Asian stocks for the rebound

Australian Financial Review, July 2008

It’s all turning to custard in Asia. Stock markets have plunged this year: China down 46.5%, India 35.5%, Hong Kong 23.6%, Singapore 16.9% – all of it much worse than the USA (the S&P 500 is down 13.7%) despite the fact the current problems stem chiefly from the US economy and American investment banks.

There may still be worse to come. But when the dust settles, there’s no question there are going to be some bargains to buy in Asia. “Asia has absolutely not been immune” to the problems in global markets, says Peter Sartori, founder of Treasury Asia Asset Management in Sydney. “But the positive spin is that a stack of stocks across the region really look dirt cheap.”

There are many fund managers who offer Asia managed funds in Australia: apart from Treasury Asia, others include products from Challenger, BT, Platinum, Aberdeen, Invesco, Fidelity, Perennial and Schroders, among others.

Smart Money asked several portfolio managers to identify stocks they think look well positioned for the long run, even if (or because) they’ve taken a hammering recently. We also looked at other portfolios to build up a list of five stocks that Asia specialists are holding in hope.

CHINA CONSTRUCTION BANK

Country: China

Listing: Hong Kong

Price/earnings ratio: 12 times 2008 earnings

This is the pick of Matthew Ingram, equity analyst with Perennial Investment Partners. Even assuming you’re only looking at Chinese stocks that are listed in Hong Kong (known as H-shares), there are still a number of Chinese banks to choose from; why CCB?

Partly because it’s in a safe area. CCB is the largest mortgage lender in China, and is also an active corporate lender. “GDP growth in China of 8 to 9% is expected to continue to drive strong lending growth in both the retail and corporate sectors,” says Ingram. “Despite rising interest rates, the quality of CCB’s loan book has improved markedly in recent years due to strong risk management and limited exposure to the more risky lending segments.” CCB is enjoying strong fee growth, driven by cross-selling mutual funds and other products to its mortgage customer base, and this is likely to increase as demand grows for capital protected products.

It’s true that CCB had some sub-prime exposure, but it wrote off the bulk of this exposure in 2007. “CCB has the fastest growing earnings of any of the Hong Kong-listed government-owned Chinese banks,” says Ingram. “Earnings per share growth is expected to be over 40% this year.”

SAMSUNG ELECTRONICS

Country: Korea

Listing: Korea, USA (ADR issue)

Price/earnings ratio: Approx 12 times 2008 earnings

Samsung Electronics is arguably the staple of Asian portfolios. If we’d written this article five years ago, Samsung would have been in it; if we write it in another five, it will probably still be there. It is, for example, the largest holding of Aberdeen Asset Management in its Asia fund; and when last disclosed on March 31, it was a top three holding in Asia products from BT and Platinum.

Why? “There are many legs in the group,” explains Adrian Lim, portfolio manager at Aberdeen Asset Management in Singapore. “There’s simple things like white goods, the stuff you have in the kitchen like fridges and washing machines; on the other hand it has TFT-LCDs [a type of computer chip used in televisions, particularly the latest flat-screen models] and other chips.” It has demonstrated over the last 10 to 15 years that it can squeeze out market share quite gradually: they’ve done a very good job of building a brand, understanding the distribution channels locally and abroad, and steadily carving out a segment for itself.” Samsung is also unusual in Korean terms in being union free: important in a country which has arguably the strongest industrial unions in the world, and certainly among the most volatile.

Incidentally, the other mainstay of Asian portfolios, Taiwan Semiconductor Manufacturing Co (TMSC), is absent from this list, mainly because of the bleak outlook for the end of the electronics market it operates in. But many fund managers have held it for years and expect to do so for much longer, attracted by the quality of the management, the market-leading technological ability and – increasingly – a hope that Taiwan might lose its laggard status among Asian stock markets thanks to a change of government that has brought a more pro-China leader to the helm. Invesco, for example, increased the Taiwan weighting in its ex-Japan Asia fund in the first quarter. “It was generally believed that a KMT win [the new party] would be beneficial for both the Taiwan economy and equity market, as the KMT party pledged to boost the island’s economy by building closer ties with China,” said Invesco in its most recent quarterly report, explaining its decision. Strangely, though, Taiwan’s market did shoot up almost 20% after the election but has since lost it all again.

Hutchison Whampoa

Country: Hong Kong (active globally)

Listing: Hong Kong

Price/earnings: 11

There was a time when Hutch was a real market darling. One of the two companies (the other being Cheung Kong) of Li Ka-Shing – the billionaire’s billionaire, and arguably Asia’s most famous entrepreneurs – for years it seemed it could never put a foot wrong, whether in ports, property, retail, energy or telecoms. And then it got into 3G.

“That company has been a complete dog since Li Ka-Shing bought into 3G in Europe,” says Peter Sartori at Treasury Asia Asset Management. “It has underperformed significantly since then: 3G has been a disaster.” But Sartori has recently bought in, and he’s not alone: it is among the biggest holdings of the Platinum Asia Fund. Why? “Firstly, it’s well and truly in the price. It’s now at a big discount to net asset value. And finally, after all these years, there’s a little bit of light at the end of the tunnel [for 3G]; it will be cash flow positive in the next 12 months and the rest of the businesses are in pretty good shape.”

Not everyone agrees, though: Macquarie’s Gary Pinge is neutral on the stock. He believes many fund managers are looking at Hutchison as a defensive investment, but doesn’t think they should, particularly since 30% of Hutch’s net asset value is derived from Europe which is where the US-led slowdown may go next. He still sees challenges to the 3G business with regulatory and competitive risks.

China Travel

Country: China

Listing: Hong Kong

Price/earnings:  13 times 2008 earnings

While Sartori finds Hutch interesting, he is more excited about a much smaller stock, China Travel, which covers travel and tourism in China from tour operations to hotels and theme parks. It has been absolutely smashed in the markets – it was trading at HK$2.10 last week compared to a 52-week high of HK$6.38. But that makes it well worth a look, Sartori believes. “Because the share price has come down so far, the valuations look attractive for the first time in a long time.”

The stock is geared to macroeconomic trends like growing Chinese wealth and disposable income, a greater willingness to travel both domestically and overseas, and the increasing interest from foreigners in spending time in China. “The whole tourism story in Asia, and particularly in China, is a secular growth story,” says Sartori. “We think it could grow at a minimum 20% a year for the next five years plus.

“Sentiment towards the sector and industry is very poor at the moment , because of the earthquakes and with the Olympics now on the nose, so we think it’s an opportunity to buy into a long term secular story.”

OLAM INTERNATIONAL

Country: Singapore

Listing: Singapore

P/E Ratio: 30.7 times (current).

When Macquarie Research published its vast Asia Equity Guide in March, one of its very top recommendations for the whole region was Olam International, a Singapore-based company that has built itself into every area of the supply chain for agricultural products and food ingredients from the farm gate to the end consumer. In early July, with the share price at S$2.30, Macquarie continued to hold an outperform recommendation on the stock, with a price target of S$3.82.

It’s this ability to be in every bit of the process that tends to appeal to analysts and fund managers, because it removes exposure to things beyond the company’s own control. It is also, arguably, a beneficiary of rising food inflation – the subject on everyone’s mind in Asia at the moment along with oil. Despite the problems other companies have had with slowing earnings, Olam’s third quarter results in May boasted a net profit up 38% year on year, with broad-based growth and improved gearing ratios (net debt to equity at 2.7 times). Recent rights issues have added more than S$700 million to the balance sheet, increasing speculation that it will take advantage of low valuations to acquire.

In July, it announced a joint venture with another stock much beloved of Asian analysts at the moment – Wilmar, the palm oil group. The venture brings Olam into a new commodity, stevia, used in the creation of sweeteners.