AI #17: Our big advantage over most Asia investors
Welcome to this week’s issue of Asia Investor. There’s been quite a lot of volatility in the Asia Investor portfolio over the last couple of weeks – our paper price gain is down around five percentage points since the previous issue. In most cases, this doesn’t reflect any news that I’m aware of – rather it’s general nervousness in the markets.
Welcome to this week's issue of Asia Investor. There's been quite a lot of volatility in the Asia Investor portfolio over the last couple of weeks our paper price gain is down around five percentage points since the previous issue. In most cases, this doesn't reflect any news that I'm aware of rather it's general nervousness in the markets. That's partly coming out of the protests in Tunisia, Egypt and elsewhere, which are making investors less confident in emerging markets generally.
The next major round of news will be the next set of quarterly results, which should start to roll in from early February. But today I'll be catching up on some recent news from a few of our portfolio stocks.
First though, I want to take a look at the Asia Investor survey I sent round a couple of weeks ago. I was very pleased to see that most of you are finding the reports useful. And I think its well worth addressing some of the queries today.
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One in particular caught me eye. It's a question that gets right to meat of the Asian Investor strategy and why we have the upperhand on most investors looking to stake a claim in Asia's rise.
You need to know what you are buying
A couple of issues ago I wrote about the history of top consumer staples brands: how the best firms in areas like food & beverage and household goods defied their unglamorous reputation to outperform the S&P during the great American consumer boom. And why history suggests that it makes more sense to pay higher prices for these kinds of businesses in Asia today than any other kind of stock.
As you'll have seen, top consumer brands are one of the two main principles behind the Asia Investor strategy (the other being overlooked small caps if we can get the two together, as in a firm like Hsu Fu Chi, it's even better). But one reader asked me what I thought of using Lyxor's fairly new London-listed MSCI Asia ex Japan Consumer Staples ETF as a way to invest in this story. Is this a better low-cost solution than buying individual stocks?
I think not. I don't think it's a bad ETF and if you're not willing to buy your stocks directly, I think it will probably do well enough over the long term (assuming it hangs around for the long term, which isn't guaranteed). But there are a couple of serious problems with it.
The first is the breakdown of the index. I should say I've arrived at this by deduction: MSCI don't disclose the make-up of their indices unless you buy a licence and Lyxor doesn't disclose the reference portfolio for the fund. But Deutsche Bank does disclose the portfolio for its broader MSCI Asia ex Japan ETF, so it's possible to work out what Lyxor's ETF should cover.
There are 36 stocks covered by the ETF. The full list is shown below.
The problem with this basket is that not all of these stocks are what we would consider consumer brands. Around 13 of them are plantation companies, which grow agricultural commodities such as palm oil and also typically have extensive real estate operations, commodity processing and trading groups, and meat processors.
Obviously, you may well want to own these stocks, especially at times when commodity prices are rising. But they are not the same as a top consumer brand and in all likelihood do not have the same potential to earn high long-term returns so it's probably a mistake to treat them the same.
In fact if you were to build an index of high-potential consumer brands, it would look quite different to MSCI's consumer staples index. First, you would drop these commodity businesses, which includes many of the largest stocks. Secondly, you would include quite a number of stocks that don't currently feature.
I compiled the list below off the top of my head. It isn't exhaustive there are plenty of others that you could justify including. But this represents 30 or so stocks that don't appear in the index but have extremely strong positions or growth potential in their markets.
In most cases, the problem is size or liquidity and some of these would be impossibly awkward investments for a tracker.
Take Fastfood Indonesia. This must be one of the world's most maddening companies. It owns the KFC franchise for Indonesia - and chicken-based fastfood in a predominantly Muslim country that's developing the income levels for massmarket casual eating, looks to me like a license to print money. But it's highly illiquid, trading only a few thousand dollars of shares a day, and management has no interest in engaging with small outside shareholders.
Some of them also suffer from the common problem of using any kind of indexing there's no screening for quality. For example, Universal Robina is a well-positioned business, but in common with many Philippines companies I hear only bad things about governance standards.
Others, like the Indian-listed subsidiaries of the multinationals are very attractive an excellent track record, the support of a huge parent, yet a dedicated play on a single economy. But the Indian market is currently closed to any outside individuals who don't have Indian ancestry, putting them off limits to most of us even as individual investors who don't need to worry about high liquidity too much.
But some are readily available to us. Vitasoy, already in the Asia Investor portfolio, is a good example of a very well run business with excellent potential that's too small to make it into an index or most managed funds. Hsu Fu Chi is another great example. Up 38% since I recommended it, the company continues to be neglected by fund managers because it is too small to meet their requirements.
That's why I think investing in solid, small-cap stocks is the best way to invest in Asia's explosive rise. Index funds and managers will spend the next ten years crowding into trades that have very little exposure to what is happening in Asia.
But by scoping out the unheralded stories the sweet makers, the bakeries, the condensed milk suppliers we can build our wealth alongside the rising tide of middle classes in cities from China to Indonesia.
Just take some of companies I am updating on today by way of example
Silverlake Axis may be eyeing a main board listing
The main development at Malaysian software group Silverlake Axis was that founder Goh Peng Ooi sold another round of 50,000,000 shares, following a similar placement in October. His stake in the firm has now dropped to 74.7%.
There are two positives to this. First, one of the main problems with Silverlake is the lack of liquidity, so any moves to increase the free float could make the stock more attractive to potential investors.
Second, and more significantly, I think this is probably a step towards moving the firm's listing from the Catalist growth stock board to the main board of the Singapore Exchange. With a free float of around 25% and a market cap of around S$700m, following its restructuring in 2010, the company is now of a size that would make this sensible.
I need to stress that this is my hunch rather than official information from the company Silverlake is not good at communicating its plans to outside shareholders. But I think there is a good chance that we will see further moves on this front in 2011.
This would boost Silverlake's profile substantially and make it more accessible to institutional investors. Combine that with the likelihood of much stronger earnings as S$210m of already-announced contracts begin to feed in and banks continue to ramp up investment spending, and I think we could see fairly substantial progress in Silverlake's shares over the next year. My recommendation remains a BUY up to a limit of S$0.4.
Keep ARA on hold
Real estate investment trust (reit) manager ARA Asset Management got off to a storming start in 2011, rising 18% in the first half of January before giving most of that back as market fears grew. The catalyst for this? Virtually nothing as far as I can see.
There was one story in late December that could have some relevance to ARA. Bloomberg reported that Hong Kong billionaire Li Ka-shing is planning what will be the city's first renminbi-denominated IPO in 2011, a reit backed by his Oriental Plaza development in Beijing.
ARA wasn't mentioned in the story, but Li's Cheung Kong holding company has a 16% stake in ARA and the firm already serves as the manager on Cheung Kong's three existing reits. And during my meeting with ARA in October, I was told that a China reit was one of the main potential additions to its current line-up. So if this IPO comes off, it wouldn't surprise me if ARA were the manager.
It may also be that some investors had assumed that ARA would be the manager of another Li-related IPO, the Hutchison Ports Holding Trust, which is expected to set a new record for a Singapore IPO when it floats in the next few weeks. But this was never on the cards; operating ports is outside ARA's area of expertise and Hutchison Ports Holding the current direct owner of the assets is going to remain the manager.
So while ARA's prospects continue to look good, I see no justification for major share price moves at the moment. At current levels, it's not insanely expensive given its record of growth and the way that its business can be scaled up. But the fact that it is to some extent a one-man band, highly dependent on CEO John Lim, makes me reluctant to put too high a valuation on it. For now, I'm keeping it a HOLD.
Why I see a 60% upside for ICICI Bank
India's largest private sector bank has been the worst underperformer in our portfolio of late. Having peaked at over $57 in early November, it's now back to around $43, cutting our paper gain on the initial recommendation to around 14%. That's despite third quarter results last week that beat expectations and showed the bank's earnings are continuing to recover as I'd hoped.
The reason that ICICI has been weak has little to do with the company specifically, and is all about wider conditions in India. The scandal over the corrupt awarding of telecoms licences that broke in November shook market confidence. More recently, fears have been growing over inflation, which is uncomfortably high: weekly food price inflation hit 18% recently after a sharp rise in the price of staples such as onions.
It looks likely that the Reserve Bank of India will need to tighten policy further, which may hit growth and consumption this year. So I think the Indian market may well remain weak over the next few months, with interest rate sensitive stocks such as banks likely to do worse than average.
But looking further ahead, ICICI remains an attractive prospect. Having overstretched itself during the last boom, it's now cleaning up its balance sheet, which is holding down profitability relative to peers such HDFC Bank. Once this process is complete, profits should rise significantly. I think the stock offers potential upside of around 60% on a two-year view, and remains a BUY up to US$50.4.
First Reit builds towards S$1bn in assets
Lastly, we saw fourth quarter results for Singaporean healthcare trust First Reit, which contained absolutely no surprises. With the acquisition of its two new Indonesian properties now complete, the reit is expecting a distribution per unit of 6.4 Singapore cents in 2011.
With these deals complete, there are no more immediate acquisitions in the pipeline, but the CEO has said that the reit intends to grow assets to around S$1bn in the next two-three years, from S$613m now. Since its sponsor Lippo Karawaci intends to grow its healthcare business substantially, this should be very achievable.
First Reit should be a low-hassle part of the portfolio, providing a steady income, with distributions paid quarterly. For investors who bought in at the initial recommendation and participated in the rights issue, the forecast payout offers a prospective yield of around 9.1%. On the current price, it amounts to around 8.4%.
In addition, there's a good prospect of capital gains, since it's likely that as the reit continues to grow in size and profile, more investors will be attracted by its higher-than-average yield and the defensive nature of its healthcare assets, pushing up the unit price.
For now, I'm keeping a BUY recommendation, up to a limit of S$0.8.
The Asia Investor Survey
Finally, I'd like to address some of the specific queries from the Asia Investor survey.
There were a few comments and suggestions that came up more than once, so it might be simplest if I answer them in the letter. For more specific questions, I'll be replying to them individually by email.
1) Several readers asked if I could specify the board lot size when recommending a share. For anyone who doesn't know this term, in many Asian markets, shares are typically traded in orders that are multiples of a certain amount it may be possible to trade odd lots' that don't fit this, but it will typically be more awkward and expensive.
I have been including this in recent issues, but it's usually been in the text above the price chart and perhaps wasn't very clear. In future, I'll add it to the summary data at the bottom of the recommendation. As a rule of thumb, Singapore lots sizes are 1,000 shares, while the minimum for UK, US and European markets is one share. Hong Kong varies by stock and can be found on each company's profile page on the HKEX website here.
2) There were several suggestions regarding updates on portfolio stocks. In general, my approach is to do a regular review of the portfolio performance once per quarter. For individual company updates, I'll often include the latest update in that review, since that coincides well with the quarterly results for many of the portfolio stocks. Otherwise, I'll cover them in an intervening email, as in today's issue.
Just to reassure anyone who's wondering about this, I monitor all the portfolio stocks constantly and if there is urgent news, I'll send a special alert. That said, the newsflow on a lot of the Asia Investor portfolio stocks is relatively quiet because these are fairly established, stable businesses although many of them are small, they're not like oil explorers or tech start-ups where make-or-break news is frequent.
A couple of you asked about making it easy to find the latest update on each stock and I'm looking into the best way of doing this.
3) The frequency of recommendations was a topic with some very varied responses. Some of you asked if the frequency could go up to one an issue, some felt the current frequency was about right and others asked for fewer suggestions because they wanted to make larger investments in each.
In addition, I'm reluctant to throw out too many recommendations because I want to keep standards high. My aim is to provide higher quality, higher confidence ideas rather than a high volume of more speculative ones. There are a limited number of companies like this around and finding and researching them takes time.
This is always a difficult compromise, but looking at it overall, I'll be aiming to increase the frequency slightly from now on.
4) Some of you asked about including estimated or target prices in the portfolio table. I have very mixed feelings on this, because target prices always seem to me to be spuriously precise. Just because I say a stock is worth S$10 doesn't mean that it is worth that much or that the share price will get there, but the exactness of the figure encourages us to anchor on it.
As you'll have seen in each recommendation, I tend to think more about a range of what I think the stock might be worth under different scenarios to reflect how uncertain forecasting is. This is much harder to sum up quickly in the table.
However, this is clearly something that a number of you want, so I'll think about the best solution and add something in the next couple of issues.
5) A few of you mentioned including commentary on market conditions, such as looking at which markets and currencies might be undervalued as opposed to individual stocks. I aim to do this in MoneyWeek Asia, which I assume that most of you probably receive (if you don't, it's a free weekly email and you can sign up here).
In a similar vein, some of you also asked whether Asia Investor will always focus exclusively on stocks or whether I'll also be recommending funds. Again, I think funds coverage fits better into MoneyWeek Asia.
With Asia Investor, I'm very conscious of trying to provide you with the best value I can for your subscription. That means I feel I should focus on specific stocks that you would rarely find covered elsewhere, plus topics that are very closely related to the strategy. If you have broader topics that you'd like to see covered, please feel free to let me know and I'll try to work them into an issue of MoneyWeek Asia.
6) There were some questions about trading Asian markets other than Hong Kong and Singapore I hope the MoneyWeek Asia I did on this subject after the survey went out helped with this. Please let me know if you have any questions about finding a broker that I can help with.
A couple of months ago, I wrote about the possibility of introducing recommendations from other markets. At present, the feedback from most of you is that you're not in a position to do make use of these. The vast majority of Asia Investor readers use TD Waterhouse, giving you access to Hong Kong and Singapore but not other markets (yes, I'm continually asking them if they're going to cover more of Asia, but no luck yet).
So I'm not planning to do this immediately, but will keep the possibility open. I'm also looking into a couple of firms that provide similar research to mine for some of these markets, with a view to referring anyone who's especially interested. I'm not sure anything will come of this, but I'll let you know if it does.
That's it from me this week. I'll be back in a fortnight with a new recommendation I'm looking at a few possibilities including a software in a very specialised niche.
Five Year Performance Of Buys Updated This Week | ||||||
Year | 2006 | 2007 | 2008 | 2009 | 2010 | 2011 (to date) |
First Reit (Dec 2006) | +0.04% | +1.32% | -47.40% | +101.23% | +19.08% | +5.56% |
ICICI Bank | +44.63% | +47.34% | -68.70% | +95.90% | +34.29% | -7.14% |
Silverlake Axis | +165.45% | -17.81% | -85% | +261.11% | +7.77% | -7.14% |
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