Corporate Earnings And The Illusion Of Emerging Market Growth

by: William Gamble

If there is one thing that gets investors, especially American investors, excited it is when CEOs announce with great fanfare that their companies are going international. Most investors view international expansion as the perfect solution for saturated markets in developed countries. They see vast potential in billions of potential new customers who are equipped with all the amenities of the home market but are not sufficiently served. Without any meaningful competition the company can embark on a voyage of profitable conquest into this brave new world.

Recent examples would include the much hyped move of Netflix (NASDAQ:NFLX) into Latin American. The stock hit a new high. There was only one slight little problem. Since most Latin American countries lack the high speed internet infrastructure, Netflix streaming technology is useless. Starbucks (NASDAQ:SBUX) stock rose after the announcement of plans to expand in Germany and its intent to produce an home coffee machine capable of making espresso. Its main competitor is the giant Nestle (OTCPK:NSRGY) who already has a well established Nespresso machine. These are also established markets and there is not a single Starbucks store in all of Italy.

If CEOs really want to impress analysts and investors these days all they have to do is to hint of expansion in China and other emerging markets. With dynamic economies, low debt and great demographics these markets are supposed to return consistent growth for the foreseeable future. Certainly this has been true in the recent past and it is certainly true in this earnings season.

For example Kimberly-Clark's (NYSE:KMB) North America sales fell as consumers bought cheaper generic products. In contrast sales were up by double digits in emerging markets. Chinese revenue increases were the highest at 45% with Latin American and Russia growing strongly at about 25% each. GE, Honeywell, Yum! Brands, McDonald's and Coca-Cola all had over double digit growth in emerging markets in some cases the growth was over 100% for GE in Russia.

Car companies are falling all over each other to build new capacity in China in hopes of strong growth. Nissan plans to invest over $400 million. Ford is investing $760 million. Volkswagen is building a $270 million plant in the western Chinese city of Urumqi and even Renault has just signed a letter of understanding with Dongfeng Automobile.

But there is one problem with all of these earnings expectations and forecasts. Emerging markets including China are slowing. For example although car sales in China grew by 35% in 2010, they only increased by 5.2% in 2011 and they actually fell by 3.4% in the first quarter of 2012, a real problem since the forecast was for a 8 to 10% growth for the year.

China's growth while still rapid has fallen steadily from over 10% in 2010 to 8.1% in the most recent forecast. In line with some predictions, China has started to reinflate with increased bank loans. However with demand softening in its major markets in Europe and the US, the extra stimulus has nowhere to go and makes inflation worse.

And China's slow down is hardly unique among emerging economies. All of them have growing problems. Brazil was once one of the stars of the emerging markets. It recovered rapidly after the crash as growth topped 7.5% by the end of 2010. Its market increased over 90% from its lows in November 2008. However its economy is now stagnating. Its growth rate in 2011 was 2.7% and its economy actually declined in January. The central bank cut Brazil's Selic interest rate to 9% its lowest level since April 2010 and only 25 basis points off its 15-year low of 8.75% despite inflation running at 5.5%.

India is also slowing. Its growth rate is still rather strong at 6.1% but this is a marked slowdown from 2 years ago when it was over 9. Like Brazil the central bank recently cut interest rates by 50 basis points to 5.5%, but also like Brazil this could help reignite inflation currently running at over 9%. Inflation heats up; both countries could be forced to slow their economies further.

Part of the problem for emerging markets is that many are dependent upon other economies. Exports to China contribute 1% or greater to the GDP growth of Russia, Indonesia, Korea and Brazil and about .8% to Germany. China also is the export market for over 20% of the exports of Taiwan, Australia, Korea and Japan and 17.3 % of Brazilian exports. So as one emerging market slows, so do they all.

To the extent that we believe earnings forecasts by analysts and companies, record earnings are supposed to continue this year and next. With Europe's problems far from solved, an anemic American economy and now rapidly slowing emerging markets, the probability that these forecasts will be anywhere near accurate is zip.

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