Performance commentary

The Maple-Brown Abbot Asian Investment Trust (Trust) returned 4.0% in AUD terms during the quarter, compared to the MSCI All Countries (AC) Asia ex-Japan Net Index AUD (Benchmark) return of 6.3%. Since inception, the Trust has delivered 9.2% p.a. compared to the Benchmark return of 9.0% p.a. In USD terms, the Trust returned 8.3% against the USD Benchmark return of 10.7% over the quarter. The Australian dollar continued to gain over the quarter as risk aversion declined on resumption of economic activity in many economies.

Markets around the globe continued to rally from the previous quarter, albeit with much more dispersion in performance across markets. The Asia ex-Japan region rose strongly, up 10.7% (in USD) over the quarter, outperforming the rest of the world. Perhaps somewhat surprisingly, the region  is up 5.4% calendar year to date, an amazing turnaround given the degree to which sentiment deteriorated earlier in the year.  Generally better than expected company results in the recent reporting season  have supported prices.  Also sustaining markets has been ‘less-bad’ news relating to COVID-19, with case fatality rates falling (despite second wave infections rising) as the medical industry is better able to treat infections.  However, the global economy experienced one of its sharpest downturns in history in the June quarter. Many economies contracted on an annualised basis by 25%-40% in a single quarter and unemployment spiked. As such our focus on companies with strong balance sheets and readily observable free cash flow remains stronger than ever.

Despite the continued improvement in sentiment, Growth continued to outperform Value over the quarter, resulting in an ever-wider dispersion in valuations. As outlined later in this report, we believe the growth outlook for stocks in the portfolio versus the wider market is not congruent with the significant valuation discounts they trade at.

Across the region, Taiwan (+16.5%) and India (+15.0%) provided the strongest returns over the quarter, followed by South Korea (+12.8%) (in US dollar terms including dividends). Returns were largely driven by improved sentiment as COVID-19 lockdown conditions eased and economic activity resumed. ASEAN markets were weakest during the quarter, notably Thailand (-14.1%), Indonesia (-6.9%) and the Philippines (-2.7%). These markets were impacted by a re-imposition of stricter lockdown requirements due to increased incidence of new COVID-19 infections. Sentiment in Thailand was also driven lower by weaker than expected June GDP figures and a far more negative outlook for the travel industry on which it is reliant for employment and economic growth. 

On a sector basis, Consumer discretionary (+29.7%) and Information Technology (+20.5%) were the best performing sectors over the three months to September, highlighting the continued narrowness of returns referred to elsewhere. Materials (+12.1%) also performed strongly, driven by strong performance from Chinese resource companies. Meanwhile, Utilities (-4.4%), Real Estate (-1.0%) and Financials (+0.1%) were the worst performing sectors. Despite record low valuations, the near-term outlook for banks remains clouded given uncertainties around non-performing loans.

At a stock level Korea Investment Holdings (KIH), Xinyi Glass and Taiwan Semiconductor (TSMC) were the biggest contributors to performance. KIH rose sharply over the quarter, after reporting better than expected first half earnings. Sentiment towards the stock was also buoyed by expectations of the pending IPO of Kakao Bank, Korea’s largest online bank, of which KIH is a major shareholder.  Alibaba (not held), PICC P&C and Genting were the most significant detractors over the quarter. Alibaba rose strongly as its affiliate Ant Group announced its intention to IPO. Its rise was overwhelmingly driven by multiple expansion as although it reported a strong set of results in the quarter, further earnings upgrades were minimal.. PICC and Genting were but a selection of value orientated names that were de-rated further from already depressed levels in an extremely bifurcated market. Indeed, PICC reported Q2 results which were typically better than expectations. Despite concerns over market deregulation in auto insurance, net income grew 5% year-on-year on better underwriting experience and continued growth in premiums.

Whilst we welcome the improved market backdrop experienced in recent months, expectations of a uniform
V shape recovery are far from assured and we expect wide dispersion in the quantum and timing of the recovery across markets. Furthermore, the upcoming US election may create further uncertainty and volatility in already uncertain markets. Companies that the market perceives to be immune from the impacts of COVID-19 and or technological disruption, remain highly rated, well above historical averages. Furthermore, the disparity in valuations between these companies and the perceived cyclical companies in the market remains close to all-time highs. As such, with many stocks in your portfolio trading at significant discounts to their intrinsic value, we believe conditions are ripe for a portfolio re-rating versus the market as sentiment normalises. We would again point to the alpha generated by our strategies in the recovery phase post the GFC as a credible signpost supporting this expectation.

The Trust's largest active sector positions are overweight Industrials (+4.3%), Communication Services (+3.7%) and Financials (+2.2%), while underweight Real Estate (-4.1%), Health Care (-3.7%) and Materials (-3.4%). On a country basis, the Trust remains overweight India (+4.7%), Hong Kong (+2.0%) and the Philippines (+1.1%) , while key underweights are Taiwan (-6.1%), China (-3.2%) and Singapore (-0.4%).

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Performance (in AUD)

The rates of return and movement in the benchmark as at 30/09/2020 are as follows:


Trust
(after fees)
%
Benchmark*
%
Since inception 25/10/2002 p.a.9.29.0
15 years p.a.6.98.3
10 years p.a.7.38.6
5 years p.a.6.410.1
4 years p.a.5.710.9
3 years p.a.1.98.1
1 year-6.610.9
3 months4.06.3

*MSCI AC Asia ex-Japan Net Index AUD

The Trust’s  performance is based on the movement in net asset value per unit plus distributions and is before tax and after all fees and charges. Imputation and foreign tax credits are not included in the performance figures.

Past performance is not a reliable indicator of future performance. Source:  Maple-Brown Abbott Ltd, MSCI as at 30/09/2020.

Performance (in USD)

The rates of return and movement in the benchmark as at 30/09/2020 are as follows:


Trust
(after fees)
%
Benchmark*
%
Since inception 25/10/2002 p.a.10.710.6
15 years p.a.6.57.8
10 years p.a.4.25.4
5 years p.a.6.910.6
4 years p.a.3.99.1
3 years p.a.-1.14.9
1 year-0.817.8
3 months8.310.7

*MSCI AC Asia ex-Japan Net Index USD

The Trust’s  performance is based on the movement in net asset value per unit plus distributions and is before tax and after all fees and charges. Imputation and foreign tax credits are not included in the performance figures.

Past performance is not a reliable indicator of future performance. Source:  Maple-Brown Abbott Ltd, MSCI as at 30/09/2020.

Maple-Brown Abbott Asian Investment Trust - cumulative performance (in AUD)

Performance attribution (in AUD)

The stocks that made the largest contribution (positive and negative) during the quarter to the Trust's return relative to the Benchmark are shown below.

Best contributing stocks% Worst contributing stocks%
Korea Investment Holdings Co (overweight)0.53
Alibaba (not held)-1.84
Xinyi Glass Holdings Co (overweight)0.50
PICC Property & Casualty - H Share (overweight)-0.62
Taiwan Semiconductor Manufact. Co (overweight)0.46
Genting (overweight)-0.61
Xiaomi (overweight)0.35
Siam Commercial Bank (overweight)-0.45
Kia Motors Corp (overweight)0.35
Meituan Dianping (P Chip) (not held)-0.43


Principal transactions

The main purchases and sales in the Portfolio during the quarter were as follows:

PurchasesSales
Vipshop HoldingsTaiwan Semiconductor Manufact. Co
Health and Happiness International Holdings58.com
WH GroupTsingtao Brewery Co - H Share
Thai BeverageTencent Holdings
Kerry Logistics NetworkNetEase ADR


Commentary on selected portfolio holdings

  • TSMC Taiwan Semiconductor Manufacturing Company (TSMC) is the world’s leading independent semiconductor foundry, manufacturing integrated circuits on behalf of its customers. It maintains a dominant market position and enjoys a clear advantage over its competitors in terms of technology, cost and efficiency. The company continues to benefit from increasing semiconductor content within its traditional realm of communication, computer and consumer electronic devices, as well as new areas such as automobiles and the Internet of Things (IoT). The rise of 5G and high performance computing will act as a tailwind to ongoing growth in these areas in the coming years. Our positive thesis on the stock is predicated on them being able to exploit their competitive advantage associated with their market leading position (both market share and technology) and maintaining their disciplined approach to capital allocation. Combined with attractive valuations (including a net cash balance sheet), we believe it will continue to outperform the market over time.
  • Xiaomi has been one of the most successful consumer electronics brands globally over the past decade. It has quickly become the world’s fourth largest smartphone manufacturer through strength in its local Chinese market. It has used this improving brand recognition to expanded into adjacent electronic verticals and geographies. Its products contain features substantially superior to other products at Xiaomi’s relatively affordable price point. Generally speaking, its products offer the most compelling price to performance ratio versus peers. As a result, we have seen a proliferation of Xiaomi smartphones and Xiaomi smartphone controlled in-home devices. As of 2Q20 there were 5.1m users with 5 or more Xiaomi devices in their home, growth of 64% year-on-year. In addition to a pervasive hardware network, Xiaomi has proven its ability to monetise this network through various in-house apps, creating a high growth, high margin, captive revenue stream. We entered Xiaomi at an attractive price earlier in 2020 as a result of a number of negative transient factors. We expect the stock to further re-rate as strong underlying growth continues and these transient factors continue to unwind.
  • Genting Berhad has been a long term holding in the portfolio. As a Malaysian based casino operator with properties in both its home country and Singapore, its current valuation does not reflect its excellent runway for growth and scope for improving returns. COVID-19 lockdowns have had a significant impact on earnings year to date and the company is expected to be loss-making in 2020. Yet its casino’s generate substantial cashflow on a normalised basis for the group which is being ignored by the market. There are positive signs of demand returning as these economies re-open post lockdowns. Genting Malaysia’s visitation and hotel occupancy are both currently at ~62% of pre COVID-19 levels. Genting Singapore has also reopened, but with a more strict capacity utilisation limit of 25%. We expect both these assets to be close to pre-COVID-19 levels sometime during 2021. The group also has a ~USD 4.3B casino project in Las Vegas expected to open in mid-2021, which should make a material impact to earnings across our four-year forecast period. We expect continued improvement in visitation in existing assets and the opening of the Las Vegas casino should provide good support to re-rating of the stock in coming years.

Analysis of portfolio

The value and balance sheet strength characteristics of the portfolio compared to the market overall at
30/09/2020 are as follows:


PortfolioMarket overall*
Price:Earnings ratio10.415.2
Price:Cash flow ratio6.39.8
Price:Net tangible assets ratio1.11.7
Dividend yield (% p.a.)3.42.4
Balance sheet strength (cash flow/total liabilities)0.490.47

* Represents our quantitative data which includes 91.7% of the index weight of the stocks in the Benchmark, plus non-Benchmark stocks.

The figures shown above are based on estimates for the next twelve months which include assumptions that may not hold true. Actual outcomes may vary in a materially positive or negative manner. Source: Data from Maple-Brown Abbott Ltd, UBS, Macquarie.

The asset allocation of the portfolio is:

Asset allocationsLow
%
High
%
Neutral
%
Actual
30/09/2020*
%
Asian equities901009598
Liquidity01052

n/an/a100100

*Excluding the distribution payable.

Sector and country weightings

The sector and country weightings (%) in the portfolio are as follows:

Derivatives

A Derivatives Risk Statement (DRS) in accordance with the parameters set out in Australian Prudential Regulation Authority derivatives guidelines has been issued. We confirm that, to the best of our knowledge, the terms of our DRS were complied with during the latest quarter.

There were no derivatives transactions during the quarter.  At the end of the quarter there was no exposure to derivatives.

Review and strategy

Economic review

The MSCI AC World Index, led by the US, increased by 8.1% in USD terms during the quarter recovering to pre-pandemic levels as many countries began to unwind social distancing measures. Investors factored in expectations of a prolonged period of low interest rates and a rebound in corporate profitability from the sharp declines experienced during the height of the pandemic. India, China, US and Germany were among the better performing markets increasing by 15.0%, 12.5%, 9.5% and 8.3% in USD respectively.

The International Monetary Fund (IMF) did not provide an update to economic forecasts during the quarter with the next release being due in October. Some market commentators anticipate positive revisions to the last forecast made in June, which expected 2020 economic output to contract by 4.9%. While recent economic data has proven better than originally feared, forecasts will continue to be heavily influenced by the trajectory of COVID-19 infections and resulting government responses.

The US printed the biggest quarterly fall in GDP[1] on record at 31.7% as the country lost control of the virus leading to a temporarily shut down of the economy. The unemployment rate improved to 8.4% in August from the highs experienced in April of 14.7%, as economic activity gradually resumed. Unlike many other countries, the US enacted wage support through unemployment benefits rather than wage subsidies which resulted in the data showing higher unemployment rather than fewer hours worked. Unemployment benefits were set at the level of average full-time earnings until July, which meant many workers were temporarily financially better off being unemployed. Having reviewed its monetary policy framework, the Federal Reserve announced it would pursue a flexible average inflation target, increasing its emphasis on achieving maximum employment.

Prolonged below target inflation has prompted central banks to review policies, allowing flexibility for periods of higher inflation to compensate for past low inflation

Source: Reserve Bank of Australia (Consumer price index; Year-ended change), European Central Bank (HICP - Overall index, annual rate of change); Federal Reserve (12-month inflation rate for headline PCE)

Europe similarly reported dramatic falls in GDP with declines of 9.7% in Germany, 13.8% in France and 19.8% in the UK. European governments have been pro-active in supporting the recovery phase with the EU announcing additional fiscal stimulus of around 5% of GDP (Next Generation EU Recovery and Resilience Facility), funded through the issue of EU bonds. In addition, the German government announced a temporary 3% broad-based reduction in consumption tax, while the UK introduced temporary VAT reductions of 15% targeted at the hardest hit hospitality, accommodation and attraction industries. Similar to the Federal Reserve, the European Central Bank is currently reviewing its inflation targeting policy objective, amidst a wide debate around central banks explicitly making up for inflation falling below target for prolonged periods of time. Meanwhile the Bank of England highlighted they were considering the possibility of negative policy rates.

Chinese GDP rebounded by 11.5% as the country appeared to successfully contain the spread of COVID-19. Significant government stimulus has been successful in stimulating fixed asset investment and industrial production, which have now returned to pre-COVID levels. Consumption growth lagged as the level of income transfer to households by the government has been modest. Japanese GDP declined by 7.9% as consumption was significantly impacted by the declaration of a state of emergency in April, while exports were impacted by shutdowns of major trading partners. GDP in India declined 25.2% as strict lockdowns led to sharp falls in production and consumption. Ratings agencies downgraded India’s sovereign rating to the lowest investment grade rating, potentially limiting the amount of additional fiscal stimulus.

Australian GDP fell 7.0% as household consumption was heavily impacted by social distancing measures. Since then, consumption has improved due to substantial fiscal stimulus, reduced outbound travel and early access to superannuation. Meanwhile, re-introduced lockdowns in Victoria are expected to impact September quarter GDP by 2%. Unemployment is expected to increase from the current 6.8% level to peak at around 10% later this year as wage subsidies (which are estimated to have supported more than a quarter of all workers) are gradually wound back. The Australian dollar continued to appreciate during the quarter to levels consistent with expectations given the terms of trade and interest rate differentials. During the quarter the Reserve Bank of Australia kept policy rates on hold and reaffirmed the prior package of stimulus measures, including an extension of the term funding facility. The RBA also reaffirmed its commitment to maintain the cash rate at or below current levels until it is confident inflation will be sustainably maintained within the target 2-3% range, on-average over time.

Asian equities

The weight of money in Asia in the September quarter was again skewed towards those stocks perceived to benefit from COVID-19 or to be immune from the economic dislocations caused by it. This concentration of money flows also once again resulted in very narrow outperformance within the market: just 27% of names (excluding A-shares) outperformed the benchmark during the September quarter (39% including A-shares), well below the longer-term average. Furthermore, it resulted in the continued significant re-rating of growth stocks, further accentuating their record valuation spread over value stocks.  These factors again resulted in market conditions that were extremely challenging for value-oriented investors such as ourselves, as the most expensive stocks in the market outperformed the cheapest stocks by around 11 percentage points. To be clear, the rally in highly rated growth stocks is in almost all instances due to multiple expansion rather than an increase in earnings expectations.                 

Although aggregate forecasts for full year 2020 earnings continued to be downgraded over the quarter, the June 2020 reporting season generally proved better than feared. Most management teams pointed to improved operating conditions in the second quarter as well as a better second half outlook as economies recover post the COVID-19 induced lockdowns. The fact that earnings are still being downgraded is not overly surprising (nor insightful) given the lag in analysts updating their estimates. What is more significant for the direction of markets however is the rate of change of forward estimates. On this basis the news is better as the three-month moving average continues to improve (i.e. the downgrades relative to upgrades are slowing). Despite some isolated second wave outbreaks in the region, generally lockdown measures are easing, and combined with ongoing fiscal and monetary measures, we expect a stabilisation in 2020 earnings.

Moderating earnings revisions

From a country perspective, earnings have been generally more resilient in those countries where the duration of lockdowns was short. North Asia stands out particularly, with Taiwan (-5%), China (-19%) and South Korea   (-24%) experiencing the smallest earnings revisions. At the other end of the spectrum, ASEAN markets such as the Philippines (-51%), Thailand (-48%) and Singapore (-41%) have seen the largest downgrades to 2020 earnings year to date.

The impact of COVID-19 on companies has been anything but uniform. At a sector and stock level, there has been a wide range of outcomes and this was demonstrated in the reporting season with ‘beneficiaries’ such as online gaming and ecommerce companies delivering strong results. Conversely, the more cyclical or leveraged parts of the market such as banks and tourism related stocks saw steep declines in earnings. Performance was similarly mixed across the portfolio. Communications, Consumer Discretionary, Energy, Financials and Utilities all saw a marked slowdown in cuts to earnings following their June results. Healthcare, Industrials and Materials continued to experience significant downgrades. Overall, portfolio earnings were downgraded 5% over the September quarter, versus downgrades of 5% in the June quarter and 39% in the March quarter.

Not surprisingly, growth expectations over our four-year investment horizon have improved throughout the year, as estimates for the base year (2020) have been reduced. This expected growth is broad based across sectors, but far more dispersed across countries. India leads the way, with expected earnings growth of 29% to 2024, driven to a large extent by improving credit conditions for financials. It is also driven by consumer discretionary names that are expected to benefit from any uptick in consumer demand on the unwinding of relatively stringent lockdown measures in many states. In light of this dynamic, not surprisingly India now constitutes our largest relative country over weight.

Perhaps more surprisingly, the portfolio’s expected earnings growth rate over the next four years sat above the market as a whole at the end of the quarter, versus a significant growth deficit six months ago. Indeed, portfolio holdings in five out of ten markets regionally are expected to grow faster than the market over the next four years. This situation is all the more remarkable given the median PE of the portfolio stood at 10.4x versus 15.2x for the market. As was the experience during the recovery phase following the GFC, the expected portfolio earnings growth should support the re-rating of the portfolio versus the market as market sentiment normalises.

Expected portfolio earnings growth FY1-FY4

As mentioned previously, while the Asia ex-Japan region has now recovered to be up 5.4% year to date, many markets have lagged since they bottomed in March 2020. The overall recovery was led by the technology laden North Asian markets of Taiwan, Korea and China. Conversely much of the region, namely India and ASEAN markets, are all still trading at levels well below the beginning of the year. In most instances, the negative share-price reaction was driven by multiple de-rating rather than a collapse in the medium term earnings outlook.  As such, we believe the depressed stock prices combined with strong earnings growth expectations bode well for further share price recoveries in these markets.

The second quarter of 2020 is likely to be the nadir of what is expected to be one of the worst years economically since the great depression. Most Asian markets reported GDP growth well below zero in the quarter ended 30 June, as five markets slipped officially into recession. In most countries in the region, industrial production and gross fixed investment fell in the double digits, or showed weakness well below the long-term average.  Furthermore, despite significant fiscal stimulus across the region, unemployment increased to levels well beyond the global financial crisis, prompting significant declines in consumer spending and consumer confidence. Many countries will begin to unwind stimulus measures in the coming quarters, which may bode poorly for unemployment and consumption in regional economies.

Despite the apparent doom and gloom, there are many reasons to remain optimistic about the long-term prospects for Asian economies. As detailed in previous paragraphs, Asian economies did suffer in the second quarter of 2020. However, consensus estimates for the economic bounce-back in 2021 see Asian economies rebounding much more strongly than developed economies and the World as a whole.

GDP growth and forecasts Asian economies

 20192020 Q12020 Q22020E2021E
India4.23.1-23.9-4.010.0
Singapore0.7-0.3-13.2-6.08.2
China6.1-10.011.52.57.5
Philippines6.0-0.7-16.5-6.87.4
Hong Kong-1.2-9.0-9.0-7.26.0
Indonesia5.03.0-5.30.46.0
World3.0n/an/a-3.95.2
Thailand2.4-2.5-9.7-7.34.5
USA1.70.3-9.1-5.43.8
Taiwan2.72.2-0.61.03.2
Korea2.0-1.3-3.2-0.62.2

Source: Bloomberg, Standard Chartered

Many developed market economies have seen consumers and corporations avail themselves of debt in recent decades taking advantage of relatively low interest rates. This surge in credit supported economic growth and significantly increased leverage in both the public and private sector. This leaves many users of private credit in a perilous position as the economic consequences of COVID-19 bite harder. However, many Asian economies, particularly those in emerging markets, remain relatively unlevered, especially at a household level. As a consequence, they are in a much sounder position to weather the COVID-19 disruption and potentially increase private credit to stimulate growth.

Niccolò Machiavelli (and later Winston Churchill) once said “never waste the opportunity offered by a good crisis”. For many Asian governments, the Asian debt crisis was a case in point. It provided governments with the opportunity to significantly reduce their overseas debts. Many were brought to the brink of default as local currencies plummeted and foreign governments called in their dues. As shown below, the reduced government debt to GDP has endured to this day for many Asian economies. While large, liquid currencies such as the USD and JPY can support huge foreign debt, smaller currencies cannot. The relatively low levels of public debt are likely to provide support for emerging Asian economies and provide some degree of firepower for governments to embark on looser fiscal policy to support the recovery effort.  

Public debt to GDP

Many Asian economies share two things in common; a young population and relatively low levels of income per capita. These forces combined have created an insatiable appetite for consumption in recent years as incomes grow. This has seen private consumption across emerging Asia grow at a significantly faster pace, compared to developed markets. Private consumption tends to occupy a significant proportion of GDP, ranging from 50% to 80% across the region. As such, the GDP growth multiplier effect from consumption in these emerging economies has been significant, turbo-charging growth. We expect this consumer demand to return in coming years as sentiment improves, lock-down measures unwind and employment becomes more certain. This in turn is likely to continue providing an excellent tailwind for growth in these economies. Chinese nutrition company Health and Happiness (H&H) is an excellent example of a portfolio holding exposed to this growth. We detail the investment case of H&H later in this report to highlight the portfolio’s exposure to this trend.

Private consumption growth 2018

We continue to live in very interesting, volatile and unpredictable times and the need for vigilance, strong balance sheets and stable cashflows remains more important than ever. Furthermore, the upcoming election in the US has the potential to muddy the already unclear path to more positive, post COVID-19 sentiment. However, history has shown in previous economic cycles that Asian economies are resilient. Their strong demographic and economic advantages are likely to continue supporting their recovery, offering growth potential available in few other places. To this end, the earnings growth outlook for stocks in the portfolio remains positive.

Whilst we were pleased to see some broadening of market participation during the quarter, including a strong recovery in several of the portfolios cyclical holdings we continue to observe valuations for many portfolio holdings at compelling levels. As such, we believe the risk/reward remains firmly skewed to the upside and give good reason for a far more optimistic outlook.  

Health & Happiness – leveraged to long-term growth in China’s nutrition market

Health & Happiness (H&H) is one of the biggest infant formula (top 5) and adult nutrition companies in China. The investment thesis for H&H is premised on the solid long-term growth outlook for both its baby nutrition and adult nutrition products that is not being priced into stock at present.

Baby nutrition – is declining birth rate a concern?

China’s number of births per year peaked in 2016 at 17.9m and has since been on a declining trend, standing at 14.7m in 2019, the lowest level in a decade. Sales of regular infant milk formula (IMF) have remained largely flat around Rmb 150bn over the 2016-2019 period. However there has been an opposite trend observable in the premium and super premium IMF segment which has seen continuous growth, with 2019 sales more than doubling 2016 sales level, or a growth rate of 35% per annum. Industry estimates are for premium IMF to outgrow regular IMF and take the bigger share in total IMF sales by 2021, accounting for 60% of sales in 2023 from 30% in 2019.

China IMF sales

Premium and super premium IMF account for 95% of H&H’s IMF sales and are expected to drive double digit growth going forward. H&H is among the top 5 Chinese IMF companies with a distinct strategy in product manufacturing and distribution. IMF production is outsourced to high-quality European manufacturers under the Biostime brand – H&H’s own patented formula and products are then imported to China with original packaging. This is a key feature that distinguishes H&H from other domestic competitors who either produce or source raw materials domestically, enabling the company to price its formula products at a significant premium over local brands and similar to global brands. Distribution since its founding has been mainly through the specialised channel – maternity stores which accounts for more than 70% of total China IMF sales. Increased online penetration whilst nascent presently represents another substantial growth driver for the company. Presently online sales are 15% of H&H’s IMF sales, considerably below the industry’s 25%.

Adult nutrition – daigous impacted by pandemic but China continues to grow

H&H entered this business in 2015 when it acquired Swisse, one of Australia’s top adult vitamin and supplement brands. Swisse products are sold mainly in Australia & New Zealand, and China (both online i.e. cross-border e-commerce, and offline through resellers or “daigous”). Post-acquisition, sales have been very strong with an average annual growth of 15% driven mainly by sales in China – an impressive 60% average annual growth with contribution growing from 10% in 2015 to 55% in 2019. COVID-19 has on one hand held back individual daigous activities (the so-called “suitcase trade” by Chinese tourists to Australia) given travel restrictions, but has on the other hand increased demand for Vitamin C and other immunity-related products. In the long-term the China adult nutrition market is fragmented and there is enormous room for growth – adult nutrition per capita in China stands at around a quarter of global average, and is forecast to grow comfortably at an average rate of 6% pa and even faster for premium branded products.

Adult Nutrition per Capita

Why we think H&H will outperform?

The sale and profit growth outlook for H&H should remain stronger than both the sector and the market overall. At a 2021E PE of 14x, a discount of 35% to its long-term average and over 50% to the sector, H&H offers a compelling risk/reward. Furthermore, its relatively un-geared balance sheet allows a more generous dividend payout. The resulting dividend yield of 3.5%-4.0% offers a good floor to the price. H&H should re-rate versus the market as the short-term COVID-19 supply chain disruption dissipates.

Hyundai Mobis – a sustainably profitable cyclical with multiple ways to recognize significant upside

Hyundai Mobis (Mobis) is a Korean auto parts manufacturer and part of the Hyundai group of companies. Mobis is the primary supplier for auto parts in new Hyundai and Kia vehicles and is the sole original replacement parts provider for these vehicles. It also owns a ~21% stake in Hyundai Motor Company. Mobis’ stock has de-rated in recent years as concerns surrounding its capital allocation and more recently the COVID-19 impact on earnings have hit sentiment. The investment thesis for Mobis centres on its ability to continue to grow earnings over time while also benefitting from a re-rating as the market recognises its positive developments made around corporate governance.

After-sales business

In recent years, the vast majority of Mobis’ operating profits was generated from its recurring after-sales business (between ~81-87% profit contribution during FY2017-2019 and over 100% during FY2020H1). Demand for Mobis’ parts in the after-market is recurring in nature as the stock of cars grows each year and use of official parts enhances vehicle longevity and resale value (this is also why Mobis has the pricing power to maintain attractive margins). As shown below, the significant contribution from the after-sales business has supported the improvement in both margins and profit growth in recent years.

Hyundai Mobis after-sales segment operating profit and margins

Mobis’ 2020 after sales business was heavily impacted by COVID-19 in the first half of 2020. Car dealerships around the world were shut during different periods in 2020H1, curtailing instalment of replacement parts. This drove the 22% decline in the segment’s operating profit during the period. Longer term, we expect the robust growth of Hyundai and Kia car ownership is likely to endure. This should support healthy growth in profit from the after-sales parts business, further supporting an improvement in overall margins group wide. 

New car auto parts

The other main business for Mobis is core auto parts for new cars, mainly selling to Hyundai and Kia directly. This was historically the biggest profit contributor for the company. However, the collapse in the profitability of their capacity in China since 2017 has been a major driver of the overall decline in profitability for the segment. Earnings have been reset in this segment and while we expect some further improvement in the profitability in coming years, we aren’t assuming it reaches prior peaks. In short, it’s not a major driver of the investment case (but should execution prove better than expectation, could provide further upside).  

Hyundai Mobis – new car parts segment operating profit and margin

Valuation

Mobis’ currently trades 9x forward P/E based on earnings from the After Sales business alone, a significant discount to history. At this level, we believe the current stock price ascribes little value to its (still profitable) New Car Parts segment. It also has more than 30% of its market capitalisation in cash on balance sheet. Furthermore, Mobis’ 21% stake in Hyundai Motor does not appear to be priced in at current levels, given its KRW 8.1 trillion market value comprises around 40% of total market capitalisation. 

Why will it outperform from here?

We believe there are multiple drivers for Mobis’ stock price in coming years that should support outperformance:

  • Significant progress in electric vehicle parts.  Sales for electric vehicles grew at around 50% YoY during the first half of 2020 and represented ~11% of overall revenue. Mobis’ is well placed within this space, which should be a good contributor to future growth. As such, it is agnostic to the EV/ICE split of future vehicle sales.
  • Capital management. Mobis continues to maintain its commitment to buyback around KRW 1 trillion in own shares over three years (currently ~1/3rd of the way). Furthermore, it continues to cancel a portion of the resulting treasury shares, a rare occurrence amongst Korean companies.
  • Potential new proposal for group restructuring. Hyundai group management continue to move towards management succession and group restructuring. In order for this to occur, we believe the company needs to offer a new group restructure proposal which is acceptable to minority shareholders. In 2018, minorities rejected an offer valued at around KRW 453k per share (~97% higher than current share price).  The rejection was largely due to a partial merger with another Hyundai affiliate as part of the deal. This rejection resulted in Mobis making tangible improvements to corporate governance, including the introduction of more independent directors, improved capital management, and better corporate access for investors. We believe this improved corporate governance and the prospect of a more generous takeout offer could support a re-rating in the future.

[1]  GDP data is based on June quarter-on-quarter growth rates.

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