Changing gears: Industry priorities are set to shift as development continues

Though the industrial and manufacturing base in Mongolia is tiny and facing significant structural challenges, several niches within this economic sector seem ideally suited for growth, and progress is already measurable. Segments including beverages, food processing, fast-moving consumer goods and pharmaceuticals look poised for expansion. Many of the metrics global investors look for in frontier markets are available in Mongolia, such as low penetration rates, rising consumer salaries and a demographic bulge under the age of 30. The time has come to brand products and build loyalty.

UPCOMING EXPANSION: Demand should rise, as production in the mining sector in 2012 seems certain to provide a great leap for this small economy. Just how much of an impact resource extraction will have on the economy is not yet clear, but a doubling or tripling of GDP multiple times in the coming decades is not out of the question. An often-cited research report by Citibank predicts that Mongolia may well end up having the highest GDP growth rate of any country in the next 20 years.

This will have both direct and indirect impacts on consumer demand. Mining itself is not a labour-intensive activity, but wage increases in the sector offer a clue of the amount by which income discretionary levels are likely to rise across the board. According to local media, the increase in sector salaries paid in 2011 was projected at 19%. Revenue from the mining sector will boost government spending, such as on wage increases, as well as unlocking economic bottlenecks and on programmes to boost the fortunes of salaried Mongolians as well as the entrepreneurs selling them goods and services.

DIVERSIFICATION: To be sure, the likelihood of a diversified industrial and manufacturing economy remains small. Even a huge boost to domestic demand is unlikely to justify spending billions on the factories and supply chains required to replace imported goods because of the small domestic consumer base. Though natural wealth is bountiful, it is not evenly spread across the range of basic commodities that are generally required.

Furthermore, China and other developed manufacturing powerhouses such as Japan and South Korea are nearby, and import channels are already developed. These countries can easily meet Mongolian demand for basic consumer goods. So for budding Mongolian industrialists, the challenge is to find a niche, and that process is under way.

FOOD & BEVERAGES: One area of strength to emerge thus far is food and beverages. In addition to local sensibilities and distribution channels, companies in this sector also have the opportunity to win large contracts to service the mining sector. Beverage-sector leader APU, for example, won a contract to supply drinking water for the Oyu Tolgoi mine, which requires 7-8 tonnes of the liquid daily, according to research from the Ulaanbaatar office of investment bank Eurasia Capital.

Alcohol in particular has stood out as a growth area since 2008, when 16 people died after drinking small-batch vodka. The government responded by abolishing smaller producers. Larger ones have been the main beneficiary – the value of APU stock has increased four-fold since. Like many Mongolian listings, however, only a small share of ownership trades publicly – about 8%, according to Eurasia Capital.

APU was founded in 1924 as the state monopoly company for vodka, beer and soft drinks. It was privatised in 1992, and is one of a small minority of Mongolian companies to have sold bonds. The firm has in the past decade focused on updating its physical plant and production processes, and now has the capacity to produce about 58.4m litres a year of its products, according to economic research by the Hong Kong securities firm CLSA. Exports go to Korea and Japan, and some raw materials are imported from China. As of early 2011 it had a 46% market share in beer and 40% market share in vodka sales.

FOREIGN SUPPORT: Rival company Vitafit, a leading producer and distributor of non-alcoholic beverages in the country, announced in December 2011 a $6.5m loan from the European Bank for Reconstruction and Development (EBRD) to upgrade its equipment. Vitafit has been a repeat customer of the EBRD, which has played a prominent role in financing the country’s private sector.

Mongolia has been a member of the development bank’s Early Transition Countries Initiative since 2006, which has brought more than $465m in loans and investment to the Mongolian economy across 41 projects in various economic sectors, according to the EBRD. The EBRD has also in the past financed the local Coca Cola bottler, MCS Coca Cola. The company in 2005 and 2006 saw sales increases of 56% and 80%, making MCS one of the largest private enterprises in the country. Coca Cola sales will soon be challenged by the entrance of PepsiCo into the market, as part of a partnership with GN Beverages.

Other players in the food-and-beverages sector include Spirit Bal Buram, MCS Mongolia, GEM International and Chinggis Shar Airag. Competing with APU will be a formidable task – it has the strongest distribution network, with an estimated 6000 sales points, and the greatest access to capital, as one of the most traded equities on the country’s bourse. In addition to its contract to supply Oyu Tolgoi with water it has also locked up service deals with a number of government ministries. Growth projections do leave room for others to prosper also. While the annual per-capita consumption of spirits, at 12 litres a year, is fairly mature, beer consumption is low – 16 litres a year per person, compared with 32 litres in China and 81 litres a year per person in Russia.

Eurasia Capital research indicates per-capita demand could reach parity with China in three to four years, implying this segment may more than double.

PHARMACEUTICALS: Similar per capita consumption numbers indicate a growth story in pharmaceuticals as well. According to data compiled by Monos Group, the dominant domestic producer, the average Mongolian’s expenditure on medication is $15 a year. Russians spend four times that, at $60, and the global average is $120. Monos’ projections show Mongolian spending rising by 33% in 2011 to $20, and by 20% in 2012 to $25. L. Khurelbaatar, the president of Monos, estimates that over the next decade, the average annual growth rate will be 25%.

Growth drivers include increased buying power, as in other sectors, but also the development of the insurance sector in Mongolia. Private health insurance in 2011 covered less than 1% of the population, but that figure is expected to increase at a 10% rate annually in the near future.

The value of the market was estimated at about $30m by Monos in 2011, of which about $12m came from locally-produced products. There are more than 40 pharmaceuticals companies in operation, but 10 have captured 90% of the market share, including Monos, which has a 40% share. Ex-Impex is the second-largest. Before 1995 there were just five companies, all state owned.

Khurelbaatar said that anti-monopoly laws in the sector have the company more interested in diversification than increasing its focus on drug production and distribution. The government has to date provided little support in the way of subsidies for drugs – between $1m and $2m a year, he said, for chronic conditions such as diabetes.

GOVERNMENT SUPPORT: The government is, however, looking to support the industry by increasing capacity to spot counterfeits and stop their entry into the country at Customs-control points on the country’s borders with Russia and China. Fake drugs are estimated to comprise somewhere between 5% and 10% of the total market.

A Human Development Fund recently created and funded through contributions from the mining sector, will also help. “The majority of funds which are expected to be budgeted towards the newly established Human Development Fund will go towards investments in public health care infrastructure such as hospitals and clinics,” Khurelbaatar said.

EXPANSION: In 2011 Monos was undergoing an expansion of its manufacturing facilities and its import capacity after receiving a $9.5m EBRD loan in 2010. The facilities are able to use locally-sourced raw materials. Currently about 80% of production is sold over the counter, and 20% is antibiotic drugs. Imports come from more than 100 multinational drug makers, Khurelbaatar said.

Monos Group’s profit has been about $6m a year, and it spends $1m on research and development. The group’s publishing division produces magazines and medical journals, and future plans include an expansion into cosmetics and an increased focus on imports. It has signed a joint-venture agreement with a St. Petersburg-based pharmaceuticals group, and is also eyeing Poland and the Netherlands as potential markets for future expansion activities.