Long-Run Growth Will Continue For EMQQ

Summary

• EMQQ's industry focus will position it well to benefit from the long-run growth of internet usage and e-commerce spending in emerging markets.
• It also minimizes exposure to common emerging market risks such as commodities, complex supply chains, and bad loans.
• In spite of unfavorable sentiment towards emerging markets, EMQQ has outperformed the S&P 500 over the past 3 years.
• I'll be looking to buy EMQQ if market weakness continues.

The Emerging Markets Internet and E-commerce ETF (NYSEARCA:EMQQ) has a unique industry and geographical focus could make it especially well positioned to benefit from key long term demographic and technological trends. The current market turmoil from the coronavirus outbreak might is unlikely to stop the key growth drivers for EMQQ.

Growth Potential

EMQQ’s target index includes only companies that derive more than 50% of their revenue from internet or e-commerce in emerging and frontier markets. The businesses in the index generate revenue online from a variety of products including search, retail, video, e-payments, and online gaming.

According to research from McKinsey & Company, half of the world increase in consumption between 2013 and 2025 is expected to come from emerging markets. Investing in the internet and e-commerce sectors is the best way to capture the rising importance of emerging market consumers.

Internet and cell phone access is increasing rapidly across the emerging world. Greater internet access is coinciding with greater acceptance of e-payments(note that that two of EMQQ’s largest holding have major e-payments businesses). Greater acceptance of e-payments is highly correlated with an increase in online commerce. Internet access becomes more important as more people get it, due to network effects. This creates a self reinforcing feedback loop benefiting EMQQ’s holdings. Although internet usage in the developed world is nearly ubiquitous, in emerging markets, there is still a massive runway for growth.

This table shows how low internet penetration is in Asia, Africa, and Latin America compared to Europe and North America.

Source: Internet World Stats

A 2018 Credit Suisse report highlighted the magnitude of the emerging market e-commerce opportunity. The trends they highlighted are continuing in full force. For example, urbanization in emerging markets is driving greater online shopping. This is especially true in for “fast moving consumer goods” (FMCG), including beverages, food, and toiletries. online food delivery only makes sense when there is population density. In South Korea 19.7% of FMCG transactions were done online, compared to 6.2% in China, but the figure is growing. EMQQ industry focus will put in a a prime position to benefit from this continued growth.

Portfolio

Since EMQQ is entirely focused on internet businesses, it avoids direct exposure to common emerging market risks. It has no direct exposure to commodities. Similarly it has no exposure to banks or financial services, other than the e-payment platforms of tech companies such as Alibaba and Tencent. Consequently EMQQ avoids the risks caused by the buildup in bad loans on the balance sheets of Chinese banks. Additionally, it doesn’t have direct exposure to heavy manufacturing or industries with complex physical supply chains. Of course, there is risk to being heavily exposed to emerging market consumers. The overall amount of consumption would certainly drop in the event of a recession, but the increasing adoption of e-commerce is a trend that is unlikely to reverse.

Contrast EMQQ with MSCI Emerging Markets index (EEM), a popular broad emerging markets fund. EEM has 24% in financial services, with large holdings in major Chinese banks, and insurance companies. EEM also has significant holdings in materials (7.11%), and industrials (5.21%), both sectors more likely to rely on complex global supply chains than typical internet businesses. EEM’s sector weighting don’t break out the internet and e-commerce industries the way EMQQ does, but it does indicate 16.07% to IT, 14.3% in consumer discretionary, and 11.5% in Communication services.

Industry focus drives different country weightings within emerging markets for EMQQ. Inevitably, any broad emerging market fund will end up with a large China exposure. EMQQ has 61.5% of its assets in China as of January 2020. This is nearly twice the 34.2% China exposure in EEM, reflecting the importance of Chinese tech giants relative to those in other emerging markets. The second largest exposure is in South Korea with 11.7%. Germany is also a major component, because the criteria are based on where a company generates revenue, not where it is listed.

EMQQ’s country weightings are shown in the following chart:

Source: Fund Fact Sheet

Of course location of listing does not always correlate with source of revenue. While EMQQ only includes companies with over 50% of revenue coming from emerging or frontier markets, many emerging market companies are heavily reliant on the developed world for revenue. For example, Taiwan Semiconductor (2330.TW), which is the third largest position in EEM, earns 60% of its revenue from the US. In this way, EMQQ is more of a true emerging market play.

EMQQ, which holds 80 stocks, is much more concentrated than EEM, which holds over 1000. Ironically, the top two holdings of EMQQ and EEM are the same, although EMQQ has proportionally larger positions. EMQQ has 8.15% of its assets in Tencent and 7.97% in Ali Baba. The index rules cap individual company weightings at 8%, with quarterly rebalancing. EEM has those holdings weighted 4.64% and 5.89% respectively. However, the holdings lists diverge significantly after that. Four of the top ten holdings in EEM are Chinese banks or insurance companies. In contrast, EMQQ goes deeper in the e-commerce space with holdings in Asia and Latin America. EMQQ holds 43 companies, accounting for 30% of total assets, which are not in EEM.

The top ten holdings of EMQQ are shown in this table:

(Insert Table)

Ticker	Company	Country	Weight
0700	TENCENT HOLDINGS LTD ORD	CHINA	7.98%
BABA	ALIBABA GROUP HOLDING LTD DR	CHINA	7.75%
NPNJn	NASPERS LTD ORD	SOUTH AFRICA	7.53%
MELI	MERCADOLIBRE INC ORD	ARGENTINA	6.96%
PRX	PROSUS NV ORD	NETHERLANDS	5.46%
3690	MEITUAN DIANPING ORD	CHINA	5.46%
BIDU	BAIDU INC DR	CHINA	4.89%
JD	JD.COM INC DR	CHINA	4.87%
035420	NAVER CORP ORD	KOREA	4.36%
NTES	NETEASE INC DR	CHINA	4.29%
PDD	PINDUODUO INC DR	CHINA	4.13%

Click to enlarge

Source: Thomson Reuters Eikon

EMQQ's management fee of 0.86% is relatively high compared to 0.68% for EEM, but it does offer a more focused portfolio.

Performance

EMQQ’s focus has delivered results. Unlike the broader emerging markets index, EMQQ has outperformed the S&P 500 over the past three years.

Source: Fund Fact Sheet

However, it sold off this past week as the coronavirus roiled markets. EMQQ is now ~12% below its 52 week high.

Source: Thomson Reuters Eikon

Given the coronavirus originated in China, and many many EMQQ investors are driven by Chines consumers, investors might be concerned that the drop in EMQQ is just beginning.

What about the Coronavirus and other Geopolitical Risks?

Companies around the world have warning of negative impacts caused by the coronavirus. The greatest risks are in companies dependent on complex supply chains needing just in time parts from factories in virus hit areas. Other countries dependent on Chinese tourists will also suffer negative impacts. With a proportionally large China exposure, EMQQ faces significant risk from the coronavirus outbreak. Internet and e-commerce companies are not immune from the virus either. Alibaba warned of a drop in revenues caused by the virus. On the other hand, internet companies are adapting and providing jobs for those displaced by the virus.

Over the next year, China faces a delicate balance between containing the outbreak, while supporting economic growth. Consumer spending is likely to be weak for the first part of this year. EMQQ investors might face some short term pain. However, the problems will be temporary.

Once the virus is contained, consumer spending is likely to recover quickly. Even if there is a longer dropoff in business travel, revenue from online businesses such as search are likely to continue growing as China, and the rest of the emerging world increases internet usage. Additionally, sentiment around Asia is extremely negative, and is pricing in a large amount of damage from the virus. If the damage ends up being less than people expect, the markets could get a sharp boost as people buy back in.

According to Franklin Templeton:

The mass adoption of technology, rising consumption and premiumization (rising consumer demand for premium goods), manufacturing upgrades and government reforms should help the country emerge from this challenging period stronger and more self-reliant, with multiple pillars of economic support.

The coronavirus outbreak, combined with trade tensions could drive a rearrangement of global supply chains, and bankrupt overleveraged firms. The disruption will negatively impact many sectors, but will not permanently alter the speed of internet adoption and the rise of e-commerce in emerging markets.

Conclusion

EMQQ’s manager pointed out on a recent Seeking Alpha podcast that with EMQQ investors are paying a slightly higher valuation than the US markets, but getting dramatically higher growth. The current pandemic will have a negative impact on near term investor sentiment, but the trends benefiting EMQQ’s portfolio companies will continue long after the current turmoil passes.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.