Sector Watch: Asia-Pacific markets are valued fairly

Wong points to successful measures by China’s policy-makers in the past two years to cool the property market, mainly by raising interest rates. Those measures were effective, but the policy-makers are considering capital gains taxes to prevent another overheated property market. Says Wong: “That’s a signal that the government will intervene to make sure housing prices are under control.”

Meanwhile, industrial production and trade are up again, although the 7%-8% growth in China’s gross domestic product (GDP) in 2013 will be a long way from the double-digits of the 2000s. Wong notes that in March, China’s new president, Xi Jinping, and new premier, Li Keqiang, officially assumed office and made a strong statement in introducing more market-oriented reforms.

“In the near term,” says Wong, “there is uncertainty because introducing changes leads to winners and losers. Some state-owned companies may be adversely affected. Longer term, however, these changes should be positive.”

Another positive macroeconomic development within the region, says Wong, is the common market that the 10 members of the Association of Southeast Asian Nations (ASEAN) will establish in 2015.

“There has already been a decline in some trade barriers,” says Wong. “But in a couple of years, there will be much more free flow of goods and services. The whole region will be more integrated. In the past seven years, GDP growth has averaged about 5% a year. It’s a very stable, high-growth region.”

From a valuation standpoint, Wong notes that regional stocks are trading at about 11.5 times 2013 earnings on average, vs 14 times for stocks in the U.S. The discount is attributable to uncertainty regarding China.

A bottom-up investor, Wong has about 30% of the Dynamic fund’s assets under management (AUM) in China and Hong Kong combined; as well as 30% in ASEAN countries such as Thailand and Indonesia; 23% in North Asian countries such as South Korea and Japan; and smaller holdings in India and Pakistan.

Running a portfolio with about 55 names, Wong likes Vietnam Dairy Products Co. (a.k.a. Vinamilk), Vietnam’s leading dairy-products maker, which went public in 2003. “[Vinamilk has] half the Vietnamese dairy market,” says Wong. “It’s a classic, emerging middle-class story. As income rises, every parent wants their kids to have milk.”

Acquired two years ago, Vinamilk’s stock is trading at roughly 113,000 dong ($6) a share, or about 13 times current earnings. “It’s trading at a 30%-50% discount to its global peers,” says Wong. There is no stated target.

Regional markets are pricing in some optimism, argues Henry Chan, portfolio manager in Hong Kong with FMR LLC (a.k.a. Fidelity Investments) who oversees Fidelity AsiaStar Fund, “but not excessively so. The market priced in a lot of pessimism last year, mainly about China. That was followed by a large market rebound toward the end of 2012 and into this year. It was more a change in expectations than a real swing in the underlying economy. What matters from here is the relative earnings momentum.”

Based on measures of liquidity, growth and valuations, Chan argues, Asian stocks are valued fairly: “Liquidity will remain neutral to favourable. I’m not assuming a tightening mode in the next six to 12 months.”

As for growth, Chan notes that consensus views point to 14% earnings growth in 2013, followed by 12% next year. Adds Chan: “Asia-Pacific generally offers a slightly better earnings outlook compared to the rest of the world.”

Regarding valuation, Chan says Asia’s markets are trading at about 1.5 times book value and 13 times earnings – comparing favourably to the recent past: “The historical trough was around 1.2 times book value and 10 times earnings. We are definitely above the bottom. If you think about that 13 times price-to-earnings multiple and 12%-14% earnings growth, that’s reasonable. We are not paying a lot for that kind of earnings growth in the coming two years.”

Given where regional economies are, Chan argues, “We are not in a sharp cyclical growth environment.” And because investors cannot expect to find growth everywhere, he adds: “You want to be invested in companies that command better pricing power.

You want to find growth when growth is scarce. Looking out three to six months, the stable growth, or consumer-related areas, should provide upside on earnings expectations.”

Chan, primarily a bottom-up growth investor who uses a top-down view to test his convictions, has allocated 34% of the Fidelity fund’s AUM to Japan, 16% to China, 9.8% to Australia, 9.6% to Hong Kong, 8% to South Korea and smaller weightings to countries such as Taiwan and Thailand.

Running a portfolio of about 160 names that is skewed toward domestically-oriented companies, Chan likes CP All Public Company, a Thailand-based conglomerate that operates a growing network of 7/11 convenience stores. Says Chan: “Domestic demand has been strong, and Thailand has been less affected by the export cycle. This is a way to capture that consumer demand.”

The company’s earnings are growing by about 20% a year, while its valuation is 28 times earnings. “It’s not cheap,” says Chan. “But [the firm is] getting a lot of market share gains. This is the sweet spot: growing consumption and a market leader.”

CP All Public shares are trading at about 45 baht ($1.56) each. Chan has no stated target.

John Millar, a specialist in Japanese equities with Edinburgh-based Martin Currie Investments Inc. and co-manager of TD Pacific Rim Fund, sharing portfolio-management duties with Jason McCay, director, Asia-Pacific, for Martin Currie. Millar also believes that markets in this region are fairly valued.

“On a price-to-book basis,” says Millar, “stocks are around 1.4 times, according to the MSCI all country Pacific index. It ranged from below 1.0 during the 2008 global crisis to above 2.3 in 2007. If that’s the range, we’re about one-third of the way up. Although markets have gone up a lot, so have earnings.”

Millar argues that China is undergoing a very gradual acceleration in GDP growth: “There were some factors around monetary policy last year, and some uncertainty over the leadership transition. But our base case is that we’re seeing the early stages of a gentle recovery.”

Japan, however, has emerged as the big surprise subsequent to the Liberal Democratic Party (LDP), led by Shinzo Abe, assuming power in December. Says Millar: “The LDP campaigned on one key issue: reinflate the economy. Policy-makers were relaxed about deflation and saw that a moderate level of deflation was acceptable. But that view has been shaken by the global financial crisis and the subsequent negative impact on Japan. The country was ready for a change, and Abe came along with a clear message: aggressive monetary easing, fiscal stimulus and deregulation measures. It’s caught the imagination of the stock and currency markets.”

Although the yen has slumped against the U.S. dollar (US$), Millar points out, the benchmark Nikkei 225 index is up by about 20% year-to-date in US$ terms.

A bottom-up growth investor, Millar is running a portfolio with about 55 holdings. Japan accounts for 33% of the TD fund’s AUM. China and Hong Kong account for 21% in aggregate, and there are smaller positions in countries such as South Korea.

One favourite name is Orix Corp., a diversified Japan-based financial services company with global interests in equipment leasing, real estate lending, life insurance and consumer finance.

“We like the company because of its exposure to the domestic real estate cycle,” says Millar. “Rents fell by over 50% in Tokyo after the global financial crisis. But we feel confident that the cycle will improve, led mainly by the ending of new supply.”

Orix stock is trading at about 1,196 yen ($13) a share, or 0.9 times book value. Millar’s target: 1,600 yen ($17) in 12 to 18 months.

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