Harvesting a New Moderation in Asia by Soo Nam, ColumbiaManagement
- Companies with competitive strengths still intact should have positive profit growth once adaptive change gets underway.
- The ability to control cost is essential to surviving the growth slowdown in Asia Pacific ex Japan.
- We do not just need companies to be adapted; we also need them to be positioned for adapting.
A New Moderation in Asia
In my previous article, I argued that conditions are in place for the slowdown in Asia to evolve into a sustained period of moderate but stable growth. In this article, we shall explore the implications for corporate Asia, and consequently for the Asia Pacific ex Japan equity outlook.
Corporate Asia has to recognize that the ultra-high growth era is over. The game of survival is no longer about chasing the top line. If Darwinian evolution is any guide, it will not be won by might and aggression. Size, claws and sharp teeth just make for a nicer piece of T-Rex fossil. If mankind was once a troop of monkeys, we have reached where we are today by virtue of our ability to adapt. Fortunately, that piece of evolutionary DNA remains very much in us.
Out of every economic crisis, we have been able to rise above the challenges. Most notable in my own memory are the 1998 Asian Financial Crisis and the Global Financial Crisis a decade later. Post-crisis market recoveries have not been just about normalization of stock valuations and reversion to pre-crisis conditions. Instead, market indices have been able to scale new highs (Exhibit 1), implying that companies ultimately emerge stronger as a fresh adaptive energy drives them towards a better survival. Of course, there are also the really good companies who do not need a crisis to effect positive change. Some may also take a little longer to awake to new realities, but as long as their competitive strengths are still intact, the impact on profit growth should be positive once adaptive change gets underway.
Exhibit 1: Total return performance, USD terms
Source: Columbia Management Investment Advisers, LLC, June 2014. Past performance does not guarantee future results. It is not possible to invest directly in an index.
As growth slows, companies positioned for the higher growth era in Asia found themselves carrying cost structures that could put them in danger of extinction. Capital expenditure plans had to be scaled down and ongoing expenses had to be cut. Li Ning, a sports apparel and equipment maker in China, is a company that has had to make painful adjustments — its same store sales growth had come in drastically below projection and inventories started to pile. A new management team had to be installed and unprofitable stores needed to be shut in the effort to nurse the company back to health.
But it has been more than two years since companies like Li Ning have been wrestling with their environment. The path of natural selection dictates that some will succeed better than others in the process. For them, the new growth path post-adaptation can still be exciting in an economy that is still expanding at a 7.5% rate.
The ability to control cost is essential to surviving the growth slowdown — in Asia Pacific ex Japan — Australian companies are particularly adept at this. Companies that have multi-year cost-out programs in place to create bottom-line growth in the face of more challenging top line outlook could be more successful. They should also pay close attention to sustainable cash flow generation, which anchors the health of the balance sheet and ultimately the dividend yield proposition.
Sense and sensibility in adapting
We do not just need companies to be adapted; we also need them to be positioned for adapting as financial markets are constantly evolving.
A good sense of the “sub-climates” within the general growth picture is needed and this is where it might get a little more complicated.
As a region that is still the fastest growing in the world, not every sector is experiencing a slowdown. In growing sectors such as life insurance, growth strategies must feature alongside cost sensibilities. For new economy sectors such as eCommerce, online media and mobile gaming, fierce battles are still being waged and a good dose of aggression is still called for.
Cutting through the diverse sub-climates must be the call for level-headedness within the corporate mindset. We like it when companies tell us they are prepared to invest for growth but are now tighter in spending every penny. As an example, mining giant BHP has been tightening the payback horizon for new capital expenditure, which means de-bottlenecking projects takes precedence over projects which need longer term projections to justify commercial viability.
A sustained harvest
A new moderation in Asia’s growth, characterized by sustainability at a stabilized level rather than a rebound, may help dull the threat of complacency creeping in. It allows for the adaptive mindset to become more entrenched as the alertness to such a need is reinforced again and again. As growth stretches for longer albeit more moderate, it will also mean a more prolonged harvesting period for companies that have adapted well, before such adaptation is overtaken by events.
The harvest will be aided by the run of Asia’s secular growth potential. In China, we will also be waiting for some sector-cooling measures to complete their course. In the luxury retail sector, some companies have seen their revenue growth curtailed by the anti-corruption drive under President Xi; banks have been working under more demanding regulatory requirements; and property companies under various price cooling measures. As these policies progressively complete their impact, a fresh revenue trajectory for the affected companies may also ensue, with a streamlined cost base to boot. The harvest will be plentiful.
The Standard & Poor’s (S&P) 500 Index tracks the performance of 500 widely held, large-capitalization U.S. stocks.
The MSCI All Country (AC) Asia ex Japan Index tracks the performance of equity securities in eleven countries in Asia, excluding Japan and taking into account local market restrictions on share ownership by foreigners.
The EURO STOXX 50 is a stock index of Eurozone stocks designed by STOXX, an index provider owned by Deutsche Börse Group and SIX Group.
International investing involves increased risk and volatility due to potential political and economic instability, currency fluctuations, and differences in financial reporting and accounting standards and oversight. Risks are particularly significant in emerging markets.