaniel E. Baker 25:49
That’s really interesting. When it comes to these companies, these consumer consumer discretionary and other ones in frontier markets, what are their supply chains like and how impacted are they getting versus like a you know somebody in the West

Hedi Ben Mlouka 26:05
Yeah, look, today, supply chain is always complex for for any business okay. I think the companies who who are relying on cross border supply chains are the ones that will be impacted the most because you think I don’t think that international travel is going to recover that quickly and when even when it does is going to be costly and it will come with a lot of risk restrictions okay. So, and also as I said earlier, very often supply chains and depending on many manufacturers in different countries, which are different stage in terms of the pandemic, so you are exposed to the lowest denominator, unfortunately, that’s what’s happening. Okay, so When you think of Vietnam, which is a big exporter, for example, yes, you will face a lot of issues because of demand in the target countries because you’re dependent also on Chinese production. And it’s very often a very complex picture, which the more complexity, unfortunately, the less good in this type of environment, but companies which are catering for local demand from local productions, are the ones that probably will be will recover the fastest. And that’s what you need to do that analysis. And it’s a complex analysis, because, you know, historically you did not focus that much on this type of details because it does not matter. And all of these things matter a lot today,

Nathaniel E. Baker 27:50
so but we have Okay, so we have consumer discretionary in countries like Pakistan, maybe Egypt, and you’re saying that some of those are already Starting to recover, which I guess would be consistent with what we’re seeing in the US. If you look at things like Clorox or certain grocery chains, Walmart even. So, yeah, anything else?

Hedi Ben Mlouka 28:13
Yeah, I mean, look, in the beginning when we were talking about recovering, we’re talking about stock price recovery, obviously. So when the sell off has started, you’ve seen a big correction in Telecom, you’ve seen correction in hospital operators, we, we’ve seen correction even in education, the education sector, and surprisingly also in this consumer staples, such as grocery shop chains, etc. Okay. And I’ve seen it across the board, I mean, from the GCC to in the Philippines, in Pakistan as well. And now what we have seen is that in these industries, now on In the sector, as you’ve seen already recovery of that, that’s why I told you look, some of these opportunities are no longer available already because people decide that actually grocery chains or supermarket chains are actually beneficiaries of what’s going on, because that’s not slowing down. Any businesses that we have a strong ecommerce platform as well, are faring much better than others because they are sometimes replacing their in store sales with even better sales. Sometimes they got gaining market share over traditional operators. What you’re also seeing is that many of the smaller businesses are in this in these sectors are disappearing because they cannot withstand the slowdown. So the larger one, the more organized one are taking market share. So you know many of the themes that we invest in which are organized versus organized retail ecommerce growth, etc, that are being accelerated by what’s happening. Which is an interesting trend, we rise and go week after week that ecommerce players now are the ones who are very well positioned in that space are doing much, much better than the other guys. And then some of the traditional businesses are disappearing, the smaller ones, especially. So, so you’ve seen an acceleration of that. And these stocks have already started recovering, they’re down maybe 10 15%. And this is exactly what you’ve seen in the US as well. Google initially job by, you know, up to 30%, I guess and then recovered. Same thing from Microsoft, IBM, the business shouldn’t be affected by this right, what is mildly be affected, they recover much quicker. Whereas, you know, oil and gas has not done the same Well, he’s looking to same extent, same thing for aviation, banks, etc.

Nathaniel E. Baker 31:06
Okay. Last couple questions, the what the shifting back to the macro picture here, obviously, with frontier markets and emerging markets and the political situation is always a bit of a concern. You know, a lot of these countries, their political situations are in flux. How much of a concern is it that things could potentially deteriorate politically in some of these countries due to the economic shock that we’re seeing?

Hedi Ben Mlouka 31:33
Yeah, I think. Look, this is probably the one thing I’m focusing the most now. And it’s probably a corollary of what we discussed in the beginning. Remember, we say, confinement lock downs? What does it mean when you go to countries like Pakistan or India, especially middle income people poorer countries, because you have a vast part of the population, which is dependent on daily wages, and there is no saving whatsoever, right? It’s what is what you kill that day is what you eat essentially. Right? It doesn’t go beyond that. Okay? And I think, for now emerging and Frontier Markets are trying to mimic the status of the that you’re seeing in the Western world. And this may have unintended consequences. So my biggest concern is that down the line, soon enough, you will see many revolutions, you know, you can you can see upheavals taking place in many of these countries. That’s why my view is that this confinement strategy especially for the frontier, and he Emerging Markets middle income or lower income, emerging market, they need to think of an alternative very, very quickly. And I don’t know whether that’s a massive testing with explicit feasible not feasible segregation between the most vulnerable part of the population. The one the or the less younger, the older part of the population stays at home whereas others can go back to work. But implementing in a testing strategy, there has to be shift. I don’t think confinement works in in the poorer or the middle income emerging and frontier math for too long. I get it for the first two, three weeks, you don’t know what’s going on. We have no stats. You have no testing kids, you have no strategy. All you want to do is just try to to slow it down, which I think is the right strategy, but in my opinion, is It’s very important that there is a shift very quickly from

Nathaniel E. Baker 34:03
Hmm. Which which countries would you say might be the most risk of this type of I mean, the the some of the Gulf countries might come to mind just because the oil shock. You mentioned Nigeria before. So yeah, so the African oil exporters Angola, out to your App Center.

Hedi Ben Mlouka 34:21
Yeah, look, I’ve actually look at the GCC countries are actually the most immune because they are rich countries. They know the impact of oil does not get them to Brink anytime soon. You see if you want to talk about the UAE the UAE can fund this deficit for many many years. So you’re not as long. Kuwait very long time Qatar as well. So I think the GCC is not right, I think is probably the most comfortable part of the EM or frontier space because they come with a strong balance sheet. They can withstand this and they also better equipped You know, in facing these things with the healthcare infrastructure is is better on average and a smaller population much easier to to control and to direct and to enforce policies etc. The countries which are more worrying of the larger population and less which country so, I’m thinking Pakistan and thinking Egypt, Bangladesh, not in the frontier, but in the emerging markets India can become problematic. In Africa, Nigeria put it in the bucket for the large population and also this fiscal space is is very small, okay. So, the low oil price short term impacts them, no doubt about it. So, you will see my opinion, devaluation there. You will see inflation therefore, and so they have very few degrees of freedom and these are the more most vulnerable. Economy Philippine is not one of them. Vietnam is now because these are countries that have ammunition today they don’t do this with ammunition from a fiscal from a current account perspective would be fine.

Moderator 36:24
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