Temasek’s dealmaking reflects big bets on rise of the consumer

Last updated: April 14, 2014 7:25 pm

Temasek’s dealmaking reflects big bets on rise of the consumer

By Jeremy Grant in Singapore

From toothpaste and shampoo in China to instant noodles and tomato paste in Africa, Temasek is betting big on growth in an emerging middle class – a significant shift for Singapore’s $171bn national investment agency, long known for its emphasis on the financial sector.

Last month Temasek struck a $5.7bn deal with Li Ka-shing, Hong Kong’s richest man, for a 25 per cent stake in his AS Watson health and beauty stores business. That came on the heels of a tender offer for Olam in a deal that values the Singapore-listed cashews-to-cotton company at $4.2bn.

When it was founded 40 years ago, Temasek’s initial portfolio included shares in a shoemaker, a detergent producer and even a bird park. The idea of “growing middle income populations” – as Temasek puts it – has been one of four key investment pillars for the past decade.

It already has a 3 per cent stake in Li & Fung, the Hong Kong-listed distributor of pharmaceuticals, beauty products and clothing to global consumer goods companies, and last year paid $300m for a stake in Indonesian hypermarket operator Matahari Putra Prima.

But the size of the AS Watson and Olam investments dwarfs anything Temasek has done before, and marks a shift of long-term emphasis.

“The consumer retail sector is a good proxy to growing middle income populations and transforming economies,” says Chia Song Hwee, head of Temasek’s investment group. “This is very much part of our investment themes as we shape Temasek’s portfolio for the long term.”

There is no suggestion that Temasek is scaling back its investments in the financial sector – its largest single-sector exposure, at 31 per cent of the value of its portfolio as of March 2013.

Temasek, which manages a S$215bn (US$171bn) portfolio on behalf of Singapore’s ministry of finance, is one of the biggest foreign investors in the Chinese banking sector, a play on the long-term growth of the mainland economy.

Yet the prospect of steady growth and solid dividends earned through companies whose fortunes are tied to markets with increasing populations and rising disposable incomes – even as the shine has come off emerging markets – is proving irresistible.

“I do think this is part of a different strategy; it’s Temasek becoming more systematic,” says Victoria Barbary, director of the London-based Sovereign Wealth Centre.

Financials produced a higher dividend yield than consumer products in emerging markets in fiscal 2013, at 3.5 per cent versus 2.2 per cent, Morgan Stanley calculates. But it expects consumer staples will generate a higher return on equity of 16 per cent by 2016, up from 14.7 per cent in 2012, and compared with 13.8 per cent for financials in 2016 – unchanged from 2012.

That is in spite of a recent slowdown demand in emerging markets that has forced the world’s biggest food and drink manufacturers, such as Nestlé and Unilever, to cut costs and prune low-growth businesses.

Lindsay Cooper, director at Arisaig Partners, a Singapore-based investment manager, says the consumer sector still offers compelling returns. “If you are looking to buy emerging markets growth, the conventional wisdom has been to buy the financial sector. However . . . every now and again the sector goes spectacularly wrong,” he says.

“In contrast the best branded consumer staples businesses enjoy multiple growth tailwinds, generate the highest returns on capital and are by far the least volatile.”

The potential is particularly high in China. AS Watson dominates with 30 per cent of the drugstore market on the mainland, which accounts for about a quarter of the company’s earnings before interest, tax, depreciation and amortisation.

CLSA, a Hong Kong-based broker, estimates that business alone has generated operating margins of 17-18 per cent in the past three years.

Jonathan Galligan, CLSA analyst, says that while China’s economic growth has slowed, AS Watson will derive most of its growth from the opening of new outlets because there is so much physical space for expansion.

AS Watson is also the largest health and beauty store operator in Europe, where it has stores across the eastern part of the continent under the Rossmann and Drogas brands, and owns Superdrug in the UK.

All the talk about volatility makes me laugh. It’s part and parcel of emerging markets, and Asia I think is a solid long-termbet

– Andrew Cosgrave of consultancy EY

“If you’re Temasek, [with AS Watson] you are getting a high return on equity and a high cashflow, which means you will receive a meaningful dividend payout. And you are getting a sizeable presence in the European and Asian health and beauty retail space, which have meaningful structural growth opportunities,” says Mr Galligan.

Temasek appears to have secured its AS Watson stake relatively cheaply, too.

CLSA estimates that the $5.7bn price tag equates to 13.5 times the company’s enterprise value over projected 2014 operating profit. That compares with a Bloomberg estimate of 19 times for Dairy Farm, the closest comparable business in Asia.

Offer documents for Olam imply a capital commitment of nearly S$2.5bn to buy out the Asian agribusiness’s minority shareholders. But Jefferies analysts believe Temasek is “sending a strong signal to both the equity and debt markets about the value it sees in the company”.

Analysts are similarly unconcerned by recent signs of a softening in consumer demand, especially in Thailand and other parts of emerging Asia.

“All the talk about volatility makes me laugh,” says Andrew Cosgrave, global consumer products lead analyst at consultancy EY. “It’s part and parcel of emerging markets, and Asia I think is a solid long-term bet.”