Investing in Overseas Manufacturing Companies

As the world finally recovers from one of the worst financial crisis in history, the rate of growth, especially in Western economies, looks as though it will remain …

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As the world finally recovers from one of the worst financial crisis in history, the rate of growth, especially in Western economies, looks as though it will remain fragile for some time to come. For example, the U.S. economy grew by 2.2% in 2014; the forecast for 2015 is 3.1%; and looking further forward, predictions indicate 2.69% by 2020. Expect a steady but not exactly inspiring rate of expansion over the next five years. Figures for the UK, Canada and Australia are broadly similar, while countries in the Eurozone are expected to remain at or slightly below 1% growth.

For investors who may have spent their entire professional lives trading stocks in any of the previously mentioned countries, this is not good news, especially if they specialize in the manufacturing sector. However, for those who are prepared to seek out alternative markets, there are a number of great opportunities. Over the past several decades, manufacturing output has begun to expand rapidly in countries such as India, China, Indonesia and Malaysia; in fact, GDP annual growth is forecast to be over 5% per year through 2020 in all of them.

Savvy investors know that in the U.S. the Fed is unlikely to significantly raise interest rates any time soon, and that cheap cash will continue to flow into Asia and the Far East. Over the next five years, the Compound Average Growth Rates (CAGRs) in Asia are expected to be double those in Europe, North America and Australia. India is set to lead the way with growth of over 30%, closely followed by China, just one or two percent behind.

China and India

China and India have become world leaders in terms of GDP growth. Think of just about any multinational corporation and it is almost certain to have a presence in one or both of these vast countries. Each has a population of over 1.2 billion, of which 50% are aged under 25 and 65% under 35. These are huge numbers, which go a long way to explaining why there is such a high demand for consumer goods – a situation that is inevitably destined to continue over several decades.

Indonesia

Across Indonesia, manufacturing grew at the rate of 5.5% in 2014, though in Sumatra it reached over 6% aided by the region’s lumber and forestry industry, which achieved a figure of 9.9%. In order to counteract increasing labor and land costs in Jakarta and West Java, the country’s government is planning to establish over 30 industrial areas on less developed islands over the next couple of decades.

In September 2013, the EU and Indonesia signed a Voluntary Partnership Agreement to ensure all lumber and timber-derived products imported into the EU were taken from sustainable and verifiable sources. As a result, the industry, which was already a major contributor to the country’s economy, mushroomed. There is also an expectation that foreign investors with expertise in areas such as sustainable cultivation methods, quality control, and other forms of new technology will be attracted by the promise of high levels of profitability. It is hoped that these investors will work in collaboration with local companies, thereby passing on their expertise to local students and trainees. Cultivation of lumber is restricted to domestic companies, though wood processing is open to all on receipt of special licenses issued by the Ministry of Finance.

One of the most prominent players in forestry cultivation and processing is RGE Group Chairman and Founder Sukanto Tanoto. Two of the group companies, Asia Pacific Resources International Ltd and Asia Symbol are involved in the production of pulp and paper, while Sateri Holdings Ltd is one of the largest cellulose manufacturers in the world.

A recent development has been the decision by several major manufacturers to move some of their manufacturing plants from China to Indonesia. In 2014, Foxconn, an assembler for the likes of Nokia and Sony, as well as a contract manufacturer for Apple, spent $1 billion establishing new manufacturing facilities in the country. Now, Samsung Electronics is about to commence construction of a factory; Toyota has opened a new engine plant in West Java; and Tata Motors, the Indian vehicle manufacturer, is set to make the country its distribution and manufacturing center for the region.

A key reason for all this investment is that the ASEAN Economic Community (AEC) is set to become a reality within the next year. Involving ten South East Asian countries, the bloc will have a population of some 600 million, a potential GDP of $2.5 trillion, and a regional market estimated at around $1 trillion.

Malaysia

The leading industry in the country is undoubtedly based on electrical and electronics, a sector that employs over 27% of the total workforce and accounts for a third of exports. Production is targeted in three key areas, solar, LED and semiconductors, the latter being the most important in terms of potential future growth. Around the world there has been an explosion in demand for devices such as tablets and smartphones; cloud computing and data center storage solutions; optoelectronics, which includes fiber optics, photonics and LEDs, and integrated circuits. In order to maintain its position as a leading electronics manufacturer, the industry is investing heavily in research and development and taking steps to outsource its peripheral activities to domestic companies rather than relying on importing components.

Advice for investors

Mark Mobius, Executive Chairman of Templeton Emerging Markets Group, is confident that due to a combination of an emerging middle class and continuing high rates of growth, there is huge potential for investors, especially in the manufacturing sector and in companies making products in high demand by the domestic market. Businesses in the software sector are obviously good bets to produce high returns on investment given the insatiable appetite consumers have for tablet computers, mobile apps and smartphones.

Mobius suggests that individuals should measure the success of their investments not by monitoring their return on equity (ROE) but by their return on invested capital (ROIC), since companies based in this region are less stable than those in the West.

Anyone considering investing in the Far East and South East Asia should use a specialist investment management company with expertise in that part of the world. They will be able to offer a suitable portfolio based on how risk averse the individual is. While the returns may be lower than might otherwise be achieved, this solution provides a high degree of confidence and reduces the possibility of suffering catastrophic losses.

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