Size Matters. Musings on the Ranks of the Largest Companies in the Coming Decade
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In This Report:
• Exxon Mobil, at US$313 billion market capitalization is the world’s largest listed company. The top 20 companies list contains an equal mix at 20% each of Technology, Energy/Commodities list, Banks, Consumer companies, with telecom and conglomerates taking 10% each. China has 5 companies in the top 20 list, up from zero a decade ago.
• Ten years ago 4 companies boasted market caps of more than US$400 billion – none comes even close today.
• Based on what we think are quite realistic assumptions, 7 of the current top 20 (Indust. and Comm. Bank of China 1398.HK, PetroChina Company Limited 0857.HK, China Mobile Ltd. 0941.HK, China Construction Bank Corp. 0939.HK, Agricultural Bank Of China Ltd 1288.HK) could achieve market caps of more than US$500 billion with a couple pushing towards the US$1 trillion mark. A handful of companies in this list could lift market cap by more than 3 times. A “buy and hold” strategy for some of these giants could produce very solid returns over the decade.
• For certain there will be a slew of new companies entering this list, possibly more from emerging markets, with China, India, possibly Brazil producing contenders for the top 20 honours.
• Given our focus on “Hard Asset” companies, we undertake a similar ranking for real estate companies. Real estate is an inherently local business with the largest company, Sun Hung Kai Properties (0016:HK) at US$43 billion market cap a mere minnow against the global giants.
• Asia/Pacific plays host to 63% of the top 30 real estate companies by market cap, with the Hong Kong market accounting for 30%. Despite the woes in the US real estate markets, US property companies still account for 23% of the top 30 league.
• Based on what we think are quite modest views on growth potential and valuations, we think about 9 companies in the top 30 list could deliver returns of around 300% or more over the coming decade.
• The list of top real estate companies will likely change dramatically over the coming decade with rapid rates of urbanization in countries such as China and India producing extremely strong rates of growth in housing development as well as commercial development. This phenomenon has already brought a slew of China and India companies into the top league. We should not be surprised to see China and India names dominating this list a decade from now.
The Global Top 20 a Decade From Now. Some Musings on the Future Shape of the World’s Largest Companies. (….. and Those in the Real Estate Sector)
As the current decade draws to a close, some of the popular financial and business press is musing as to which of the largest companies in the world might first achieve US$1 trillion in sales, or US$500 billion in market capitalization at some point during the coming decade. (The way the dollar is declining, that might come sooner than we think!)
This exercise is a bit more than merely fun conjecture. It poses questions as to what growth is needed for the main contenders to get there, and what sort of stock valuation is needed for stocks to hit that lofty $500 billion market cap target. What industries are likely to be the big growers? What structurally new industries might emerge that challenge conventional businesses and business models? Will countries that do not appear on the current global big hitter list, suddenly produce serious contenders that way China has done in the past decade?
Some see one or other of the oil companies as potential first achievers of this target, while others place their bets on technology names, or consumer giant Wal Mart. Banks do not seem to feature much in people’s thinking on this score, understandably, but one of China’s banks could be a good bet.
Remember there was a time in the late 1980’s when Taiwan’s handful of banks sported a market capitalization well in excess of the entire US banking industry. Japanese banks at around the same time also enjoyed huge market capitalizations, some trading at ludicrous PE valuations of around 90 – 100 times earnings.
Given this newsletter’s focus on “Hard Assets” we follow this global exercise by looking at the world’s largest property companies.
Figure 2 ranks the current world’s 20 largest companies by market capitalization, together with some valuation data and growth characteristics. Exxon, at US$313 billion tops the market capitalization rankings by a decent margin. Just as a point of comparison, we also list the largest listed companies identified by the Financial Times in September 2003 (figure 3). Only ten names are common to both lists. Most notable perhaps is the fall from grace of the large US financial houses, and the rise of Chinese companies into the exalted top 20 list. For example, the Chinese banks and energy were certainly not on the earlier list – and most were not even listed a decade ago.
Who would have thought that Google, the tiny “garage” start up upstart a decade ago, would be amongst the top 20 globally today. Think of Apple, a company that had almost been written off as yesterday’s technology poster child a decade ago would rise to #2 in the global rankings, ahead of rival Microsoft. Perhaps given the state of the US and western economies, it is still surprising that US listed companies comprise still the majority of the top 20 rankings.
Just to take simple stock of the top ranked companies by market capitalization:
- Most are “global” companies – the Chinese banks being the main exceptions.
- Chinese companies make up 25% of the list from zero a decade ago.
- The spread across industry sectors is quite wide, with 20% each in Technology, Energy/Commodities, Banks, Consumer, and 10% each in conglomerates and telecoms.
- Geographical spread of listing and operations is wider than previously, with 9 companies in the current top 20 being non-US companies vs 6 in the 2003 FT list.
Looking to the next decade, probably all we can say is that there will likely be as many changes to the rankings as there have been in the past decade. But where will they come from?
Part of the Underpinnings in These Rankings are Cyclical and Others are more Structural
The inclusion of more “emerging market” companies is a result of both structural and cyclical factors. Such companies are growing rapidly in economies that are growing rapidly.
Moreover, as at this point in time, emerging market economies are performing well, while developed market economies are languishing in the wake of the global financial crisis. China banks for example are attracting high valuations, typically well above 2X book value in response to their robust near term prospects, while western banks are trading generally below these valuations. It is quite conceivable that these roles could be reversed in the coming decade. A financial crisis in emerging markets in the next decade cannot be ruled out. This could occur at a time when Western banks are well into recovery mode and trading at significantly higher valuations while emerging market banks trade at valuations closer to those of western banks today.
Could we see some Latin American companies enter this top league, perhaps some Russian entries, and possibly quite likely an Indian entry or two, and possibly more China names.
At this stage we might indulge ourselves in some harmless speculation as to where our top 20 might be a decade from now in terms of potential market capitalization. Our methods here are far from rigorous, and intended as an amusing piece of postulation – it is by no means a forecast.
We examine the rates of revenue growth that has got these companies to the top 20 today. Then, on the heroic assumption that a broadly similar growth path can be maintained, and today’s valuation is maintained, where would the market cap of these companies be. In some cases it is highly unlikely that the rates of growth that got companies where they are today can be maintained. Nor will current valuations be maintained. We make adjustments for these.
For example, (See Figure 4), taking today’s top ranked company, Exxon Mobile, we see that the company has managed a 5.3% per annum compound revenue growth over the past decade. Assuming this average can be maintained, and assuming a similar valuation a decade from now, Exxon’s market capitalization could rise from US$313 billion today to around US$525 billion a decade from now.
An assumption of revenue growth of around 5% may not be unrealistic for this company, but use of growth rates of the past 10 years to project forward for some companies is likely to be very much less realistic. Moreover, some of the inclusions in today’s list are trading at multiples that reflect an environment of “investor love” – Google and Apple’s valuation multiples probably reflect a nirvana like, priced for perfection state of affairs. In addition, as these companies mature, it must be questionable as to whether they can maintain their past levels of growth and their lofty valuations.
A similar case can be made for the Chinese banks and energy sector.
Berkshire Hathaway has also enjoyed sterling revenue growth over the past decade, a pace of growth that may be difficult to replicate.
How many of these companies might break the US$ 500 billion even the US$1 trillion market cap threshold in the coming decade?
Figure 4 presents a look at the potential future market capitalisation of the top 20 on the basis of “the future continues the same as the past” – i.e the companies in the list maintain the same revenue/earnings growth trajectory and the same market valuations. The only adjustment is for Google, whose past revenue growth has been more than 200% pa. We adjust this down to 30% pa for this exercise.
We also undertake an “Adjusted Future” ranking which considers perhaps more realistic growth trajectories for some companies.
How Much Nonsense is There in the Uncensored Arithmetical Gymnastics? Probably Quite a Bit
First – Apple. It is hard to imagine Steve Jobs’ company maintaining its string of iPod, iMacs, iPhone, iPad hits that have driven this company from the edge of oblivion to icon in the past decade. So what if Apple’s growth slows down to half its recent pace, to a still respectable 10% and the stock’s “we love you” valuation falls to about two thirds of its current status, market cap would be around US$445 billion, well short of the $1 billion mark. But still up a healthy 70% from today’s level. Not all bad.
And what about the China banks? One has to question whether they can maintain the 15% to 20% revenue growth over the coming decade. China’s government is trying desperately to rein in lending right now. There is a growing risk of a wave of non-performing loans following the government’s exhortations in 2009 to “Go Forth and Lend!”, with the pace slowing only slightly in 2010. Also, Chinese banks are trading at relatively high valuations. A drop in revenue growth to about two thirds of the recent levels and a more “industry average” valuation would bring market capitalisation a decade from now back to the $450 – $600 billion range. Still, not to be sneezed at.
The other three “Trillion Dollar” contenders in this list, BHP Billiton, Petro China and Berkshire Hathaway have all enjoyed revenue growth at the top end of the range of this group of top market cap companies. With the US economy set to grow at well below its theoretical potential in the coming few years, I would have to assume that Berkshire is going to be hard pressed to maintain the pace of revenue growth that it has enjoyed in the boom years of 2000 – 2007. The leadership question of the company is also likely to cast a pall over investor perceptions going forward. The sage of Omaha is only human!
In the second part (see figure 4), we make some subjective adjustments to assumed revenue growth based and on valuation metrics, particularly for companies we see as currently trading at very much exalted valuations.
This produces what we think is a far more realistic profile of potential future market caps of the current top 20. Here we see some 7 companies rising above US$500 million market capitalization level with a couple pushing close to the $1 trillion mark – China Mobile and PetroChina.
BHP Billiton comes through as a potential challenger in the very top of theleague. Natural resource prices may well be buoyed by emerging market growth and a general shortfall in supply of many commodities and core energy. Also, these companies may well grow through acquisition as much as organically by product price appreciation.
All in all, I have to conclude that the chance of seeing the first US$1 trillion company in the coming decade is no more than 50/50. It will require a perfect bringing together of earnings/revenue growth and a top-of-cycle valuation. That is what has got Apple and Microsoft right up there in the top league, as well as the Chinese banks and energy companies.
Will there be a new Google out there, coming from way behind the curve? Will something out of bio-tech be the next Google, a product of the genome project? Will we see some emerging market giants come screaming out of the chutes? Will some of the old contenders such as US banks get a new lease of life, and catch the next wave of growth and valuation over the coming decade?
Given our Hard Asset Focus, Let’s Run this Process for Global Real Estate Giants
For some time we have been watching the relative rankings of companies and countries in our sector of real estate. While listed real estate companies cannot claim the extreme market capitalizations that we see in some other sectors, the size of companies does tend to fluctuate considerably, particularly in Asia, and size of companies has grown significantly in the region, over the past decade.
Real estate companies are never likely to become part of the ranks of the “mega” companies. Most of the “mega” companies are global in scope of their businesses, with the exception of the China companies that are still largely domestically focused. That however is changing and the pace of global penetration of these China businesses is likely to quicken.
Most goods and services that are contained within the global mega companies are globally priced, or at least close to it. Real estate however, is very much locally priced and detailed understanding of one local market does not translate easily to another market even in the same country, let alone across borders.
Figure 7 lists the top 30 listed property companies around the world by Market capitalization. Asia (including Australia) accounts for 63% of the top 30, with the Hong Kong market hosting a total of 30% of the top 30. Hong Kong’s Sun Hung Kai Properties (0016:HK) at US$43 billion market capitalization is largest by a decent stretch, but still is less than one quarter of the smallest company on the global top 20 list.
The number of US companies in the top 30 property list is perhaps a bit surprising given that it is the US property market and lending to this sector that has driven the global financial crisis. There are likely to be many shoes to drop in the commercial property lending scene in the US over the coming year or two, as nonperforming commercial real estate loans grow. The residential mortgage defaults are well known and likely to be a continuing drag on the sector for at least a couple of years yet.
The growth of several of the US and European names on the list has been driven by acquisitions rather than organic growth of a core portfolio. This is a far cry from Asian markets where growth by acquisition is virtually unheard of – unless it is acquisition of portfolios from the controlling shareholder’s personal portfolio!
City of 7 million hosts 30% of world’s largest property companies
Asia has long played host to the largest names in the listed real estate universe, and most particularly Hong Kong. It is perhaps something of an oddity, that a city of a mere 7 million people can produce the largest listed real estate companies in the world. These companies have got to this level primarily by developing and holding properties just in Hong Kong itself, but are increasingly active in China.
In recent years property players in the region have become rather more international in scope, in particular, by tapping into China’s frantically growing real estate markets. However, China properties still account for a small part of the net asset value of such companies, but it is likely to continue to grow.
China and India property companies have come out of the gates at great speed over the past few years, and in China’s case, in great numbers. There are 121 property companies listed in China’s domestic ‘A’ share market and literally thousands of unlisted companies. Ten years ago this was a mere handful. There are now 46 China property companies listed in the Hong Kong market and a handful in Singapore.
In Asia, the listed property scene is dominated by property developer companies whose operations are largely a “build and sell” model. The focus is largely on residential property for sale, but increasingly such companies are building up their portfolios of investment properties to ensure more steady income streams. These companies account for about 60% – 65% of the regional listed real estate universe.
Property investment companies typically buy or build to hold for long term rental income and capital growth. Asset turnover is low, and income streams more stable and predictable. In Asia these companies account for about 20% – 25% of total market capitalization in the property sector.
Real Estate Investment Trusts (REITs) are a relatively recent phenomenon in Asia, though have been around for a lot longer in Australia. They account for about 12% – 15% of regional property sector market capitalization. They will likely grow rapidly in markets like China and India the next time the property sector produces a rash of non-performing loans in the domestic banking system. They should appeal also to an emerging pension and insurance industry.
Headline Numbers from the Past Make No Sense for Identifying the Future in this Sector
Looking forward to try and see how the sector might shape up over the coming decade, we find considerable difficulties in using past published numbers as a realistic guide of potential future growth.
Possibly the biggest problem comes from accounting rules changes over recent years that require property companies to take property revaluations through the Profit and Loss account rather than through reserves in the balance sheet, which was what most companies did in the “good old days”. This piece of accounting nonsense is driven by the “mark to market” rules imposed by the accounting mandarins in the post Enron era. Little concern do they have for the fact that it makes a complete nonsense of the P&L accounts of large numbers of companies whose core business is holding assets for the long term, and not just property companies are affected by this.
This rather absurd accounting rule makes for massive distortions in published accounts of most companies in this sector around the world.
To plot future growth based on historical published numbers makes no sense whatsoever for large swathes of the sector.
What we have done here is take a more subjective look at the nature of the business of each of the top 30 in the sector, and give some ranking as the theoretical potential growth that the companies might achieve given our understanding of their business model, sector, geographic location, point in the business/property cycle. This does give some credence to past performance of core earnings but is not a simple forward projection of these.
We assign each company to one of the three categories identified above and assign a “theoretical” growth rate for that kind of company adjusted in some cases based on business model, geography, or sector. We then apply a multiple that has traditionally been in the historic range for such companies.
The global listed property sector is made up of three types of companies that have inherently different growth and valuation characteristics. We can broadly define these as follows:
Group 1. Property investment companies and Real Estate Investment Trusts (REITs)
The earnings of the first group are typically dominated by rental income, which in turn is dictated by the lease renewal cycle in each country. Earnings growth can therefore be expected to be modest, (probably mid-single digits over the long run) even in rental up-cycles as an owner typically may be renewing only say one third of his leases in any one year.
Group 2: Property developers/investors in mature markets.
Companies in this group often have a mix of properties for build and sale, and possibly some properties for rental income. In mature markets, demand is typically quite stable and price trends tend to be modest both on the way up and down – Hong Kong and Singapore may be exceptions to this stable price tendency. Developers often have the potential for higher earnings growth than property investment companies/REITs but typically can be high single digits to mid-teens growth rates.
Group 3: Property developers, emerging markets.
Developers in this group tend to be big beneficiaries of a rapid pace of urbanization in emerging markets, and rapidly rising economic growth and household incomes. Sustainable growth rates of 15% – 30% are not unusual.
Bearing in mind that our objective here is to attempt to put some scale on the world’s largest property companies a decade from now and some crude idea of ranking, this is never going to be the last word in accuracy. There is any number of factors that could derail these trends:
- Companies that today may be on the cheap or expensive end of their ranges, may be in a completely different part of their respective cycles a decade from now, sporting very different valuation multiples.
- Our models make no assumptions about any future acquisitions, mergers etc, something that has certainly been a factor in the growth of US and some European property companies, but not so in Asia.
- Companies may change in nature. For example some of the more aggressive high profile developer companies may take on a lot more investment properties which may in fact slow earnings growth and produce rather different valuation metrics.
- A rise in securitization in some markets such as Asia may lead to large divestments of property assets into REITs or other such vehicles, which could well impact the size and nature of the original parent company.
- As indicated earlier, we should not discount the possibility of another destabilizing down-cycle in certain property markets within our universe.
A Good Number of Top 30 Property Companies Could Conceivably Grow Their Market Capitalisation Fourfold in the Coming Decade
Based on our assumptions as to potential growth and our assessment of “reasonable” valuations, the sector may well produce a handful of companies with market capitalization of more than US$100 billion from the ranks of our top 30. But the numbers of such companies are likely to be quite small (see figure 8).
Perhaps more important is the potential growth in market capitalisation that investors might expect over the coming 10 years from this group. This might give a better impression of how investment in this asset class might fare over this period.
So if size, liquidity and growth are the targets for investors in this sector, some powerful performances look quite possible in the coming decade from our existing top 30 list. Some of the larger companies in the US could resurface from their current difficulties and produce similar rates of growth if recovery occurs rapidly enough.
This list is unlikely to contain the absolute fastest growing companies in the sector for sure – this honour will likely go to any number of much smaller companies, and some that may not even be listed as of now. Latin America, Middle East, China and India are likely to be the homes of such companies given the rapid rates of urbanization that is occurring in some of these countries along with rapid rates of economic growth.
An apparently easy subject made very difficult by data providers hard to understand practices and even harder to understand accounting rules.
This newsletter has surprisingly proven to be the most difficult note to write that we have experienced for quite some considerable time.
Firstly, we find that it has been surprisingly difficult to extract longer term data from our core data service provider, a company with a household name which has been in the financial data market for more years than I can remember. This company continues to this day to collect stock market data but does not save it. The company throws away valuable historical market price data after certain periods of time and therefore cannot provide longer term stats on a whole range of market data.
In the days of yore, when data storage was expensive, this practice seemed almost defensible (though others still managed to retain their data). However, today when even the smallest of companies (like ourselves) routinely have terabytes of cheap storage, the practice of discarding longer term market and economic data seems daft.
Secondly, the published data that is available in most data services, particularly for property companies, is nonsensical to use in its unfiltered form. This is because of recent mark to market accounting rules that have been introduced, particularly in the wake of Enron scandals and other such problems of the past decade.
In specific terms, the new rules require property companies, for example, to take any revaluations of their property assets through the P& L account, rather than through the reserves in the balance sheet as was previous practice. As property companies typically revalue their investment properties each year to current market value this practice produces massive distortions of published numbers that then find their way into the data bases of the major service providers.
For example a property investment company that has a $1 billion portfolio of properties that it leases out, producing say a net rental income of say $50 million, revalues its properties in the wake of the financial crisis. The portfolio could easily be marked down by 20%, to say $800million but the company could still be turning a rental income of around $50 million. The company’s P&L accounts would reflect a headline loss of $150 million. And this year, as the market recovers, a $150 million profit.
Due to these issues, what seemed like an easy enough project to begin with has proved to be a difficult beast to tame.