Rethinking BRIC

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Michael Krause submits:

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The term "BRIC," coined in a 2001 Goldman Sachs report, was simply meant to group the "big four" emerging markets, not represent an investment theme. But it has become one, with at least three ETFs tracking the artificial grouping, not to mention offshoots like "Chindia."

That's unfortunate, because BRIC countries have little that tie them together as an investment theme-economically, demographically, or politically. Now there's a movement which includes MSCI and Nouriel Roubini among others to throw Russia out of the quartet in favor of Indonesia (turning it in to "BICI" supposedly).


Their basic argument is that Russia, given its corruption and demographic challenges, is unfriendly to investors and may never graduate from the class of emerging markets. Indonesia-though a smaller economy-with faster growth, better demographics and declining corruption seems like a better fit for the "super-charged" image that the group has come to represent (Table 1).

Table 1: Economic Snapshot

Russia vs. Indonesia

Russia

Indonesia

GDP ($bns)

1,302

592

Growth rate 1

4.2%

6.3%

Population (mns)

139

243

Growth rate 2

-0.6%

0.9%

Elderly (% of pop.)

13.0%

6.1%

Transparency 3 '01

2.3

1.9

Transparency 3 '10

2.1

2.8

Source: Bloomberg, Census Bureau, Transparency International

Notes: 1) Avg. 2010-12E 2) annual, 2010-2030E 3) Corruption Perceptions Index, higher figure means greater transparency, less perceived corruption

And investors have noticed: year-to-date (as of 11/30/10) the Market Vectors Indonesia fund ( IDX ) has jumped 44% compared with a gain of 18% for the Market Vectors Russia fund ( RSX ). So is it a good idea to jump on the bandwagon?

We begin as always by examining the underlying composition of each index. IDX is most heavily exposed to the Financial sector, at 27% of assets, followed by Energy at 18% and Materials and Consumer Staples at 13% each (Figure 1 ). In contrast, two-thirds of RSX is commodity-driven, with Energy accounting for 45% of assets and Materials another 21%.

Figure 1: Sector Breakdown

Market Vectors Indonesia (( IDX ))

Source: AltaVista Research

Firms in RSX have a marginally higher level of profitability over the course of the business cycle-averaging 21.5% versus 20.5% for firms in IDX-but as you might expect given the dominance of commodity-related stocks in the Russian index, profitability has been more volatile, with higher peaks and lower troughs (Figure 3 ).

As a result, firms in RSX are forecast to report much better EPS growth this year and next as profitability rebounds, but over the long term Russian firms are expected to generate annual earnings growth of about 10% compared with 16% for Indonesian firms.

Figure 2: Return on Equity

IDX vs. RSX, 2006-2011E

Source: AltaVista Research

However, here is where we part company with fans of Indonesia: no matter how good a nation's economic prospects, at some point its stocks become too expensive. This is increasingly true in today's global economy, where domicile of a company's headquarters matters less and less, i.e., all the things mentioned above may adversely affect Russia's energy companies, but they're probably not nearly as important as oil prices.

It appears to us that Indonesian stocks already more than reflect the country's bright economic prospects. Stocks in IDX are currently trading at 3.2x book value, more than double that of Russian stocks despite their slightly lower average profitability (a figure that stands out even more when one considers the large exposure to Financials-typically a low P/BV sector-in Indonesia). As a result, after fees IDX has a relatively low ALTAR Score™ of 5.6%, compared with 13.2% for RSX (Table 2 ).

Table 2: Calculation of ALTAR Score™

Index

Avg. ROE

2006-10E

( A )

Price-to-Book Value

( B )

Less: Expenses

( C )

ALTAR™ Score

(A/B) - ( C )

Market Vectors Indonesia ( IDX )

20.5%

3.2x

71 bp

5.6%

Market Vectors Russia ( RSX )

21.5%

1.5x

62 bp

13.2%

Source: AltaVista Research

Other traditional valuation metrics show a similar disparity (Figure 3 ). Perhaps Russian equities deserve a valuation discount, but do Indonesia stocks deserve this much of a premium? Even Chinese stocks in the iShares FTSE/Xinhua China 25 fund (FXI) trade at cheaper multiples.

Obviously, this analogy isn't perfect in that if Indonesian stocks replace Russian stocks in the BRIC quartet they won't have the exact makeup as those in IDX. But from a big-picture perspective, it appears as if many investors have already bid up the price of Indonesian stocks-whether in belated recognition of the country's prospects or an attempt to front-run a change in the popular benchmark from BRIC to BICI (which would compel all the money tracking it to dump Russian stocks and buy Indonesian). We think it would be a mistake to jump on the bandwagon now.

Figure 3: Valuation comparison

P/E, P/CF & P/Sales multiples on 2010E

Source: AltaVista Research

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

See also JJC: Too Correlated to SPY? on seekingalpha.com



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , International

Referenced Stocks: A , B , C , IDX , RSX

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