Investing selectively in Asia by Soo Nam Ng, ColumbiaManagement
- Beneath the surface of slowdown headlines lay pockets of exciting growth opportunities.
- As companies step back from chasing revenue growth and start emphasizing profit delivery, better cash flows and dividend payouts typically follow.
- We see the greatest contrarian opportunities in sectors where market sentiment has been most depressed.
In my previous two articles, I argued that big picture conditions for more sustainable growth are beginning to surface in Asia (article1, article2). Furthermore, Asia’s corporate sector has been adapting to the moderated growth environment by streamlining cost and capital expenditure. The final question we shall address is how investors should respond going forward.
The field is ripe for growth opportunities as adaptive changes run their course and set investors up for prolonged harvesting. Asia ex Japan is still the fastest growing region in the world and its secular growth drivers remain intact. The consumption trend, for example, is still on an upward trajectory. However, one needs to be selective as to which sub-segments offer the greatest potential. While Swiss watches and Italian handbags are reeling from an anti-corruption drive that affects lavish “gifting” to officials, the underlying appetite for luxury consumption in China remains healthy as evidenced by the brisk sales of BMW cars. While infrastructure spending has slowed, investments in rail locomotives and rolling stock are still increasing in order to intensify usage of the rail network.
Beneath the surface of slowdown headlines lay pockets of exciting growth opportunities which behoove investors to be selectively engaged.
As Asian companies step back from chasing revenue growth and start emphasizing profit delivery, better cash flows and dividend payouts typically follow. Through diligent research, it is possible to uncover these companies which exist in greater abundance in the developed markets of Hong Kong, Singapore and Australia where corporate cultures are more shareholder-friendly. But to appreciate their investment merits, the investor needs to value resilient growth over high growth and be willing to harvest dividends over a multi-year horizon.
While return expectations from potential share price appreciation may need to be moderated, the investor should consider a more deliberate harvesting of dividends as an equally important and recurring source of return to help anchor performance consistency.
While the underpinnings for contrarian opportunities are in ample supply, we shall limit the discussion to those that flow from the new moderation outlook.
We see the greatest opportunities in sectors where market sentiment has been most depressed, e.g. China’s banking sector. An acceleration in shadow banking credit and fears that non-performing loans will escalate have spooked investor confidence. As a result, leading Chinese banks are now trading at around 5x price-to-earnings with a dividend yield of around 6% despite efforts by policymakers to regulate trust products and make it easier for corporates/local governments to raise financing based on free market risk- pricing. The re-rating process may take time, but investors can still enjoy an attractive yield while they wait.
China’s anti-corruption drive in the last few years is another shifting cloud. Its oil and gas sector is emerging from the anti-corruption purge of Zhou YongKang, China’s ex security czar who has had his power base within it. Recent positive developments include Petrochina’s plans to invite private capital to take stakes in its oil pipelines. After a corruption clean-up, investor interest In the railway sector may also be returning, lured by its multi-year secular growth story and world class capabilities that rival the likes of Alstom in competing for contracts globally.
Some clouds will stay where they are while the market slips from their shadow. In China, the ban on lavish “gifting” and entertainment under the XiJinping leadership had cast a pall over the past two years for luxury brands. As the base of comparison shifts going forward, we are likely to get a cleaner comparison that shows growth driven by true consumer potential rather than “gifting” to government officials.
Adapting takes time and some ships are easier to turn than others. A depressed stock may still be an exciting opportunity if the company understands its challenges and has started doing what is necessary to survive. Of course, one of the keys to contrarian investing is not to get into the stock too early.
Opportunities can open up if we expand our concept of the turning ship to include corporate governance improvements. In Korea, decades of sub-par practices amongst the conglomerates may finally start to change. As founding patriarchs pass on, control structures that were custom-designed for them may lose relevance, setting the ball rolling for corporate restructuring that holds scope for positive outcomes for minority shareholders.
Now that we are two years into the Asia slowdown, the region as a whole could be a contrarian opportunity given its recent underperformance. As growth stabilizes and the base of comparison shifts, it will become more and more difficult for the market to worry about a slowdown while progressively supplied with data that shows a consistent level of growth. This will act like cognitive therapy to push aside slowdown fears and help attract liquidity flows.
As disciplined and informed investors, we consistently avoid being bullish or bearish in our emotional disposition. But these are exciting times, as we cast our thoughts on the selective but significant opportunities evolving under Asia’s new moderation landscape.