How to Survive Getting Hit by a BRIC

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 |  Includes: CHRW, EEB, EWZ, EXPD, FXI, IFN, OAOFY, TRF, UPS
by: Michael K. Dawson

Now I know what it feels like to get hit by a BRIC: Brazil (NYSEARCA:EWZ) -8.81%, Russia (NYSE:TRF) -8.2%, India (NYSE:IFN) -7.5% and China (NYSEARCA:FXI) -10.7%. It may take a few days or weeks before our bells stop ringing, but it will. Unless Goldman Sachs grossly miscalculated the economic potential of these countries, February 27, 2007 will simply be a blip in a long term profitable cycle. However, hard hats will be standard issue going forward.

I believe this action lends credence to my quest of developing indirect methods for investing in the BRIC economic cycle. It may be helpful to read my earlier article before continuing.

Pseudo-ETFs

Low cost brokers and basket trading have made it financially feasible and practical to create your own “pseudo-ETFs.” A “pseudo-ETF” is a basket of stocks fitting your criteria that can be bought or sold with one order. Refer to my article on basket trading for more details. Last year, I created two “pseudo-ETFs” to capitalize on the BRIC trend. One was comprised of an equal weighted basket of EWZ, TRF, IFN and FXI (the direct method). The other consisted of companies that provide raw materials and supplies necessary for the industrialization of the BRIC economies (the indirect method). Both had phenomenal returns: direct +49.1% and indirect +41.2%. Their year to date performance, including the 2/27 meltdown, is direct -14.5% and indirect +3.5. I realize that 14 months is a small data set, but it appears that the indirect method captures most of the upside while minimizing the downside. Obviously, there is no guarantee this trend will continue. Nonetheless, I am currently in the process of replacing the direct “pseudo-ETF” with another indirect one.

Growth Creates Opportunities

Along with economic growth are some unintended consequences such as China’s substandard drinking water and badly polluted air. China has committed $125 billion over the next five years to address these problems. Four companies that will benefit from this spend form the first pillar of this basket. This was addressed in detail in Part I.

Another area that is experiencing great pains is the transport and logistics industry. To bring China’s manufactured goods to Europe or the US, to ship Brazil’s cars or to supply China’s demand for raw materials more ships, trucks and airplanes are needed each year. This boom has created congested ports, railways and roads.

The infrastructure in China and the other BRIC countries are years behind developed countries. The following story from Logistics Management paints the picture.

Just before Christmas, somewhere in Tianjin or Chongqing or almost any other major city in China for that matter, a truck was being loaded with parts destined for a factory elsewhere in the country. The factory managers worried about when the goods would arrive. They knew how much red tape they would have to wade through to get the parts they needed. If anything is likely to crimp China’s growth, it will be logistics bottlenecks. Freight transportation can be downright primitive by global standards; there’s a fair chance that the truck in Tianjin was loaded by hand, that its driver had to pay off a low-level government official somewhere along the road, and that the condition of the road itself made for unpredictable delivery.

According to China Logistics 2006, the latest report from U.K.-based research firm Transport Intelligence [TI], it has long been understood that if China’s economy is to maintain its momentum, its logistics costs—currently up to three times the level of those in developed countries—must come down. Jones Lang LaSalle, a global services consultancy, expects China’s logistics market to double from $105 billion to $210 billion by 2009.

The Opportunists

The goal is to identify global companies that will benefit from this spend. However, since the ultimate objective is to create a “pseudo-ETF” the companies must trade on a U.S. stock exchange.

Air Freight:

UPS (NYSE:UPS) – has been in China since the 1980s. UPS Supply Chain Solutions entered the market in 1998 and now is one of the area’s leading 3rd Party Logistics companies. Its services include transportation, warehousing, international air and ocean freight and customs brokerage.

Fed Ex (NYSE:FX) – the world’s largest express transportation company. Entered China in 1984 and employs more than 2,300 people in China.

DHL – would be an excellent choice, but it does not trade in the U.S.

Express Package:

TNT N.V. (TNT) - Dutch postal and express mail company with operations in high-growth markets of Brazil and India, among others.

Logistics Outsourcing:

Many of the large 3rd Party Logistics companies are private, thus are not eligible to be added to the “pseudo-ETF.”

C. H. Robinson Worldwide (NASDAQ:CHRW) - one of the world’s largest third-party logistics companies, CHRW offers shippers a wide range of customized global transportation, logistics and supply chain management solutions. CHRW doesn’t own equipment. Its relationships with truck, rail, ocean, and air carriers mean more equipment options and greater flexibility to bring freight to market. CHRW has been serving customers in South America since 1991 and has 8 offices in China and one in Hong Kong to
provide ocean and air freight forwarding services.

Expeditors International of Washington (NASDAQ:EXPD) - provides logistics services worldwide. The company’s services include consolidation or forwarding of air and ocean freight. It also provides customer brokerage, distribution management, vendor consolidation, cargo insurance, purchase order management, and customized logistics information.

Rail:

Major investments are underway and more planned in China railways. China sees railroad development as clearly an opportunity to showcase their technological innovation. Although some foreign companies such as France’s Alstom, German conglomerate Siemens AG, Canada’s Bombardier Inc. and Japan’s Kawasaki Heavy Industries have had some success selling railway equipment and expertise to China - their preference is clearly on homegrown technology.

Road:

China’s highway networks have only been partly built and the road quality is quite varied. There are more than 2 million trucking companies with between 5 and 6 million trucks in China, most operate locally or regionally. If you have to transport something a long way often you must switch logistics providers increasing paperwork and costs. Trucks are prone to break down and clog roads.

YRC Worldwide (YRC) – is one of the largest road carriers worldwide. It has announced its intentions to enter the trucking arena in China in 2007. Its logistics arm has partnered with one of China’s largest freight forwarders.

The Data Says

The results are quite similar to Indirect Method I. Much of the gain is captured while downside is minimized. I could be accused of curve fitting, but I believe the overall approach is valid.

BRIC

Conclusions

The BRIC transport and logistics industry is very fragmented and local. Many of the major players are either private companies or are not listed on U.S. stock exchanges. This significantly reduces the available companies to choose from. I am not quite satisfied with this current mix of stocks and will continue tweaking it over the next few weeks. Hopefully by then, the ringing in my head will have stopped.

Disclosure: Author has a long position in some of the above-mentioned securities.