In early January Ned Bell undertook company research in China, visiting both Shanghai and Hong Kong. He attended the UBS Greater China Conference in Shanghai and met with a number of companies in Hong Kong.
What was the purpose?
The purpose of the trip was mostly ‘discovery’ in nature. I met with management of a number of companies to identify new ideas for the portfolio.
Which companies were of the most interest?
Of the 13 companies I had engaged with on the trip, there were really 4 that stood out the most. They all meet the initial stages of our investment process and have some unique long term growth drivers. We have undertaken research on these companies previously but the team are undertaking more analysis to build our confidence on how they could potentially contribute to the portfolio.
What stood out most about the companies that you visited?
I would say that corporate governance and overall management professionalism has improved quite markedly in the last two years.
The SOE’s (State Owned Enterprises) in particular, have clearly improved in response to the government’s crackdown on corruption. As a manager with a strong quality bias, we will only invest in companies that we believe have competent management teams that will act in the best interests of all shareholders. The net result being that we are more likely to invest in some selective Chinese names than we were in the past.
How is this market performing at present?
The Chinese equity market as a whole seems to be behaving a little more rationally than it did in 2015 when we saw a leverage fuelled boom and bust. The market was essentially flat last year but seems to be having a strong start to 2017. At a more granular level, an area of concern for us are Chinese banks, due mostly to their overall credit quality which we expect will remain an issue over the medium term. Looking across the sectors we think the most interesting opportunities are amongst the major internet companies like Tencent and Alibaba who are continuing to build market share and simultaneously consolidating the numerous underlying verticals. Further, the government also seems determined to consolidate the property industry as a way to drive out the speculators – which could provide some interesting opportunities.
What can local investors learn from this market?
When I was in China two years ago, it seemed clear that the government had a desire to reduce economy’s reliance on infrastructure spending as a source of growth.
It now seems that plans are afoot to build a number of large scale subway systems across a range of cities to reduce congestions and make more residential land accessible.
From an Australian investors perspective, this is arguably a net positive for investors in basic materials stocks.
Do you have any holdings in China?
We have had exposure in the past to China and continue to look for opportunities. Currently we don’t have any holdings in China. There are a number of companies that we would consider investible but valuation is really the catalyst. We will invest at the right price. We are currently building our theses on a number of companies at the moment.
Are you considering changing your allocation to the market?
As a bottom up manager, individual stock selection drives our Country and Sector allocations. At this stage we are treading carefully and being patient with regard to valuations. I have come away from the trip a little more constructive on the companies themselves, so we may well have a handful of holdings in the portfolio in the foreseeable future.
What is driving growth in the Chinese market?
There will be a multitude of growth drivers for the economy this year – the property market and infrastructure spending being the more notable ones for 2017.
As far as the equity market is concerned – it’s our belief that the large U.S. listed Tech names like Tencent and Alibaba will probably account for the best earnings performance in 2017.
Having said that, the CSI300 Index is heavily weighted to large cap Financials - whose collective earnings’ outlook are mixed at best. While reported credit quality metrics like NPL’s (non-performing loans) appear reasonable, under the surface the shadow lending industry is growing quite rapidly.
What are the risks in this market?
There are a number of risks that investors need to consider with the Chinese market:
– Corporate governance: while it has improved, we still feel it has a long way to go
– Shadow lending: is growing quite materially and does represent a risk to overall credit quality.
– Protectionism: under the Trump administration, it would seem that corporate China could well be a net loser in what will become a more combative global trade landscape.
– Scarcity value: in the large cap space, there are relatively few companies that could be regarded as by our measure, being ‘high quality’ when compared to their global peers. As a result these companies have a tendency to be extremely well owned and can come with meaningful valuation risk.
What implications do these findings have for your portfolios?
Subject to further due diligence and being patient on valuation’s, we are more likely to add a select number of Chinese companies to the portfolio than we were a year ago.
Next planned trip?
A number of team members will be meeting management of companies across the globe in 2017. For me, my next company research trip will be in the second quarter, May which will be a combination of meeting a number of Small/Mid cap UK and European companies and visiting the US companies in the Global Technology, Media and Telecom space.