Why site visits are an essential complement to desk research in emerging markets.

Digging through the small print in quarterly reports and bond documentation is obviously an important part of the emerging markets debt analyst’s day job. But sometimes we need to get out from behind our desks and do some real digging. In this article we show that some actual mining, rather than just data mining, can be the best way to get a close-up view of our portfolio bond issuers and their performance.

With that in mind, on recent research trips to China, South Africa and Argentina, three of us sent postcards back to our colleagues sharing details that we simply couldn’t get from desk research. Some of these details re-affirmed our existing views and some challenged them—but every trip supported contrarian positions, and concerned a range of performance and risk issues, from environmental, social and governance questions to capital efficiency.

Postcard From: Alexander Sklemin in South Africa

I was in South Africa recently, visiting several facilities owned by two gold- and diamond-mining concerns in our portfolio.

The gold miner has growing U.S. operations but remains essentially a South Africa business—which partly explains why we were able to buy its bonds at such attractive valuations in 2017.

A lot of deep underground operations at South Africa’s legacy mines are being restructured or closed due to high costs. Uncertainty reigns over the government’s contentious Mining Charter. The company I visited is closing one mine as a result of strikes, illegal mining and costs, and suspending investment in another.

My visit was an unusual opportunity to learn more about the technological realities of ultra-deep gold mining, and the only way to get real confirmation that the ESG issues that afflicted the company’s other sites are being dealt with rigorously at the sites it is still investing in.

I was not only able to observe how seriously safety is promoted at the mine—I actually experienced it, too, as I was kitted-out with a state-of-the-art breathing apparatus. Working conditions are likely to have a big impact on the salary negotiations expected in 2018, and they also play a notable role in the ESG scoring that is an important component of our corporate debt strategy.

The tight security measures I saw reassured me on illegal mining by “Zama Zamas”, which had been so damaging at the other sites. Zama Zamas are usually former miners who enter facilities illegally to steal gold via unauthorized mining. They often pay legitimate employees to bring them food so that they can stay down the mine for days at a time, at their own extreme risk.

I came away reassured that this company’s bonds represented genuine value. On top of that, descending into the three-kilometre-deep mine was a genuine “parachute-jump” moment for me, one of life’s great adventures that I will never forget and will always share with those close to me.

Alexander Sklemin kitted-out for work 3,000m underground Stringent measures to tackle illegal—and highly dangerous—unauthorized mining

Our diamond-mining issuer was another value opportunity that required thorough verification.

A recent credit downgrade due to elevated risks at its operations in Tanzania, as well as labor disruptions in South Africa, has led to volatility in its bonds. Its future prospects depend upon two recently completed investment projects for mining and processing diamonds, from which the company expects significant cost savings, due to more sophisticated crushing and processing of the ore, and substantial automation. This sounded promising, but the new technology is still ramping up: my visit would help to assess the claims.

I was impressed. The processing plants were empty of people. Once ore is mined, virtually every stage in the process is automated and the plants can operate 24 hours a day, seven days a week.

Once ore is washed and crushed, the latest equipment at these new plants X-rays it to identify large diamonds. These are extracted, and the remaining ore is crushed again and the X-ray machines are re-tuned to detect smaller stones. With the old technology, a lot of these smaller diamonds would end up in the “tailings”, or mine waste: the new X-ray technology improves yield and cuts waste.

I came away reassured about the efficiency improvements, which should help the company reduce its leverage and return its balance sheet to better health.

Postcard From: Doreen Saik in China

I was visiting three major Tier-2 cities in China—Nanjing, Hefei and Hangzhou—to see whether reality matches the story of a slowing property market that we hear from official data, professional research and the media.

All three cities have implemented policies to ease housing demand, such as home purchase restrictions, re-sale restrictions, higher mortgage rates and lower credit availability. Still, anyone who goes to see real estate developers and their projects with their own eyes cannot fail to see robust demand. Houses are being snapped up quickly at launch because buyers fear that rising prices will make them unaffordable if they wait. It is not unusual to see developments 95 – 98% sold-out at launch in these three cities.

Remarkably, many of those transactions are cash-only, partly because mortgage rates can reach as high as 1.2-times the benchmark lending rate and banks’ lending quotas are very limited, but mainly because it enables developers to register them as contracted sales. Young university graduates will borrow cash from their parents rather than risk prices flying away from them as they try to save it.

On top of this robust demand I also saw constrained supply. Price caps introduced in an attempt to cool housing costs have made some local authorities reluctant to release land for sale. Others are opting to release cheaper, out-of-town plots rather than prized city-center land. That has reduced housing inventory in these three cities to an average of around nine to 12 months’ worth of current demand, and in some cases as little as three months’.

China is determined to take the heat out of these markets. Policies will remain tight and new restrictions will be tried out. Expect greater focus on rental housing, for example; Nanjing’s local authorities now require developers to build social housing for government ownership as part of land auctions, and to hold a percentage of their bid land as an investment portfolio. Policies like these should eventually slow down the appreciation of land and real estate prices—but for now demand more than matches supply, leading us to remain constructive on the opportunities in these regions.

Postcard From: Isidro Arrieta in Argentina

I was in my home country of Argentina getting local color on the new administration’s energy sector reforms, as well the outlook for Argentinian banks.

Following years of subsidies and non-adjustable tariffs for consumers, underinvestment has left Argentina struggling to meet demand for power. That is all changing. The administration elected in 2015 is removing subsidies, allowing tariff adjustments, and auctioning power-generation projects. This has attracted established utilities, but also some interesting newcomers that are raising capital to finance projects, sometimes in partnership with multinational engineering and utility groups.

One such company caught our eye with a tap issue of a high-yielding bond in 2017. Following a series of agribusiness investments, it had partnered with a multinational engineering conglomerate to build four power plants. The construction is currently delayed and during our site visit we were able to get a better grasp of the difficulties that the company is facing, and other valuable updates that have been key to our discussions on positioning.

I also met management at some other Argentine utilities and all of them were very positive on the outlook for their sector. The companies visited had all participated in auctions of either thermal or renewable energy that the government held in 2016 and 2017. For these companies, higher prices and a more attractive regulatory environment are the key drivers for higher investment, which they expect to continue growing over the next two years. Overall, Argentine utilities are expected to build 4.7GW of thermal energy and 4.5GW of renewable energy during 2016 – 2019, and this trip gave us valuable information on the progress they are making toward realizing that capacity.

The picture has also improved for the Argentine financial sector since the new administration came to power in December 2015. Banks have increased their willingness to lend, with the loan growth rates of the country’s top banks significantly above the inflation rate.

Management that we met highlighted the importance of the government’s fight to reduce inflation. For Argentine banks, lower inflation expectations as well as higher rates are making longer-duration lending more attractive. They were also talking up the potential for higher mortgage growth—perhaps as high as 10% of GDP as opposed to the current rate of 0.3%—after the government introduced new regulation that essentially allows banks to adjust the capital lent to a customer by inflation.

It’s really exciting for me, as an Argentine, to see the locals with a brighter outlook for the country. Companies see more opportunities to invest and the strong interest in the government’s power auctions was a very clear signal that they expect improvement to be significant and sustained. I came back from my trip with a positive outlook on the country and I expect to see further growth in new bond issuance.

Trust, but Verify: The Value of Seeing with Your Own Eyes

As we noted, some of what we learned on our site visits reaffirmed our views, some challenged them, but all supported contrarian positions. The mining companies had genuinely addressed the safety and efficiency problems that had dogged previous projects; China’s Tier-2 city real estate developers are far from drowning in a sea of unoccupied apartments; and in Argentina we learned to interrogate more closely the individual opportunities at the heart of the country’s undoubted power-generation story, and got a sense of how exciting the lending opportunity is from inside the financial sector.

A securities analyst has to trust reported data and the good faith of company management communications, but it is not cynical to acknowledge that executives spin things as positively as they can, and to verify things with your own eyes. They are often not as rosy as described. But on occasion, we are pleasantly surprised to find that they are.