online.wsj.com
02/18/2002 MONDAY, FEBRUARY 18, 2002
The Bull Lives
At least in non-Japan Asia, apparently, but does he have legs?
The markets of non-Japan Asia have been storming lately. Since mid-September, South Korea and Taiwan are up 60%-plus; this year, smaller Pacific Basin markets such as Thailand, Indonesia and the Philippines are playing starring roles. Thank the global appetite for risk, stoked by numerous easings by the U.S. Fed and assumptions that the world stands on the brink of recovery. But the rollover in U.S. stocks reminds many that in recent history, the fortunes of non-Japan Asia depended completely on the U.S. Which led us to wonder: Does this bull market have legs?
One blustery afternoon in Hong Kong, we asked a trio of seasoned observers for their opinions on this, on China, on the Korea discount, and other issues. You'll find them divided in their outlook, but all agree that Asia looks cheap and that an emerging story of domestic consumption may offset sagging U.S. demand. Oh, and of course, they offered up a host of tempting stock picks.
--------------------------------------------------------------------------------
Barron's Asian Forum
Simon Rudolph
Templeton Investments Asia
Han Ong
Salomon Smith Barney
William Kennedy
Fidelity Investments
--------------------------------------------------------------------------------
Our panelists include:
William Kennedy, the Tokyo-based chief of Fidelity Pacific Basin and Fidelity Advisor Japan. Kennedy picks stocks for Fidelity Investments' Japanese and Southeast Asian accounts, and in the past, oversaw the firm's Hong Kong research efforts.
Han Ong, Salomon Smith Barney's Asia strategist in Hong Kong. Ong formerly headed Mercury Asset Management's Pacific team of fund managers, and was Japan research chief for S.G. Warburg.
Simon Rudolph, the Hong Kong-based portfolio manager for Templeton Investments Asia, a Unit of Franklin Resources. Besides Asia in general, Rudolph's areas of expertise include consumer goods, small caps, India and Japan.
-- Leslie P. Norton
Barron's: Asian markets have roared higher since their post-September lows. But to paraphrase Yeats, we've never seen a bull market that lacked either conviction or intensity to such a degree. How convinced are you that Asia is in a bull market? Are stockbrokers simply retailing a story that will end up in a bargain bin?
Rudolph: There is quite a bit further to go in non-Japan Asia. Liquidity, in the current low-interest-rate environment, is very favorable to equity markets. We are very much bottom-up stock pickers as opposed to top-down asset allocators. Still, it's a shame we didn't have this conversation in the third quarter because we found an awful lot of stocks that were very cheap. There aren't as many now.
Panelists, from left, Simon Rudolph, William Kennedy and Han Ong: In coming months, they wonder, how closely will non-Japan Asia's fortunes depend on a business recovery in the U.S.?
Ong: Remarkably, almost to a man, every market turned on the 21st of September. The massive injection that kick-started the markets could have kick-started the deadest mule. The market bought the highest-risk assets. The emerging markets were the greatest outperformers. Does this have legs? The tap feeding the liquidity has begun to slow. The major markets have halted, the Nasdaq rolled over. In January, Latin America fell back but for Mexico.
Asia has a different dynamic. North Asia stopped leading. Today, it's Southeast Asia. At a sector level, the market has broadened. My guess is asset allocation flows will keep us going, global monies saying Asia is a better place. But we could be in for a correction.
Q: How good are earnings prospects and valuations?
Ong: We've had two bubble periods in Asia's history over the last 10 years. In the early 'Nineties we had massive current-account surpluses, fixed currencies, and markets ran like mad. After the crisis of '97-'98, the pumping as a result of the Long-Term Capital Management bust and then pre-Y2K led us straight into another bubble. Price to book in Asia is 1.6, in developed markets, well over 2. Still, that's narrowed.
We've had the early-market-cycle run, pushed by money, led by the long-duration telecoms, the high-beta, and the interest-rate sensitives. You've had chemicals, airlines taking off recently. But growth is less imminent than people think. Over the next three to six months, we need the traction of rising earnings momentum. I don't see that traction digging in within the next six months. If you are priced to perfection now, stocks don't stay where they are. Asia pays the piper along with everyone else because we've decided we can't grow unless the U.S. does, because we want to sell to the U.S., because we haven't restructured enough.
Kennedy: I tend to focus on bottom-up stockpicking, but in Asia in general I find companies are cheap relative to their historical trading ranges and to global peers. There has been a risk premium attached to Asia because it's a volatile market. Nearly 50% of companies in Asia yield more than the local savings rate. A technology company in Taiwan or Singapore or Korea tends to be cheaper than their global peers. Given the low cost base and the outsourcing story that predominates here, they're growing faster as well and tend to have better returns on capital. The markets have been liquidity driven, but we've seen a stabilization on earnings, not the huge downgrades of before. In Hong Kong, you earn less than 50 basis points [a half percentage point] on a bank deposit. Some of that is starting to work its way into the stock market, and that's the case in Korea, too, where interest rates are a lot lower. So you might get a pullback, but Asia relative to its global peer group is still quite cheap.
Q: Are the fortunes of non-Japan Asia completely dependent on a U.S. recovery?
Rudolph: No. In Korea domestic demand has picked up. In India exports and imports relative to GDP are very low. The Taiwan stock market is 60% roughly tech-related. You can't generalize. But if there isn't a recovery in the U.S., there will be a pretty serious cloud over Asia.
Ong: We have such a skewed global economy that for the last 10 to 15 years, the U.S. needed to grow for us to grow. India and China apart, Asia is really in equilibrium only when the global economy is skewed toward excess demand. We have to sell into that excess demand for us to stay stable. What's changing? Asia is restructuring. We are creating more-balanced economies. Korea, even in this downturn, was able to live off domestic demand. There are early signs of this in Malaysia and possibly even in Thailand.
Kennedy: India and China tend to be more domestically driven; countries like Korea and Taiwan with higher export-to-GDP ratios will be at the mercy of the United States. If the U.S. goes back into recession -- even though we've seen recent positive GDP numbers -- it will hurt Korea's consumption boom. So much employment is geared around exports. Hong Kong and Singapore will be at the mercy of the U.S. Particularly Singapore, where the numbers last year were devastating. But now we're starting to see demand pick up, cargo utilization pick up, the export story reinvigorating itself. That should help some of the smaller countries.
Q: Your views on a U.S. recovery?
Ong: Our house view is that the U.S. grows by 1.8% this year, that we get a big bounce in this quarter because the heavy inventory corrections of the fourth quarter get reversed, and the consumer comes back in the third and fourth quarters. But it really matters not what our house view is, or Bill's, or Simon's. Everybody and his dog has bought into the certainty of a second-half recovery. The issue isn't whether the U.S. comes out of the doldrums, it's whether the recovery in earnings comes sooner or more strongly than the market has already discounted.
Q: You've spoken of domestic consumption as a new Asian investment theme. How widespread is this?
Kennedy: Saving rates are very high in Asia. In most economies, they are 20%-30% of personal income. There's room for consumption to pick up. But for consumption to sustainably rise, Asia needs to see less extreme cyclical swings. The Asian consumer sees this volatility and hoards savings as a result. I can't see consumption go down from here. Over the next five years, consumption will be a significantly larger piece of the overall economy. People are spending in Korea because rates are so low. They're spending in Southeast Asia. Even in Hong Kong and Singapore, we're seeing property transactions pick up rates.
Ong: We've had high savings in Asia because the return on those savings has been so erratic. You need to put away that little bit more, just in case. Korea is a terrific example of the restructuring that is taking place. The chaebols once hogged the money. Any other enterprises would have to pay 30%, 40%, 50%. Just madness. The result of the chaebols being broken up and the banks being reorganized is rates fell and capital is becoming more efficiently allocated. That's an early sign. And from a bottom-up view, consider Malaysia. MRCB has been restructured. The Renong Group has been broken up. MAS was broken up into a domestic and foreign airline. In Malaysia and even in Thailand, return on equity has been relatively more stable than the Asian average. EPS has held up better.
"Asia is restructuring. We are creating more-balanced economies. Korea was able to live off domestic demand. There are early signs of this in Malaysia, even in Thailand."
Q: Is Korea an outlier?
Rudolph: In Taiwan, you don't have the domestic demand or a balanced economy. In Singapore, the consumer is dead. People are scared stiff about losing their jobs. You are very much seeing the perils of deflation in Hong Kong. People don't buy houses because they think they'll be cheaper in six months. Property developers have absolutely no pricing power at the moment.
Q: What kind of threat does Japan pose? The rest of Asia is howling about the yen's slide.
Ong: That Japan won't do anything to save itself is the easy assumption and the consensus assumption, and the safest assumption in the world has been to think the yen will keep dripping down. It's not like Argentina, where you can telegraph the news and take action. Japan is the world's second largest economy. If it implodes, it will have a major impact. But even if Prime Minister Koizumi did nothing, or his successor, or his successor's successor, demographics will solve Japan's problem. As you age, you save less, you spend more. But at some stage over the next 10 to 15 years, things will have to get a lot worse. The bank index has been going down in a straight line --
Rudolph: For 10 years!
Ong: But they are half nationalized. You have the April 1 milestone when depositary insurance vanishes.
Rudolph: We're lucky the Japanese economy is as insular as it is. I'm not sure the yen is as important as people think; it has to go a lot further before it becomes an issue for the rest of the region. And people shouldn't underestimate Japan's capacity for radical change in a crisis. Look at the Meiji Restoration.
--------------------------------------------------------------------------------
Han Ong's Picks
Company Country Symbol Recent Price
Kookmin Credit S. Korea 3115 KS 55,300 son
Magnum Malaysia MNM MK 2.57 ringgit
Big C Supercenter Thailand BIGC TB 23.30 baht
Huaneng Power China 600011 CH 12.75 yuan
Zhejiang Expwy China 576 HK 2.08 yuan
Source: Bloomberg
--------------------------------------------------------------------------------
Q: And the yen?
Kennedy: I am concerned about Korea and Taiwan, which compete directly with Japan. Hong Kong doesn't have the currency to get more competitive, so you need to see continued deflation.
Ong: It's never white and black. Korea has potentially the greatest number of overlapping industries in direct competition with Japan -- shipbuilding, steel, autos, consumer electronics. So the won is weakening. But the positive side is that when you indulge in excess supply of your currency, you create a bubble potentially, which is very good for your stock market.
Where do you find opportunities now, regionally speaking? Let's look first at China, now the region's second largest market after Japan. Global investors who use China Mobile and China Unicom as proxies have gotten burned.
Rudolph: A very, very difficult market to invest in. There are major issues about corporate governance, accounting transparency, and being sold stuff at the top of the market. We'd rather play China through Hong Kong. Even in our Asia Pacific funds, China is a very small part vis-a-vis global benchmarks. Regulation risk is always a risk, but when you invest in China, you price it in. I don't see that going away. So our hurdle rate for Chinese investments has always been fairly high. We prefer to play China through companies like CNOOC, where we're impressed with the qualities of management, and through China Mobile, but at lower levels. [China Mobile was trading last week at HK$23.70.]
Ong: China in many ways is an emerging market in an emerging-market region. Trying to be too smart at the stock level will come to tears. So you play what you know will have to work, get the dividends out. We've been telling clients to go for power companies -- Huaneng Power, Beijing Datang. In a growing economy, you need energy. They yield 5% odd in dollar terms. A close equivalent is the expressway companies. Take Zhejiang Expressway. It's in the Shanghai Ningbo area. Zhejiang Province's GDP is growing 10%-plus, above the China average. That's also yielding just under 5% in dollars. These 1.3 billion people are going to travel.
Q: What about the coming listings in a number of Chinese enterprises?
Rudolph: We should look at them with care. I wonder if you really want to be buying Chinese IPOs, when everyone loves China. Are investment banks able to convince people selling to leave something on the table? You have the same problem in India. Everyone buys into the long-term China story, but if you have a series of big fat negatives, you will get more cynical. China Mobile listed at 10 or something, went above today's price very quickly, but most people who bought probably lost money.
Kennedy: Like any market, China has good companies and bad. CNOOC talks about returns on invested capital, cost of capital, about what drives value. They have a decent idea of where they're going strategically. The consumption of energy in China will be pretty big over the next couple of years. Lots of companies are cheap for a very good reason. The other big issue is excessive regulatory risk. The Ministry of Information Industry is restructuring the telecom industry, and it tests the market to see how things sound, like calling-party-pays plans recently. That creates volatility. You've seen multiple compression in the telecom industry, in part because investors are fed up with the regulatory experimentation. And growth in average revenues per user has collapsed for both the mobile companies. Prepaid cards are an issue. And you currently have two licensees out there and talk about more, you have uncertainty with 3G, and you don't know what telecom will look like in China in the next five years, while you have a pretty good idea what it will look like in Hong Kong, Japan, Korea, Taiwan.
The second point about China is you want to buy it when people hate it. Right now, people love it. It's difficult to find companies trading at good valuations relative to global peers. So the next 12 months will be more difficult in China than the past 12. I tend to play Taiwanese companies, Korean companies that are moving production to China. The incremental boost you get for return on capital from moving 30% of your production there is very large.
Q: Are we at maximum pessimism for China Mobile and China Unicom? People seem more positive on China Unicom.
Kennedy: For me to get excited, you need a deep-valuation argument as well as more regulatory certainty.
Rudolph: I see worrying about the margins. The EBITDA [earnings before interest, taxes, depreciation and amortization] margin is in the high 50s. Compare that with margins elsewhere; it's hard to think of them as long-term sustainable.
Q: Let's talk about the rest of the region. What do you like, and what do you hate?
Rudolph: India is my favorite. It's always hugely risky because they contrive to snatch defeat from the jaws of victory pretty regularly. There's political risk, and not just because of a war with Pakistan, but also elections. But there are very good companies if the economy picks up in the next 18 months. We like a number of sectors -- cement, for example. Anyone who's been to India knows the infrastructure stinks. The Indian cement industry is consolidating, which means much more pricing power and discipline. However, Indian cement companies are ones that you don't want to buy and hold. You need to get in and out. We also like one or two of the IT companies, like Satyam Computer, which we think has a number of sustainable advantages. Short term, I'm pessimistic on Hong Kong. It's difficult to see why this economy should hum along.
"There are a hell of a lot of extremely well-run, profitable companies that fell off the radar screens of investments banks in Asia, which have reined in costs."
Q: What about South Korea, which some believe is overowned by foreigners?
Rudolph: You have to be selective. I like the consumption story. I wonder whether a bubble is brewing. We liked Samsung Electronics very much below KRW150,000. It still looks cheap versus global peers, but there's a big Korea discount. The one thing that really worries me now, particularly about Korea, is the way analysts have changed price targets. The stock reaches the target and some justification is found to significantly hike the target. Interestingly, at the peak of the previous cycle, the price targets and earnings expectations were almost identical to what they are now. Samsung got to about KRW380,000. The old price targets where anywhere from KRW500,000 to KRW700,000. That's exactly what you see now. The risk is that people get too carried away.
Q: Han, what do you like and dislike?
Ong: The world has bought into a U.S. recovery as a matter of certainty, so those markets seen as beneficiaries are arguably most at risk if growth were more anemic. I wouldn't go for exporters right now, I'd go for Asian domestic demand. I worry about Korea for the same reasons as Simon. Korea is a multi-year story, a structural, not just a cyclical, upturn. Shinsegi has doubled, doubled again, and doubled again. That surely reeks of a bubble. Yet it doesn't look terribly expensive, even with the gearing. So what is a Korea discount? Should it be as large as in the past? Korea is always prey to a mood pendulum -- when things are bad, it's suicidal. But the pendulum today is clearly very good. If it's restructuring, and volatility is decreasing, then the risk premium should drop. You have to be prepared to buy and hold, which is always difficult in Asia. As alternatives, I'd look to Malaysia and even Thailand, where I have a cute stock -- $400 million market cap, Big C Supercenter. When they repealed the foreign business act, Tesco from Britain came in, Carrefour came in. Hypermarkets are now 30%-35% of the retail business in Thailand. Big C trades at five times cash, seven times earnings. This is restructuring. The equivalent in Malaysia is more difficult to find, but you can still find fairly liquid consumer substitutes -- like gaming companies, such as Magnum and Tanjong, or leisure, such as Resorts World. Leisure is a beneficiary of China. The richer Chinese will travel more, stay in hotels, use Star Cruises.
--------------------------------------------------------------------------------
Simon Rudolph's Picks
Company Country Symbol Recent Price
Kookmin Bank S. Korea 6000 KS 60,900 son
DBS Group Hldg Singapore DBS SP 14.70 Singapore dollar
Satyam Comp India SCS IN 295.25 rupiah
Techtronic Ind Hong Kong 669 HK 4.13 Hong Kong dollar
Yue Yuen Ind Hong Kong 551 HK 20.00 Hong Kong dollar
Assoc Cement India ACC IN 167.05 rupiah
Gujarat Ambuja India GAMB IN 219.55 rupiah
Source: Bloomberg
-------------------------------------------------------------------------------- |
