Asia Themes 2011 Best ideas in Asian equities 16 December 2010 Find CLSA research on Bloomberg, Thomson Reuters, CapIQ and themarkets.com - and profit from our evalu@tor ® proprietary database at clsa.com Trendlines (As at 15 Dec) Large-cap BUYs Baidu BIDU US Bank of China 3988 HK China Construction Bk 939 HK China Mobile 941 HK China Telecom 728 HK Infosys INFO IB PetroChina 857 HK Ping An Insurance 2318 HK Standard Chartered 2888 HK Tencent 700 HK Large-cap SELLs BYD 1211 HK Cathay Financial 2882 TT Chalco 2600 HK CNOOC 883 HK LG Electronics 066570 KS Mega Financial 2886 TT PICC 2328 HK S-Oil 010950 KS Telkom Indonesia TLKM IJ Zijin Mining 2899 HK What to watch for? with Anirudha Dutta We expect more of the same in 2011: Western economic growth disappointments, reflation of Asian assets and more intervention to curb inflation. Earnings growth should moderate sharply after a sterling 2010, while there is headroom for a rerating of Asia ex-Japan valuations, currently near 20-year means. Chris Wood remains sanguine with expectations of an asset bubble in Asia supporting his Overweight stance on the region for now. Russell Napier warns of more government interference as the belief that markets have failed will spur politicians to establish their primacy over the world of finance. Capital controls are now just a matter of time. Eric Fishwick also expects tightening in 2H11, as well quicker Asian domestic consumption and construction activity thanks to QE2. From China, Andy Rothman hopes that inflation will moderate as both monetary policy and weather conditions normalise. Sector themes include: stronger credit growth for banks; reviving consumption; strength in enterprise spending on tech; return of revenue growth for telcos; resources M&As. Meanwhile, Amar Gill identifies a few ROIC-Ebit/EV gems. By market, look for companies taking advantage of China’s various advances; best-managed Indian firms that leverage rising commodity prices; reform plays in Malaysia; dividend-payers in Singapore; and growth stocks in Thailand. Our Feng Shui master warns that the bunny is an ecstatic but unpredictable animal. Enjoy the ride and best wishes for the Year of the Rabbit. GLOBAL STRATEGY: How does Asia's asset bubble play out? Chris Wood remains steadfast in his belief that global recovery is subpar and the extremely easy monetary policy in the West has set the stage for an Asian asset bubble. While this is the near-term argument for remaining Overweight Asian equities, the long-term consequence will be an inevitable boom-bust cycle in the region. However, Chris is more optimistic about Asian governments, which understand the risks and seek to counter them. GLOBAL STRATEGY: Will the free movement of capital survive? No, it will not, if Russell Napier is right. He argues that as governments step back into the marketplace to assert the primacy of politics over finance and mark the end of long-term deflation, the secondary-market valuation for capital will decline. The USA is likely to stand out as an anti-Merkelist bastion and in the near term attract more capital. GLOBAL ECONOMICS: What does QE2 mean for Asia? Eric Fishwick expects cost of capital to come down globally thanks to QE2. This will boost credit, domestic consumption and construction activity in Asia. Regional currencies should remain soft and inflation is likely to rise. Eric believes monetary authorities will start tightening in 2H11 and the region will become more “Chinese” in how it administers banking systems, ie, using capital controls to restrict inflows at source. CHINA STRATEGY: Will inflation rise further? Andy Rothman remains a bull on China. While he expects CPI to moderate next year, as weather and monetary policy normalise, he believes equities and real-estate prices will surge on increasing wealth. Ample domestic liquidity will shrug off concerns about rate hikes and fuel a large asset-inflation cycle. ASIA THEMATICS. Desh Peramunetilleke, Amar Gill , Andrew Riddick and Evelyn Moore also highlight their investment themes and ideas for 2011. Desh expects rising costs to put pressure on margins, with India, Indonesia and Thailand most at risk. Amar’s high- ROIC-EV/ Ebit screen has so far worked well in locating outperformance. And for the long-term believers in our Billion Boomers story, Andrew and Evelyn recommend buying into plays that serve the growing discretionary-consumption market and companies that are building strong franchises. Also inside Asia: Autos; Banks; Consumer; Resources; Technology; Telecoms; Social responsibility; Thematics Australia: Market China: Strategy; Market; A shares Hong Kong: Property India: Market; Economics; Politics Japan: Market Malaysia: Market Singapore: Market Thailand: Market Asia: Feng Shui; Review Valuations above mean MSCI Asia ex-Japan trailing PE 5 10 15 20 25 30 93 94 96 98 00 02 04 06 08 10 (x) Max 25.46 Avg 14.26 Min 9.63 Source: CLSA Asia-Pacific Markets Which countries will be FII favourites? YTD net FII inflow 0 5,000 10,000 15,000 20,000 25,000 30,000 India Indo Japan Phil Korea Taiwan Thailand Vietnam Pakistan (100) 0 100 200 300 400 500 YTD net % YoY (RHS) (US$m) 833% (%) Note: FII = Foreign institutional investment. Source: Bloomberg, CLSA Asia-Pacific Markets Hypergrowth in Chindonesia ® www.clsa.com
Transcript
Asia Themes 2011 Best ideas in Asian equities
16 December 2010
Find CLSA research on Bloomberg, Thomson Reuters, CapIQ and themarkets.com - and profit from our evalu@tor® proprietary database at clsa.com
Trendlines (As at 15 Dec) Large-cap BUYs Baidu BIDU US Bank of China 3988 HK China Construction Bk 939 HK China Mobile 941 HK China Telecom 728 HK Infosys INFO IB PetroChina 857 HK Ping An Insurance 2318 HK Standard Chartered 2888 HK Tencent 700 HK Large-cap SELLs BYD 1211 HK Cathay Financial 2882 TT Chalco 2600 HK CNOOC 883 HK LG Electronics 066570 KS Mega Financial 2886 TT PICC 2328 HK S-Oil 010950 KS Telkom Indonesia TLKM IJ Zijin Mining 2899 HK
What to watch for? with Anirudha Dutta
We expect more of the same in 2011: Western economic growth disappointments, reflation of Asian assets and more intervention to curb inflation. Earnings growth should moderate sharply after a sterling 2010, while there is headroom for a rerating of Asia ex-Japan valuations, currently near 20-year means. Chris Wood remains sanguine with expectations of an asset bubble in Asia supporting his Overweight stance on the region for now. Russell Napier warns of more government interference as the belief that markets have failed will spur politicians to establish their primacy over the world of finance. Capital controls are now just a matter of time. Eric Fishwick also expects tightening in 2H11, as well quicker Asian domestic consumption and construction activity thanks to QE2. From China, Andy Rothman hopes that inflation will moderate as both monetary policy and weather conditions normalise. Sector themes include: stronger credit growth for banks; reviving consumption; strength in enterprise spending on tech; return of revenue growth for telcos; resources M&As. Meanwhile, Amar Gill identifies a few ROIC-Ebit/EV gems. By market, look for companies taking advantage of China’s various advances; best-managed Indian firms that leverage rising commodity prices; reform plays in Malaysia; dividend-payers in Singapore; and growth stocks in Thailand. Our Feng Shui master warns that the bunny is an ecstatic but unpredictable animal. Enjoy the ride and best wishes for the Year of the Rabbit.
GLOBAL STRATEGY: How does Asia's asset bubble play out? Chris Wood remains steadfast in his belief that global recovery is subpar and the extremely easy monetary policy in the West has set the stage for an Asian asset bubble. While this is the near-term argument for remaining Overweight Asian equities, the long-term consequence will be an inevitable boom-bust cycle in the region. However, Chris is more optimistic about Asian governments, which understand the risks and seek to counter them.
GLOBAL STRATEGY: Will the free movement of capital survive? No, it will not, if Russell Napier is right. He argues that as governments step back into the marketplace to assert the primacy of politics over finance and mark the end of long-term deflation, the secondary-market valuation for capital will decline. The USA is likely to stand out as an anti-Merkelist bastion and in the near term attract more capital.
GLOBAL ECONOMICS: What does QE2 mean for Asia? Eric Fishwick expects cost of capital to come down globally thanks to QE2. This will boost credit, domestic consumption and construction activity in Asia. Regional currencies should remain soft and inflation is likely to rise. Eric believes monetary authorities will start tightening in 2H11 and the region will become more “Chinese” in how it administers banking systems, ie, using capital controls to restrict inflows at source.
CHINA STRATEGY: Will inflation rise further? Andy Rothman remains a bull on China. While he expects CPI to moderate next year, as weather and monetary policy normalise, he believes equities and real-estate prices will surge on increasing wealth. Ample domestic liquidity will shrug off concerns about rate hikes and fuel a large asset-inflation cycle.
ASIA THEMATICS. Desh Peramunetilleke, Amar Gill, Andrew Riddick and Evelyn Moore also highlight their investment themes and ideas for 2011. Desh expects rising costs to put pressure on margins, with India, Indonesia and Thailand most at risk. Amar’s high- ROIC-EV/ Ebit screen has so far worked well in locating outperformance. And for the long-term believers in our Billion Boomers story, Andrew and Evelyn recommend buying into plays that serve the growing discretionary-consumption market and companies that are building strong franchises.
Also inside Asia: Autos; Banks; Consumer; Resources; Technology; Telecoms; Social responsibility; Thematics Australia: Market China: Strategy; Market; A shares Hong Kong: Property India: Market; Economics; Politics Japan: Market Malaysia: Market Singapore: Market Thailand: Market Asia: Feng Shui; Review
Valuations above mean MSCI Asia ex-Japan trailing PE
5
10
15
20
25
30
93 94 96 98 00 02 04 06 08 10
(x)
Max 25.46
Avg 14.26
Min 9.63
Source: CLSA Asia-Pacific Markets
Which countries will be FII favourites? YTD net FII inflow
Asia - INTRODUCTION What are the themes for 2011? Remain Overweight Asia.
Next year is likely to be similar in many ways to 2010, but watch for increased policy risks. The recovery in the West remains anaemic and the USA is still in a deflationary mode. Asian asset prices will continue to inflate as long as the region is coupled to US monetary policy. Hence, we are likely to see more government intervention in Asia even as inflation remains stubbornly high. For now, we are Overweight the region. We provide insights from our strategists and research/sector heads in the following pages.
Macro and global - From Washington with love US recovery remains weak and the outlook on EU is pessimistic;
monetary policy in the West will remain loose; secondary-market valuations will decline as governments step back into the marketplace.
Ample liquidity in Asia should result in asset inflation, particularly in equities and property; China will be the epicentre of the Asian asset bubble.
With accelerating domestic consumption and construction in the region, inflation will remain a key concern in 2011.
Increased government intervention, first in property and likely to follow with capital controls; the renminbi should continue to appreciate, by 7% next year.
A key risk is margin pressure.
Sectors - A(utos) to T(echnology) Autos are in a sweet spot globally with developed-market capacity
addition muted and demand from the emerging world surprising on the upside.
A brilliant year awaits Asian banks, with healthy credit growth, widening margins and limited provision costs; focus on banks with high ROAs.
Asian consumers remain upbeat and will benefit from the positive job outlook and wage inflation in 2011; buy affluence and companies that are building strong sustainable franchises.
Hong Kong residential-property prices will continue to rise; we prefer the landlords to the developers.
Resources companies are well placed with healthy cashflows and therefore, capex and M&A will remain in focus.
A positive year ahead for technology: enterprise spending will remain strong after a decade of underinvestment; new products will keep consumer demand high. Stop worrying about wage inflation.
Telcos will witness revenue growth again on growth in data revenue, cheaper smartphones and Asian telcos’ own application stores. Valuations are undemanding.
Markets of choice Australia offers exposure to the growth of Asia without emerging-
market risk. With China emerging as the No.1 global consumer, there are multiple
ways to play the theme. Negative sentiment for the policy-sensitive stockmarket could reverse as weather and monetary policy normalise.
Commodity-price hikes and governance issues plague the Indian market. Inflation, high prices of resources and tight liquidity conditions are likely to be transient and we expect a revival in investment demand.
Return of inflation is good news for Japan, an oversold market with undemanding valuations. We see upside potential.
Malaysia is likely to see progress in reforms notwithstanding the sceptics, which will drive a market rerating.
Sharply up since the downturn US-dollar market performance since end-2008
0 100 200 300
IndonesiaThailand
PhillipinesKoreaIndia
TaiwanSingaporeMSCI Asia
MalaysiaHongChina
USAJapan
(%)
Source: Bloomberg, CLSA Asia-Pacific Markets
Upgrades are moderating Consensus EPS forecasts
25
30
35
40
45
50
Feb 09 Sep 09 Apr 10 Nov 10
2010E
2011E
2012E
(%)
Source: Datastream
Asia Themes 2011
4 16 December 2010
After two years of positive returns, Singapore is no longer cheap. Focus on dividend-related investment themes.
A continuation of capex and credit growth alongside a return of the present government after the next election will boost earnings in Thailand. Markets will react positively.
Valuations - Room for upside. We forecast Asia ex-Japan earnings growth to sharply moderate from 42.3% this year to 13.6% in 2011. The 12-month forward PE, at 12.1x, suggests valuations are not yet demanding in the aggregate. We estimate strong free-cashflow growth of 98% for next year. This, coupled with reasonable valuations, should provide upside to regional markets even as EPS growth slows. Our strategists remain Overweight Asia, while being cognisant of the risks, particularly from government action. Meanwhile, according to our new Feng Shui master, the year of the Metal Rabbit can be quite unpredictable, if history is any guide.
Global - STRATEGY How does Asia's asset bubble play out? Asia to enter a bubble if US interest rates take a long time to normalise.
The macroeconomic backdrop in America remains deflationary; hence the Federal Reserve’s willingness to embark on QE2. The US bond market continues to signal a subpar recovery. The more anaemic the Western recovery proves to be, the longer it will take for Western interest rates to normalise and so the more likely it will be that Asia enters into an asset bubble.
Unhealthy US recovery. By the first half of 2011, it should become apparent whether US consumption and employment are really normalising. The view here is that neither will recover healthily. This also seems to be the message from the US government-bond market, which has remained relatively well bid, despite the ongoing rally in the S&P500 amid rising optimism. Indeed the 10-year Treasury bond yield is still 117bps lower than the 2010 high reached in April. In this sense, the US bond market continues to send an entirely different message from the US stockmarket.
Asian asset bubble . . . China is likely to be the epicentre of an Asian bubble. The situation in the West is critical in terms of how the Asian cycle evolves. Western policy is likely to remain super-easy because of the lacklustre outlook for consumption and employment in an American economy, where consumption still accounts for 70.4% of total nominal GDP and 88.5% of nominal private-sector GDP. Another reason for policy remaining super-easy in the West is the potentially systemic issue of Euroland sovereign debt.
. . . and tightening policies. Asian governments and central banks are going to have to be very aggressive if they really want to head off the risk of an asset bubble in an environment where Western monetary policy stays so easy. Such an aggressive approach is theoretically possible in terms of much higher interest rates and allowing currencies to float freely. But the most likely outcome at present is that Asian tightening policies will continue primarily to address symptoms of the bubble risk, such as higher property prices, not the cause of it.
Renminbi appreciation. One important aspect of this potential Asian policy response remains Chinese currency policy. For now the view here remains that China will allow only an incremental appreciation of 5-7% per year. Still, the political noise on the Chinese exchange-rate issue is likely to escalate next year if the US labour market continues to be unhealthy.
Remain Overweight Asia. The extremely easy monetary policy in the West remains a perfect ingredient for an asset bubble in Asia, which is an argument for now to remain Overweight on the region. From a longer-term perspective, the other side of an asset bubble in Asia, with China at its epicentre, is a deflationary bust. This is why it is correct to say that an extended period of near-zero rates in the USA has the potential to destabilise Asia in the sense that the long-term healthy
Bond yield still below April high S&P500 and US 10-year Treasury bond yield
600
700
800
900
1,000
1,100
1,200
1,300
1,400
1,500
Jan 08 Dec 08 Dec 09 Dec 102.0
2.5
3.0
3.5
4.0
4.5S&P500 (LHS)
US 10-year Treasury bond yield(%)
Source: Datastream, Bloomberg
Continue to Overweight Asia MSCI AC Asia ex-Japan relative to MSCI AC World
50
100
150
200
250
300
1988 1995 2003 2010
(Jan 1988=100)
Source: Datastream
Asia Themes 2011
16 December 2010 5
domestic demand story anticipated in the original Billion Boomers report (The Real Pacific Century - Asia’s Billion Boomers, September 2002) is fast-forwarded into a boom-bust cycle. Still, it is a positive that the Chinese leadership, as well as other Asian governments, understands this risk and will be seeking to counter it.
Global - STRATEGY Will the free movement of capital survive? From mercantilism to Merkelism and the perils to capital.
The Merkelists’ desire to assert the primary of politics over finance reverses the assertion of Thatcherism that ‘you can’t buck the market.’ Government retreat from the marketplace and a long disinflation dramatically lifted the secondary-market valuation of capital from 1982 to 2000. We need to realise that we are faced with governments stepping back into the marketplace and the end of that disinflation - a combination that should structurally reduce secondary-market valuations for capital.
Merkelism is a convenient label. However, it is not confined to the ex-members of the Free German Youth Movement of the German Democratic Republic. Merkelism is a global movement forced upon politicians by perceived market failures. Of course, many of these failures stem from government intervention, most notoriously the refusal of China to permit exchange-rate revaluation, but this is irrelevant in the reactionary world, which is politics. Merkelism will have many manifestations; the key one for investors will be that politicians will seek solutions to Greenspan’s flaw. The flaw, as the Maestro outlined in testimony before Congress, is that the ‘enlightened self-interest’ of the private sector cannot correctly determine the appropriate level of credit for an economy. This is now the job of the authorities.
‘Primacy of politics over finance’. Anyone serious in asserting this needs to make capital as sluggish and inflexible as labour and government. The superior speed of capital has allowed it to arbitrage labour and government and thus asserted the primacy of finance over politics. Capital controls, whether introduced proactively in a Merkelist conversion or reactively in a crisis, are now just a matter of time.
Capital controls - A barrier to arbitrage. The emerging-market Merkelists believe that they will be able to target interest rates, thus credit, and their exchange rates simultaneously. The emerging-market authorities are marching down this route to avoid the credit bubble they suffered in the mid-1990s and the US endured for the past decade or more. Such controls are likely to be insufficient to control credit and defeat inflation and this will inevitably lead the Merkelists to seek to more directly control bank credit. Almost certainly one day they will have to follow Volcker rather than Merkel and attack their endemic inflation problems with interest rates and abandon the attempt to ‘whip inflation now’ with administrative measures. This approach is currently too radical, as it will inflict the political pain of higher interest and exchange rates simultaneously. Political expediency is driving the emerging-market authorities to Merkelism rather than monetarism. As with the USA in the 1970s, monetarism is a medicine too strong for all but those already weakened by a prolonged period of Merkelism.
Merkelism will spread. Most investors will be surprised that the Merkelist drive to assert the ‘primacy of politics over finance’ will also inflict Asia. Forecasting its spread within Europe is much less contentious. When all else fails, Merkelism can save the euro but at the expense of the free movement of capital and by cajoling private-sector savings into public-sector debt. Many might see such a move as imminent as the fiscal glue to cement the euro as it melts in the heat of Spain. This might be true but ignores that fact that when the fiscal arbitrage that passes good credit to bad credits reaches its limit, there is another solution in reserve. The monetisation of European sovereign debt by the European Central Bank (ECB) will save the euro.
‘I won’t let up on this because otherwise that primacy of politics over finance can’t be enforced,’ Angela Merkel, Chancellor of Germany
Markets versus central banks. Markets can take on and defeat governments whose fire power is limited to the funds they can extract from their citizens. However, markets must bend to the central bankers whose fire power is unlimited as they conjure money out of thin air. Most believe that the ECB would never pull this rabbit out of a hat because once upon a time, in 1923, another European central bank tried a similar trick. However, with the failure of the commercial banking system of Europe assured, if the euro fails then the ECB will have to follow the Fed and the Bank of England to defeat the markets. If the ECB saves the euro then Merkelism need not. However, it will not be held in abeyance for long. Once we thought Merkelism would appear to save the sovereign debt of Portugal, Ireland, Greece and Spain. Of course, if the ECB saves them, then one day Merkelism will appear but to save the sovereign debt of Germany itself.
Will the USA hold out? The USA is likely to stand out as an anti-Merkelist bastion. As the owner of the reserve currency, it must resist any movement towards the capital controls that would restrict the injection of foreign savings, which send it to work every morning. This resistance may even attract more capital as capital considers the balance between politics and finance to be in its favour in the USA. However, the primacy of finance in the USA is not some cunning legacy of Alexander Hamilton, but a result of a society addicted to the easiest money of all - the easy money called the reserve currency. Even the USA will question the primacy of finance when it realises that finance is not always cheap and readily available. That day for America will dawn when Volcker comes to Asia. When the emerging markets are forced to attack their endemic inflation with high interest rates and flexible exchange rates, then the USA will have to pay the real cost of finance. It is a price that it arguably has not paid for a century and at least not since the seventies. Emerging-market savings will no longer be on tap and US Treasury yields will soar. Then, and probably only then, will the USA be forced to impose capital controls, assert the primacy of politics over finance and bring Merkelism to America.
Global - ECONOMICS What does QE2 mean for Asia? Asia to see credit growth and faster consumption and construction.
QE2 will drive down the cost of capital globally and thus Asia is likely to see credit growth and accelerating domestic consumption and construction activity in 2011. But GDP growth will be slower amid weak world trade. Malinvestment resulting from emerging-market monetary policy internationalising QE2 will define the end-game for this cycle, but the party could last several years. The more immediate problem is consumer-price inflation. We expect Asian monetary authorities to start tightening in 2H11.
The “Bernanke put”. QE2 will drive down the cost of capital on a global scale. It will accelerate credit cycles in those countries in which, as a result of interest-rate and exchange-rate practices, import US liquidity. This includes most of Asia. Next year is likely to see credit growth and domestic construction activity accelerate. Most of Asia is export-driven, so in the weak-world-trade environment that we expect for 2011 GDP growth will be slower than this. But consumption and investment will be stronger than previous export-GDP correlations would suggest. QE2 represents the “Greenspan put” supersized into the “Bernanke put” of 2011. Our bearish economic forecast makes it a certainty that the US will extend QE2 into 2H11 and potentially beyond.
Don’t overplay euro weakness. QE2 will generate liquidity flows into risk assets far greater than the Fed’s direct purchases of Treasuries if it makes the US dollar appear a risk-free short. At the moment, this is not the case as the euro is contaminated by sovereign-risk concerns. Event risk in the euro will dissipate only by Portugal and likely Spain following Ireland and Greece in accessing International Monetary Fund and European Union funding. So doing will require aggressive austerity
Importing US liquidity Aggregate Asian forex reserves
USA as an anti-Merkelist bastion Gross Federal debt as a portion of GDP
0
20
40
60
80
100
120
140
1940 1952 1964 1976 1987 1999 2011E
(%)
Source: whitehouse.gov
Asia Themes 2011
16 December 2010 7
measures vindicating a pessimistic outlook for EU growth. As the bailout pacts are progressively triggered for Portugal and finally for Spain, liquidity risk overhanging the euro will dissipate. As this happens, the currency should again start to outperform the dollar.
Asia a soft-currency region in 2011. With export growth already under pressure and China unwilling to allow anything more than a cosmetic appreciation of the yuan, Asia as a whole in 2011 will be a soft-currency region. Exchange rates will appreciate versus the US dollar but only because the latter is even weaker. Asian currencies will fall relative to physical stores of value (gold and commodities in general), freely floating commodity currencies (the Australian and New Zealand dollars) and, as sovereign risk dissipates, the euro.
Asia coupled to US monetary policy. In Asia, QE2 will appear as a reduced cost of capital as underleveraged banks try to raise loan/deposit ratios (LDRs). The return on savings will also fall (especially in real terms). With cyclical (export) sectors weak, liquidity will pool in property markets. The combination of QE2 and Asian monetary policy will support both domestic credit growth and fixed capital formation. With exports under pressure, Asian economies will appear finally to have decoupled from world-trade flows. Our forecasts for 2011 are slower than 2010 but far from pessimistic given our US and EU assumptions. Asia will have decoupled, but only by virtue of remaining intimately coupled to US monetary policy.
Inflation will rise in Asia. On the street, liquidity is likely to be most visible as persistent upward pressure on property prices. Consumer-price inflation is already appearing in Asian inflation statistics today. Asia, like most emerging markets, is vulnerable to rising food prices because of the large weight of unprocessed food in Consumer Price Indices (CPIs). Inflation has started to rise across Asia and we expect headline rates to rise further as QE2 continues.
Asia will become more “Chinese”. QE2 has the potential to make the most economic difference in economies like Indonesia and India, which historically have had high cost of capital and constrained bank balance sheets. More and more aggressive interference in property markets and attempts to control banks’ ability to lend will characterise 2011. There is also likely an increase in the use of capital controls to restrict inflows into monetary systems at source, as is the case in China (which is therefore one of the countries best able to handle them). And in 2011 we would expect the rest of the region to become more “Chinese” in how it administers banking systems.
Tightening will occur in second half. Eventually, Asian monetary authorities will be forced to react. But historical precedent, both in how they respond to terms of trade shocks and their willingness to raise rates while US rates remain low, suggests that interest rates and exchange rates will lag inflation. By end-2011, we expect interest rates to be raised and attitudes towards currency appreciation to be more open. But it will have taken inflation rates at or around 10% to have caused the shift.
China - STRATEGY Will inflation rise further? CPI to moderate next year as climate and monetary policy normalise.
Inflation in China is primarily a weather-driven phenomenon, with monetary policy playing a supporting role. As these factors normalise next year, the increase in CPI will not be dramatically higher than the 3.6% average annual rate of the five pre-stimulus years. Still, we expect high levels of liquidity and rising income to fuel price surges in the country’s two asset classes - equities and real estate.
Largely bad weather. The primary driver of CPI inflation has been bad weather across the country, leading to a sharp fall in fresh vegetable and fruit supplies. Food accounted for 74% of the November CPI rise, while
Rerun of 2008 inflation, for longer Average CPI inflation (2009 GDP weights)
(2)02468
1012141618
2003 2004 2005 2006 2007 2008 2009 2010
(% YoY)OverallFoodNon-food
Source: CEIC, CLSA Asia-Pacific Markets
Credit decoupling Asia Real GDP forecasts 2009 2010CL 2011CL 2012CL
Australia 1.3 2.7 3.9 3.6
China 9.1 10.2 8.9 9.5
Hong Kong (2.8) 7.0 5.4 4.3
India 7.4 8.8 8.3 9.0
Indonesia 4.5 5.9 5.7 6.0
Korea 0.2 6.4 5.1 5.4
Malaysia (1.7) 6.7 4.3 4.5
Philippines 1.1 7.0 4.8 5.3
Singapore (1.3) 15.0 4.0 5.0
Taiwan (1.8) 10.2 5.1 4.1
Thailand (2.3) 7.7 4.0 4.7
Memo: USA (2.6) 2.8 1.8 1.1
Memo EU (3.6) 1.1 0.0 0.5 China is a small upward revision. Recent PMI data suggest that sequentially 4Q will be stronger than 3Q and this pushed the CY10 number up a little and the CY number up about 0.5ppts. I'll characterise as 8-9% in the text. Source: CLSA Asia-Pacific Markets
residence expenses contributed another 18%. Ninety-two percent of the headline CPI increase came from just those two categories. We are not arguing that the sharp rise in the growth rate of money supply has had no inflationary impact, but monetary conditions account for only a small share of the CPI surge.
It isn’t always money. Core CPI was only 1.5% in November. The sharp fall in money velocity has largely neutralised last year’s dramatic increase in money supply. Monetary policy accounts for only a small share of the CPI increase, and the growth rate of money supply is normalising.
Social unrest. Higher food prices are unlikely to result in social instability. The key factor is that a decade of rapidly rising income has left Chinese far better equipped than many of their emerging-market counterparts to manage higher food prices.
Higher rates. Beijing is once again using administrative measures to cool off inflation. But as was the case in 2008, we don’t expect the Party to freeze food prices. The Communist Party will keep raising interest rates until food prices cool off. This means two to three more 25bp increases are likely by mid-2011. Lending and one-year deposit rates should rise in tandem.
Higher RRR. Bank reserve-requirement ratios (RRRs) will also rise with CPI, but as with interest rates, this is primarily a political signal that will have little impact on food prices or bank lending. Demand for credit will remain strong, and supply is controlled by quota. With the system-wide loan/deposit ratio still at about 66%, well below the 75% ceiling, very few banks will find their lending constrained by a much higher RRR.
Not significant tightening. Higher real rates and RRR will have little impact on the economy or on the housing market, and do not foreshadow significantly tighter monetary policy next year. New lending will be very low in December as the Party sticks close to its full-year target, but in 2011 loans outstanding is likely to rise by 14-15%, near the average annual rate of 15.7% during the five pre-stimulus years.
FAI will stay strong. Nominal fixed-asset investment (FAI) growth, which drives commodities demand, will normalise at about 25% YoY this year and next, roughly the same pace as in the six pre-stimulus years.
No change to currency policy. The Party does not consider the exchange rate as a tactical tool for managing short-term problems such as high food prices. Rather, gradually moving the currency towards a market-based equilibrium rate is considered a long-term structural adjustment. The renminbi is appreciating at a 5-7% annualised pace against the dollar, and we expect that to continue for the next couple of years.
Non-food inflation. There are two factors keeping non-food prices low. First, steady gains in productivity. Second, overcapacity in most manufacturing sectors severely limits the ability of firms to raise final goods prices.
Hot money. A second round of quantitative easing in the USA has sparked expectations of a wave of “hot money” into emerging markets. In China, however, the key will continue to be domestic liquidity. Capital-account controls make it difficult to move money into the country, and the absence of a significant bond market will make other emerging markets more attractive to many investors.
Asset-price, not CPI inflation. While we expect CPI to be moderate next year, high levels of liquidity and rising income are very likely to fuel price rises in China’s two asset classes, equities and real estate. We note that in 2007, when rates rose seven times and the RRR was increased 10 times, the Shanghai composite index rose from 2,800 to 5,300. If this time investors also shrug off inflation and higher rates, there is ample domestic liquidity - household bank deposits equal to US$4.4tn, larger than the combined GDPs of Russia, India and Brazil - available to fuel a large asset-price inflation cycle.
Asset-price, not CPI inflation Shanghai composite index, interest rate and RRR
1,0002,0003,0004,0005,0006,0007,000
Jan 07 Jul 07 Dec 07 Jun 08 Dec 08
(%)
5791113151719
Shanghai stock composite index (LHS)Benchmark interest rate for one-year loansRequired reserve ratio
Source: CEIC
Fresh veggies and fruit the key driver CPI-Food, CPI-Fresh veggie and CPI-Fresh fruit
(% YoY)
100
105
110
115
120
125
130
135
Jan 10 Mar 10 Jun 10 Aug 10 Nov 10
CPI-Food
CPI-Fresh vegetable
CPI-Fresh fruit
Source: CEIC
Higher reserve requirement CPI-Food and RRR
95
100
105
110
115
120
125
Jan 04 Sep 05 Jun 07 Feb 09 Nov 10
(%)
468101214161820
CPI-FoodRRR (RHS)
Note: non-food inflation before 2005 is based on estimate. Source: CEIC
No significant tightening RRR, interest rate, M2 and loan growth
51015202530354045
Jan 04 Sep 05 Jun 07 Feb 09 Nov 10
(%)
5.0
6.0
7.0
8.0
9.0
10.0Loan growth YoY (LHS)Required reserve ratio (LHS)M2 growth YoY (LHS)Interest rate for one-year loans
Asia - MICROSTRATEGY What is the key earnings risk in 2011? Rising costs and easing demand create widespread margin pressure.
Margins remain a key EPS-growth driver at almost any point in the cycle. From a top-down perspective, there are some reasons to be concerned about margins. Costs are rising, particularly raw-material and energy prices. This, and easing demand, creates widespread margin pressure. Analysts underestimating these headwinds in their bottom-up forecasts could put earnings at risk in 2011. Our India, Indonesia and Thailand analysts exhibit the most optimism in margin assumptions presently.
Rising costs add to margin pressure. Producer prices have risen significantly in Asia, with the Producer Price Index (PPI) outpacing the Consumer Price Index (CPI). History shows that this will create major headwinds for Ebitda margins. We expect by 2011 gross margins to hit an all-time low as variable costs increase more than we forecast due to higher input prices and rising wages in the region.
Peaking operating leverage. Any decline in global growth impacts Asian earnings due to the high levels of operating leverage in the region. Given the focus on manufacturing, Asian firms tend to have high proportions of fixed costs. This means that any increase in sales goes directly to the bottom line, so earnings growth can be spectacular when economic times are good. The recovery of Asian markets in 2009 saw operating leverage peaking at 3.1. This should see a steady decline to 1.2x in 2011, highlighting the pressure on margins. EPS for our Asia ex-Japan (ex finance) universe is set to grow by 8.4% in 2011 but a 1ppt decline in margins would see growth become negative at -1.2%.
Focus on sustainable growth. Asia has long been a paradise for growth-at-a-reasonable-price (Garp) investors. However, pricing growth based on ratios such as PE/G has always been a challenge given the volatility and low reliability of EPS forecasts, especially when margin optimism in analyst estimates remain a concern. One of our recent reports introduced sustainable growth as a reliable long-term measure and a key component behind through-the-cycle valuation analysis. Sustainable growth (SG), defined as ROE X (1 - payout ratio), is the core organic growth potential of a company, excluding M&A and any increase in gearing. Our backtests further highlight that price of sustainable growth (PSG), defined as (12-month forward PE/SG), is a better predictor of share-price performance than PE/G for Asia. We found J-curve-driven Chindonesia® to be cheap on a PSG basis.
Asia - SALES VIEW Where to invest in Asia? Buy affluence, sell peasantry.
Investors should structure their portfolio holdings to buy plays on affluence and sell those on peasantry in 2011, in order to profit from Asia’s serious wealth creation. Apart from higher wages, wealth will come from improved investment returns, availability of leverage, new investment and consumer credit products, and less savings for non-discretionary expenses. Labour is no longer docile, but aspirational and connected. Social networks and broadband have brought branded goods and luxury living to billions.
Buy stocks that service emerging wealth. Margins, valuation expansion and shareholder profits will come from companies positioned to sell to and service emerging wealth. Two decades ago, profits in Asia stemmed from first-time buyers of government housing, taxi rides, eating out, and wardrobes beyond workplace uniforms. Today, the riches want to own the best-in-show products, to hide and insure assets, to be among their own kind, to give children superior educations and to feel and look
Margin squeeze ahead PPI/CPI relationship with Ebitda margins
good to infinity. Buy stocks representing the best brands in discretionary items, land, travel, organic goods, online shopping, private transport, cool tech gadgetry, blue-chip financial services, insurance, education and healthcare, and companies focusing on broadband buildout and internet mobility. Steer away from staples, utilities, bicycles and cigarette stocks. Think paintings, not paint. In sum, when choosing stocks in Asia, buy affluence and sell peasantry.
Behavioural finance will rule gold and Japan trades. Therefore, be long gold as investors and pundits re-anchor their price target from recent all-time high of US$1,423/oz to the inflation-adjusted high of US$2,387/oz. When people think of something being at record highs, they are less likely to buy, but when they reframe on a new anchor, their loss-aversion bias kicks in and they are driven to act in order to take advantage of this apparent “deal” before the “cheap” offering of gold disappears. Ready your portfolio for the view that gold has another 68% to go before it simply matches its real money peak of 30 years ago. Recent performance of Japanese equities and the yen will lead equity investors to re-anchor from a view of multidecade decline to multiyear recovery.
Asia - SALES VIEW Does consumer remain the way to go? Thought-provoking insights on companies with economic moats.
A CLSA salesman caught singing the praise of non-CLSA research never endears himself to his research colleagues. At the risk of being hung out to dry, my recommendation is to get hold of some of the reports boutique investment-fund managers Arisaig & Partners produces, for some provoking thought process. As they say in their consumer-sector research, if consumers don’t eat it, drink it, clean with it, wear it or shop in it, they do not own it. These are the areas where cyclicality is most reduced and quality of earnings most increased.
Dominant Asian companies create value. Arisaig constructed a simple, equally-weighted index of 54 Asian dominant consumer companies and looked at what might have happened if they had had the wisdom and foresight to buy and hold these since 1 January 1997 through to 31 December 2009. During a period in which the MSCI Asia ex-Japan returned a net 4.2% Cagr with EPS growth of negative 0.1%, this index returned 31.0% Cagr with a 23.2% EPS Cagr. Consumer-staple companies in Africa and Latin America achieved similar massive outperformance over the same period. But not only there: as it happens, the story in the USA back in the 1980s is just as impressive. Stocks with high "moats" (brand, distribution, scale) generate high ROEs, create cash and permit growth, both organic and acquisitive.
Power of compounding. The conviction in the power of compounding underlies Arisaig’s research. To quote, ‘what matters more than short term valuations is that we own for the long haul the alpha generating businesses that have what it takes to compound earnings come rain or shine (in short: scalability, high gross margins and low capital intensity). In other words, it makes a great deal more sense to let the best businesses do the heavy lifting for us than to make the mistake of trying to time or finesse markets and sectors.’ Whether you agree with Arisaig or not, their research underpins such a provocative and persuasive conclusion.
A 15% compounded is what you need. ‘Sometimes people forget the simple maths: US$1m invested in a business that compounds its earnings at 15% would be worth US$16m in 20 years. This would be US$12m if the valuation compressed from say 25x to 18x in a straight line over that period. However, US$1m invested in a fund rotating across sectors within a universe growing its earnings at say 6% (which is what history suggests is likely) would be worth US$3m in 20 years; and, no doubt, less taking account of transaction costs and the inevitable misjudgements along the way.’
Upside in Asian demand Swiss-watch imports to GDP
SpainJapan
Germany
UK
Taiwan France
Italy
Saudi Arabia
Russia
ThailandChina
USA
UAE
Hong Kong
Singapore
0
50
100
150
0 20,000 40,000 60,000
GDP/capita (US$)
Swiss-watch imports (US$/capita)
¹ Assuming 50% of exports to HK are re-exported to China. This is a meaningful adjustment to achieve as conservative a result as Hong Kong is the largest importer of Swiss-made watches in the world (imports are 3x larger than China). The federation also bases its China per-capita calculation on an urban population of 594m (not 1.3bn). The data are based on annual data, collected monthly. Source: Fed of Swiss Watch Industry
Power of compounding Compounded returns versus MSCI AxJ
Masterly inaction. With a portfolio on 25x forward earnings, a period of consolidation probably beckons, while some of their research is clearly also designed to be self-serving. But it offers a rock whereby to try to look at various investment opportunities. Increasingly I accept that the lack of patience and unwillingness when investing in good businesses to give them time to do their work is one of the greatest errors of many investors. For the time being that is not something Arisaig can be criticised for. Nor Warren Buffet. There is a message in this.
Asia - AUTOS Is the global sector in a sweet spot? A healthy world supply/demand picture after the GM restructure.
The global auto sector should remain in a sweet spot after the restructuring of General Motors. This is due to lacklustre capacity expansion in developed markets and surprisingly strong addition in the emerging world. Healthy free-cashflow generation in Asia raises the question on deployment. We continue to like Kia Motors, Guangzhou Automobile, Great Wall and Toyota in Japan. Maruti Suzuki is a top long-term pick in India, though we are hesitant about it near term. Post GM restructuring. During 2000-08, General Motors famously “pushed” production into its US inventory system, forcing large incentives to move vehicles to customers. It was trapped in a vicious circle of high fixed costs and declining market share but rising debt-service obligations. The bankruptcy that followed has shed its debt and the company is acting more rationally now to allow demand to “pull” its production schedule. Widening margins. As a result of GM’s more rational tone, the market has turned more positive on the sector and consensus is forecasting 2010-12 operating margin of 7.4% for companies like Ford. This compares with the negative 4.1% and negative 1.5% the US automakers reported for the five and 10 years to 2009. We believe this indicates a better pricing environment in the USA, despite the generally weaker demand this year. US demand is ticking up. The overall US auto market was up 17% YoY in November to a 12.3m run rate, beating our 13% expectation. Industry executives talk about dealers seeing people who “want” to buy a car, rather than “need” to buy one. Some forecast 13m units of sales in 2011, while JD Powers expects 15m vehicles in 2012, both ahead of our current forecasts of 12.5m and 13.5m. On the supply side, we see Volkswagen adding capacity but not a dramatic rampup overall to disrupt the enjoyable returns. Europe also improves. Renault and Fiat represent the mass-market European manufacturers and we note that 2010-12 consensus margin estimates have improved versus history: 3.1% for Renault versus the 1.1% it achieved over 2004-09; 4.6% for Fiat versus 3.8%; and 8.0% for Daimler versus 3.3% and 9.0% for BMW versus 6.4% in recent years. An improved Chinese business partly explains this, but also a generally healthy premium segment. Giant Volkswagen should also reach 5.8% operating margin versus the 4% it achieved over the past decade. Some disparities. The Japanese companies are suffering the most relative to the past decade, due mostly to the strong yen. We forecast operating margins of 1.2%, 6.0% and 6.0% for Toyota Motor (7203 JP - ¥3,260 - BUY), Honda Motor (7267 JP - ¥3,170 - U-PF), and Nissan Motor (7201 JP - ¥809 - U-PF) in 2011. This compares to a decade average of 8.1%, 7.7% and 7.8%. We also expect demand from Europe to be down YoY, post stimuli in key markets like Germany. China still going strong. Latest data suggest China might finish 2010 up 30% YoY versus our forecast of 26% YoY from a couple months ago, and 19% at the start of the year. Demand growth is outstripping capacity additions, and this will remain the case for 2011, so we expect industry margins to remain at healthy levels. Top picks. We like Toyota in Japan, Kia Motors (000270 KS - 51,300 won - O-PF) in Korea, as well as Guangzhou Automobile (2238 HK - HK$10.58 - BUY), SAIC Motor (600104 CH - Rmb17.21 - BUY) and Great Wall Motor (2333 HK - HK$24.80 - BUY) in China. Abhijeet Naik still likes Maruti Suzuki (MSIL IB - Rs1,413.5 - O-PF) as a long-term pick but expects it to languish on price wars with Toyota’s new models in India near term.
Indicative of global margin trend Volkswagen operating margin
Asia - BANKS Will the sector continue to outperform? Healthy credit growth, widening margins and limited provision costs.
A brilliant year awaits Asian banks, with healthy credit growth, widening margins and limited provision costs. What’s more, Tier I ratios are high and remain liquid - which is good in the new world of Basel III. Positive structural factors are plentiful, including limited consumer-loan penetration and young population. We remain Overweight Asian banks, focusing on high-ROA, high-growth markets. Our top picks are Bank of China, Bank Central Asia, HDFC Bank and Standard Chartered.
Credit growth. For the highest-growth countries, credit growth is 15-25% per annum and more countries are likely to enter this range during 2011. With increased investments in India, growth will rise and increased corporate facilities in Thailand will drive growth in the country. Where Indonesia’s banks become more aggressive at raising loan/deposit ratios (LDR), loan growth will accelerate. China has seen its loan growth step down already, where study of our China Reality Research (CRR) team suggests it will rise marginally. But for more developed regions, including Australia, Korea and Japan, expect subpar loan volume to continue.
Credit quality. The global financial crisis was not global, as it never really hit Asia. Nonperforming loans did not rise during 2009-10, even though Asian banks prepared for the worst, with higher provision costs. Going into 2011, the region’s NPLs/loans should be below pre-Asian Crisis (1997) lows, at 2.5% versus 3.9% in 1996. Where many banks have seen 50-80% lower provision costs during 2010, persistently low loan-loss provisions (LLP) will characterise 2011. With average NPL-coverage rates at 131% on 11CL, this is in a different league to pre-Asian financial crisis, at 72%. Indonesia and the Philippines stand out, where LLP/loans remain high at 1.5-1.8% this year.
China’s banks. A simple chart showing share-price performance of Indonesian, Indian, Thai, Malaysian and Philippine banks during 2010 shows no discrimination, with a 55% increase. Adding China to the chart leads to anomaly in performance, up 10% during the year. And yet, there are many similarly positive structural features, no NPL formation, 17-20% ROE and 1.2-1.5% ROA. Performance has been frustrating in 2010, but with far less in the way of regulatory risk, good NPL trends and still good profit growth, China’s banks will shine in 2011.
StanChart and HSBC. The big shock in 2011 for Standard Chartered (2888 HK - HK$217.60 - BUY) will be its consumer-banking (CB) transformation, where the income delta has been negative for two years. While wholesale banking remains strong, credit costs low, meaningful growth in CB will drive 14% EPS growth. HSBC’s (5 HK - HK$81.95 - O-PF) ROA should see the best improvement among major Asian banks, from 25bps in 2009 to 85bps in 11CL, and 2010 should mark the first year of more normal credit costs. An improved focus on commercial banking in Asia and Hong Kong will support revenue, allowing for total EPS growth of 29% in 11CL. ROA and recommendations. Countries with higher ROAs typically perform better and we doubt that will change in 2011. This is a key reason for our Overweight stance on markets with higher returns. When we looked at actual stock performance over the past 15 years, the bank basket of high-ROA countries only underperformed in just one year. This compares with five years of underperformance for high-ROE countries. We are Overweight China, Indonesia, India, Hong Kong, Thailand, Malaysia and the Philippines, and Underweight Japan, Australia, Korea, Singapore and Taiwan. Our top stock picks are Bank of China (3988 HK - HK$4.22 - BUY), Bank Central Asia (BBCA IJ - RP6500 - O-PF), HDFC Bank (HDFCB IB - RS2236.1 - BUY) and StanChart.
O-WT on higher returns Change in ROA, 11CL versus 10CL
0 10 20 30 40 50
KoreaHSBC
TaiwanStanCharThailandAsia avg
SingJapan
MalaysiaPhils
ChinaAustralia
IndiaHK
Indonesia(%)
Source: CLSA Asia-Pacific Markets
Continue to improve StanChart CB - Fee income vs loan growth
0
10
20
30
40
50
01A 02A 03A 04A 05A 06A 07A 08A 09A 10CL
(%)
(20)020406080100120(%)Fee growth (LHS)
Loan growth
Source: Company reports, CLSA Asia-Pacific Markets
Focus on high growth LDR versus Loan growth 10CL LDR (%) Loan growth (% YoY) India 78 25 Indonesia 77 22 HK 67 20 China 61 18 Singapore 72 17 StanChart 88 12 Malaysia 83 12 Philippines 66 10 Thailand 85 10 Korea 127 5 Taiwan 73 4 Australia 131 4 HSBC 89 1 Japan 65 (4) Average 83 11
Source: Company reports, CLSA Asia-Pacific Markets
Key driver for China China - Non-interest income to assets, 10CL
0.0 0.5 1.0 1.5 2.0 2.5
ThailandPhils
IndonesiaStanChar
HSBCMalaysia
AvgIndiaJapanSing
TaiwanAustralia
HKChinaKorea
(%)
Source: Company reports, CLSA Asia-Pacific Markets
Asia - CONSUMER Will Asian Boomers ride high? Chindonesian consumers remain upbeat amid wage inflation.
China, India and Indonesia’s (Chindonesia®) consumer sectors should exhibit J-curve hypergrowth over the next five to 10 years on rising incomes and propensity to consume and take risks. Even in the face of slower global growth, their consumers remain upbeat and will benefit from strong liquidity inflows and wage inflation in 2011. Our top picks are Air China, Baidu, Bank of China, Cathay Pacific, HDFC Bank, Evergreen, Want Want, Parkson Retail, Sands China, Wynn Macau and SAIC.
Rise of the middle class. We estimate that the middle class makes up 19% of Asia ex-Japan’s population, and that should rise to 30% in five years, or an 11% Cagr. The aggregate number of those in the region’s middle class will increase from 570m currently to 945m by 2015. China will account for two-thirds of the new members, while Chindonesia® will represent 90% of the 375m increment. We expect the social cluster’s consumption spending to increase from US$2.9tn to US$5.1tn over this period. For more of our analysis, see our spring report, Mr & Mrs Asia - Moving up the J-curves.
High aspirations, though grounded in reality. This autumn, we revisited the Chinese, Indian and Korean respondents in our 20 20 20 project in 2005. Now 25 years old, our 20 20 20s have certainly moved ahead: most are now working, many of them outside their home countries - and also spending. Despite the financial crisis, they remain optimistic overall and confident about the future - not only for themselves, but their countries. That said, they clearly have a more mature and balanced view than they did in 2005.
Responsible hedonists. Now that most of our 20 20 20s are finally earning a wage, they spend a good deal of it. This is clearly a generation of “baby” consumer Boomers. But whereas brand awareness is high (particularly for electronics), brand loyalty is not (especially when it comes to clothing and sports goods). Pragmatism rules and the brands must be seen to offer value. Our 20 20 20s may be consumer Boomers, but they’re not spendthrifts. Most manage to save a significant amount of their earnings, typically with the aim of buying big-ticket items such as cars and travel, and eventually a home of their own (except in Korea, where renting is the norm).
Moving up the J-curves. Some key trends of this generation: low loyalty to brands; high savings rate but not financially savvy; increasingly purchasing everything online; and priority areas of spend are travel, house and car. Key sectors to benefit from the growing consumption would be online travel companies, airlines, hotels, real estate, retail financial services, automotive plays and companies earning the loyalty of this generation by building strong franchisees. Global brands that have a strong resonance with this generation are Apple (i-Whatever), Canon (7751 JP - ¥4,080 - BUY), Nokia, Samsung Electronics (005930 KS - 929,000 won - O-PF) and Sony (6758 JP - ¥2,988 - BUY).
Top picks and risks. We project hypergrowth in discretionary spending on autos, transport and tech, while telecoms should see a more moderate increase. Travel and buying a house are among the top priorities for the Asian Boomers. Our top consumer plays include Air China (753 HK - HK$8.88 - BUY), Baidu (BIDU US - US$106.62 - BUY), Cathay Pacific (293 HK - HK$23.70 - O-PF), HDFC Bank (HDFCB IB - RS2236.1 - BUY), Evergreen (238 HK - HK$5.45 - BUY), Want Want China (151 HK - HK$6.76 - BUY), Parkson Retail (3368 HK - HK$12.86 - BUY), Sands China (1928 HK - HK$16.58 - BUY), Wynn Macau (1128 HK - HK$17.06 - BUY) and SAIC Motor (600104 CH - RMB17.21 - BUY). However, rising interest rates and policy intervention could impact high-value discretionary spending in 2H11.
Asia - RESOURCES How will miners spend their capital? Capital management in focus for Asia’s mining companies.
With balance sheets bulging, capital expenditure reaccelerating and more M&A activity, capital management is an increasingly important investment theme for mining companies. Wide-scale capital returns are unlikely, so a company’s organic growth opportunities and M&A strategy is key to delivering superior returns. Names to focus on in this theme include BHP Billiton, Adaro and Riversdale Mining.
A two-year turnaround. What a difference two years can make. From distressed balance sheets and slashed capital-expenditure plans following the 2H08 commodity-demand shock, miners’ balance sheets are bulging once more. This is thanks to two years of strong demand recovery and elevated commodity prices. The weighted average gearing level (net debt/equity) for our universe of mining stocks has decreased from 50% at the end of 2008 to around 10% in 10CL. This is particularly true for the coal sector, where resilient pricing in 2H08/1H09 has contributed to balance-sheet support: 56.3% of the 16 coal producers we cover in Asia have a net-cash position.
Capital returns unlikely. While large-cap miners typically have a dividend policy of distributing 20-30% of earnings, few outside the majors have a track record of share buybacks or special dividends. We don’t expect this to change, at least in the near term, with most companies indicating a preference for investment in organic growth or pursuing M&A opportunities, rather than returning capital to shareholders. It seems that mining companies believe they can spend it better than investors. Among the majors, BHP Billiton (BHP AU - A$45.65 - O-PF) has recommenced a suspended buyback that will see the company purchase A$4.2bn of its share this year. Rio Tinto (RIO AU - A$87.90 - O-PF) will also commence a new progressive dividend programme.
Organic growth options. The capital-expenditure cycle reaccelerated in 2H09 as improved balance sheets and confidence in the economic recovery prompted miners to commit to a raft of expansion plans and new developments. Our coverage universe is set to increase capital expenditure from US$31bn in 2009 to US$34bn this year and US$37-40bn in 11-12CL. This reflects a combination of brownfield and greenfield developments, with investment heavily geared towards the iron-ore and coal sectors. We note that capital spending in China has lagged target levels in the past two years due principally to government delays in permitting. Working capital is also set to rise to support higher levels of production.
M&A activity to continue. After a hiatus in 2H08 and 2009, mining-sector M&A is back in a big way. Miners have announced some US$130bn of deals in 2010, with coal and gold being the two hot segments. Given strong balance sheets and opportunity for consolidation in the mid-tier space, this theme is set to continue. The Chinese and North American coal majors and Coal India are all seeking acquisitive growth, with the Australian coal miners in the cross-hairs, and Whitehaven Coal (WHC AU - A$7.02 - O-PF) and Riversdale Mining (RIV AU - A$16.23 - BUY) potential targets, in our view. Among the Chinese coal names, we believe Yanzhou Coal (1171 HK - HK$22.45 - O-PF) is best placed in terms of capital management. We also like Adaro Energy (ADRO IJ - RP2550 - BUY) in Indonesia. Among the diversified majors, Rio Tinto has indicated appetite for only modest-sized acquisitions, but further investment in Toronto-listed Ivanhoe Mines appears likely at some stage. The multibillion dollar question mark remains BHP Billiton’s next move, with our money on an oil & gas play.
M&A back in vogue M&A in the global mining and metal sector
Asia - TECHNOLOGY Will 2011 be a “cleaner” year? Consumer and business demand likely to move in tandem.
The sector endured a “messy” year in 2010. Business spending has revived nicely, but the distracting influence of tablets on sales of traditional gadgets has spooked consumer demand. Wage-inflation worries persist. However, moderated estimates, inventory and valuations, and strong holiday sellthrough bode well. The sector should also cleanse itself of lingering overcapacity next year - TFT-LCD should be the first, but Dram and perhaps LED should also look healthier in 2H11.
Consumer demand has sorted itself out. The success of the iPad created a US$30bn market for tablets (estimates for 2011), forcing a dramatic reset of the consumer wallet last year. China’s PC-shipment growth fell to 12% in 3Q10, down from 30%+ levels in the previous four quarters, raising further worries. Mid-year, estimates for PCs and TVs were cut, and tech underperformed. Since September 2010 though, we have argued that this process of recalibration has ended, and estimates are now low enough to warrant no more surprises. At 3.5% YoY value growth for 2011, global consumer-tech-demand forecasts are at their most sobered levels of the decade, barring the downturn, and the street expects consumer PCs to show zero growth YoY in 1H11. We like this setup, amid positive holiday season sell through in North America, modest valuations, and strong dividend support. China’s long-term PC trajectory should stabilise at about 18% shipment growth, impressive for what is now the world’s No.1 PC market.
Business spending on a roll. If technology somewhat held on amid the vagaries of consumer spending, its other half - enterprise demand - should take a bow. Businesses spent heavily after many years of sloth - enterprise servers, PCs, software and IT services all sold briskly, and with the refresh cycle at an early stage, we see more to come in 2011. Our CIO survey indicates that upto 70% of companies will be running Windows 7 by end of 2011, up from less than 15% now. There is much left to be done in reversing a decade of underinvestment in enterprise IT. Encouragingly, budgets for 2011 are being framed on time.
Wage inflation will be passé. Wage inflation hit media headlines in 2010, raising persistent margin fears for assemblers. These worries have been proven overdone, as we have noticed some pass through of costs to customers, while crashing component prices for Dram and TFT-LCD panels helped extract more wiggle room. Wage inflation is a two-decade reality in Chinese manufacturing, but in 2011, it needn’t be a bugbear, in our view.
Product innovation continues. Tens of tablets are set for launch next year. Intel’s Sandybridge, Google’s Gingerbread and initial takes on Windows 8 are some of the key events to watch. LED-TV penetration will continue to rise, while its usage in general lighting should also go up. Overall, the sector has no dearth of new products in the offing, but unlike 2010, which was as creative as messy for stock returns, 2011 should also be a year to make money.
More positive than negative. We continue to like the beleaguered PC space, where Acer (2353 TT - NT$96.2 - BUY) is our top pick, but we also like Lenovo (992 HK - HK$5.30 - O-PF) and Asustek (2357 TT - NT$278.5 - BUY). Among the assemblers, Quanta Computer (2382 TT - NT$63.2), Compal Electronics (2324 TT - NT$39.3 - O-PF) and Wistron (3231 TT - NT$60.6 - O-PF) will start to ship tablets and more televisions, expanding their repertoire beyond just notebooks. Hon Hai (2317 TT - NT$115.0 - BUY) had a tough 2010, but 2011 should show it has the means to fight back on wage-inflation headwinds. Advanced Semiconductor (2311 TT - NT$32.6 - BUY) is our top semicon pick, but we also believe sceptics will blink against TSMC’s (2330 TT - NT$69.0 - O-PF) continued financial performance. In Korea, Samsung Electronics (005930 KS - 929,000 won - O-PF) continues to consolidate its dominance
Sector starting to outperform MSCI Asia Tech versus MSCI Asia
in memory semicons, while handsets, TVs and now tablets add further momentum. A bottoming-out also seems to be at hand for TFT-LCD panel makers - LG Display (034220 KS - 41,600 won - O-PF), among them, but also Taiwan’s AU Optronics (2409 TT - NT$30.6 - O-PF) and Chimei Innolux (3481 TT - NT$38.3 - O-PF). In Japan, Sony (6758 JP - ¥2,988 - BUY) is in a midst of a turnaround that nearly makes yen/US-dollar vagaries irrelevant - cost-savings should ride over it all.
Asia - TELECOMS Can data push revenue growth? Data volume could reach a hockey-stick growth stage.
Asian telcos’ revenue is growing again due to rising data volume and the increasing popularity of smartphones and wireless broadband service. Data growth may reach a hockey-stick growth stage in 2011 with regional operators building out their own application stores and China driving down smartphone prices. We expect Hong Kong, Japan and Korea to enjoy the biggest leverage of data growth, while China should see the largest data upside. Our top picks are China Mobile and SK Telecom.
Data revenue up 20-30% in most Asian countries. Hong Kong, Taiwan and Singapore have showed the fastest real data (non-messaging) growth in 2010, given low bases and market affluence. 3G users account for more than 50% of their customers and smartphone users have also increased to 10-20% of total. Data Arpu of smartphone subscribers is normally two to three times that of feature-phone users. Thailand and Malaysia have benefited from a strong wireless-broadband uptick. Internet access has been the most popular mobile data application in Asian emerging markets. Given the low fixed broadband penetration, wireless broadband has become the primary form of internet access in these countries.
Asian telcos want their own app stores. Japan is the pioneer in developing data applications (apps). NTT Docomo has launched a wide range of data services from social-networking services, entertainment (movie, music, games, books), location-based service to mobile payment. Korea’s SK Telecom (017670 KS - 175,500 won - BUY) has also announced that it will invest 1tn won (US$888m) to speed up its mobile data platform. The country remains relatively protective of its mobile data market, favouring domestic players. Foreign apps store such as Apple’s iTune Store and Google’s Andriod Market have yet to offer Korean songs and games. All three Korean telcos have already launched their mobile apps store. China Mobile (941 HK - HK$77.40 - BUY) has launched big marketing campaigns to invite students and young people to write apps and has received 100,000 submissions. In the recent Asia-Pacific Economic Cooperation CEO Summit, company chairman Wang Jianzhong said he believes China’s future data contribution will reach Japan’s level (50% of Arpu).
Smartphones get cheaper. China’s large mobile market has helped support the proliferation of mid- to low-end smartphones and drive down prices globally. About 19% of smartphones sold this year was whitebox, while nearly 80% of China Mobile’s 30 TD smartphones available in the stores were sold for US$150-300. With subsidies, the smartphones only cost US$0-150. We believe China is one of the best positioned markets for mobile data growth given its good telecom infrastructure and large internet market and culture. Its 3G users are likely to reach 46m by year-end and should double in 2011. Majority of the 3G subscribers are smartphone users.
Top picks. Asian telcos are trading at undemanding 13x 11CL PE, 15-20% below the historical average. China Mobile and SK Telecom are best positioned for the new data era and their valuations are attractive at 7-11x 11CL PE with 4-5% yields and potential data upside.
Asia - SOCIAL RESPONSIBILITY Is Asia becoming more responsible? It’s all about environmental and labour standards.
After the BP and Foxconn events this year, world investors are putting more focus on the environmental, social and governance (ESG) risks and opportunities facing the stocks they own. ESG investing is on the rise and in some parts of the world pension-fund managers are mandated to invest along these lines. Companies can disclose their activities through corporate-social-responsibility (CSR) reporting, which is rising fast in Asia, despite still being essentially a voluntary activity.
Reporting on the rise. Corporate social responsibility, if defined by the publication of CSR reports, apears to be on the rise in Asia. The region now accounts for more than 20% of global CSR reports versus 12% just five years ago. Based on the absolute number of companies, Europe still leads the way. We believe this reflects the pull effect of European funds and legislation in 2000 that required pension funds to highlight to members if they take into account the environmental and social governance of the companies they invest in
CSR reporting remains largely voluntary. Unlike in Europe and Australia, CSR reporting remains mostly a voluntary affair in China, Japan, Malaysia, Thailand, Hong Kong and Singapore. Recent policy moves in Indonesia and the Philippines could represent a move towards mandatory reporting. In August 2007, the Philippines’ Board of Investment started requiring CSR programmes and reporting. Back in 2007, the Indonesian government enacted a corporate law that required most companies outside of the financial sector to disclose their CSR activities.
It’s different in Asia. The concept of CSR is rooted in the Western principles of liberal democracy, justice and social equity. We believe Asian firms, operating in fast-growing economies with different environmental and labour standards, face unique issues, where many of these Western principles may not apply. Investors who have a focus on CSR need to assess regional CSR through a set of “Asian lenses”. Our November Corporate goodguys? report analyses the CSR reports of 50 of Asia’s largest companies. While the move to more reporting is positive, we are critical of the lack of disclosure and transparency in many. While CSR’s deeper subtleties in the West are yet to emerge in Asia, we believe here it is all about environmental and labour standards. Related laws will only tighten over time, so firms that are doing the most in these areas should be able to maintain their ROEs and outperform those that are lagging in CSR. Three approaches to responsible investing
Type Detail Examples
Negative screening
The exclusion of certain companies or industry sectors from investment portfolios on the basis of their profile against various social, environmental and ethical criteria
Armaments, firearms and military contracting Nuclear power Tobacco
Positive screening
The building of investment portfolios from companies that have been actively selected on the basis of their strong performance on social, environmental or ethical issues
Environmental policy, codes, management systems Respect for human rights, working conditions
Engagement The use by investors of robust dialogue with the boards or other management of companies with the aim of altering corporate behaviour in relation to social, environmental or ethical issues
Discussions on risks related to: Lack of policy on climate change Activities in Burma Pricing of medicines in developing countries
Integration Environmental and social governance is incorporated into all investment analysis and decision making
The ESG impacts to earnings are assessed and priced into the stock
Asia - THEMATICS Which stocks might get discovered? ROIC screen to identify undercovered stocks with rerating potential.
Our high-ROIC-Ebit/EV basket was up 39% YTD to 10 December, almost three times the return of MSCI Asia ex-Japan. Part of the power of the screen is in identifying stocks that are undercovered. As these stocks cross US$1bn market cap, they get onto more investors’ radar screen. Some of are mid caps of about US$5bn in size. Advanced Info Services, Kangwon Land, Soho China, China Zhongwang, TVB, CJ Corp, Berau Coal and Wan Hai Lines are potential outperformers into 2011.
The ROIC-Ebit/EV screen in brief. Our screen picks stocks with pretax ROIC above 25%, of which we take those in the top quintile on Ebit/EV. We derive the data from Bloomberg, with ROIC and Ebit based on trailing 12-month reported financials. We use a cutoff market cap of US$1bn and US$1m average daily volume.
Star performers often the unrated stocks. As we use Bloomberg data, the universe of stocks goes beyond our core coverage. We have found that the strongest performers in this basket have tended to be stocks not well covered by the street - at least we do not cover them. Most of them are just getting over our market-cap (US$1bn) and liquidity (US$1m/day) thresholds. Some are companies that have fallen out of favour, thus we (possibly other brokers as well) have dropped coverage. Those on this screen are able to generate a good return on capital; applying an Ebit/EV valuation overlay the screen helps to pick those that are potentially due for a rerating. YTD, the stocks not under our coverage in this basket are up 42.5%, against the 38.9% return for the ROIC-Ebit/EV screen.
Which stocks have potential to rerate? Twenty stocks in the basket are not under our coverage (see sidebar). Most are just above the US$1bn market-cap cutoff. Of the larger ones are two of the Thai telcos, Advanced Info Services and Total Access Communication, with the latter at an Ebit/EV of almost 14%. From Korea, Kangwon Land in the past 12 months generated a pretax ROIC of 29%, while CJ Corp has an ROIC of 73%; both are currently at Ebit/EV of 10%. The mid caps from China in the list are China Zhongwang and Soho China. At around US$2bn market cap but not under our coverage are TVB of Hong Kong and Berau Coal of Indonesia.
Buyer beware! The trouble with using trailing data is that the businesses for some of the companies may be heading down. The attractive trailing valuations could thus be misleading about prospects. Hence, the approach works as a basket, or as a prompt of which stocks are worth further investigation. We provide a list of stocks with above US$1bn market cap that show up on the screen and may be worth a closer look in the sidebar.
Australia - MARKET Seeking Asian exposure without EM risk? Major iron-ore and coal suppliers to China and India.
For investors with similar concerns to Russell Napier about corporate governance, currency controls, liquidity and/or sovereign risk, Australia is their answer. China and other emerging markets are driving demand for energy and materials, of which Australian companies are among the leading providers. A range of secondary beneficiaries will also see topline growth. The key risk is labour- cost inflation. In addition, those companies exposed to domestic discretionary consumer spending look unlikely to share in the upside.
Resources - Excellent exposure to Asian growth. Leading the pack is BHP Billiton (BHP AU - A$45.65 - O-PF) and Rio Tinto (RIO AU - A$87.90 - O-PF). Both operate a suite of world-class assets, generally in Organisation for Economic Cooperation and Development (OECD) countries, but supply the bulk of their output to emerging markets, in particular
Worth a closer look ROIC and Ebit/EV Company Code ROIC (%) Ebit/EV (%) China Zhongwang 1333 HK 26.2 35.6 Soho China 410 HK 32.4 29.1 Taekwang Industrial 003240 KS 30.2 24.9 Wan Hai Lines 2615 TT 35.7 18.7 Shenzhou Int’l 2313 HK 39.1 15.8 Green Cross 006280 KS 41.3 14.8 Total Access Comm DTAC TB >100 13.8 Berau Coal BRAU IJ >100 13.8 Hyundai Home 057050 KS 58.2 12.0 Grand Korea Leisure 114090 KS 62.4 11.8 361 Degrees 1361 HK 30.6 11.8 Fufeng 546 HK 30.1 10.8 Peak Sport 1968 HK 26.1 10.6 Powerchip Tech 5346 TT 35.8 10.5 Asiana Airlines 020560 KS 27.9 10.3 Television Broadcasts 511 HK 30.5 10.2 Xingda Int'l 1899 HK 25.6 10.2 CJ Corp 001040 KS 73.1 10.1 Kangwon Land 035250 KS 29.0 10.0 Advanced Info ADVANC TB 167.5 9.9
Source: Bloomberg, CLSA Asia-Pacific Markets
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China. As can be seen in the charts, China is the key source of marginal demand for iron ore and coal (India is also a major coal consumer). BHP and Rio are top Australian producers of both and account for much of the supply increase over the forecast period. We continue to prefer BHP’s more diverse commodity mix (no commodity makes up more than one-third of earnings) to Rio’s dependence on iron-ore (about half of earnings).
Independent coal producers and developers. Riversdale Mining (RIV AU - A$16.23 - BUY) is our preferred coal play, with its unique and much-sought-after exposure to hard coking coal. Macarthur Coal (MCC AU - A$12.84 - BUY) offers direct exposure to the Asian steel markets through its dominant position in the seaborne pulverised-coal-injection market. Investor sentiment on gold is buoyant, Chinese imports are surging and we believe Newcrest Mining (NCM AU - A$40.83 - BUY), Asia’s own gold major, offers the most secure and low-risk exposure to the yellow metal.
Secondary beneficiaries. These are the suppliers of products and services to the miners. Key exposures: commercial explosives to the mining industry - Orica (ORI AU - A$25.03 - BUY) and Incitec Pivot (IPL AU - A$3.76 - O-PF); engineering and project management to oil & gas - WorleyParsons (WOR AU - A$27.45 - BUY); contract mining - Leighton (LEI AU - A$33.62 - SELL) and Monadelphous (MND AU - A$17.39); mine construction - Boart (BLY AU - A$4.48); and infrastructure construction to support production and export of resources - Leighton, Downer (DOW AU - A$4.65), Decmil (DCG AU - A$2.65), Asciano (AIO AU - A$1.62 - SELL) and QR National (QRN AU - A$2.77). We forecast significant demand for these firms over the coming two years.
And then the companies that have Asian assets. Goodman (GMG AU - A$0.66 - O-PF) is a global developer/fund manager of logistics-warehouse assets. It is 18% owned by China Investment and has one of the largest Hong Kong logistics-warehouse business (US$1.6bn assets under management). It is also growing in China: US$200m of assets in Shanghai and a project-development agreement with Langfang municipal government.
China - STRATEGY How do you fight hot money? Use quantitative tightening to battle quantitative easing.
The Chinese government is worried that hot money may have contributed to inflation. The PBOC in an unprecedented move raised the reserve-requirement ratio (RRR) twice in 10 days in November and once in December with more measures to follow. If China continues to experience hot-money flows and inflation continues to rise, Beijing is likely to implement new quantitative tightening measures. This may be good for the economy, but will hurt sentiment in the policy-sensitive stockmarket.
Hot money has the government worried. The unusual amount of hot-money flows in September has the Chinese government worried, especially with the USA’s QE2, which caught China by surprise. Beijing is even more concerned that the inflows maybe part of the reason why the country’s CPI inflation has soared. It has already announced some measures to curb hot money but has yet to reveal the full extent of its plan. Investors that are looking to benefit from QE2 flows to the stock market need to be aware that China will not just sit and not take countermeasures, especially when it believes it is the cause of rising inflation.
Plans to trap hot money. China has a closed capital account and the ability to manage/restrict hot-money flows better than most countries. The easiest way to circumvent capital controls is to disguise it as trade or foreign direct investment. People’s Bank of China (PBOC) governor Zhou Xiaochuan had already confidently talked about the central bank’s plan: ‘We can have our own administrative measures to block the flow of this hot money . . . we will collect and put this money into a pool so that it will not affect the economy’.
Mainly from China and India Global coal (coking and thermal) demand
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New measures announced hint at things to come. The State administration of Foreign Exchange has taken action and announced seven policies to plug some of these loopholes.
Impose a floor on banks’ net forex balance, which cannot be less than the level as at 8 November 2010. This should prevent excessive forex flows from building up at the banks and not entering the market.
Strengthen forex settlement management. Banks will be restricted in using letters of credit for settlement.
Manage quotas of foreign short-term debt financial institutions use.
For trade and forex transactions, strengthen identification process of parties. Check whether if transactions are legitimate or getting around forex controls.
Strengthen the supervision of foreign direct investment, which is a large source of capital inflows.
Restrict repatriation of capital by Chinese companies that raised capital overseas.
Restrict onshore companies/individuals setting up offshore companies.
New quantitative tightening. If hot-money flows continue and inflation remains a problem, the PBOC is likely to announce more serious capital controls. Governor Zhou’s plan to keep hot money in a pool sounds like he intends to use unremunerated reserve requirement (URR), which is one of the most popular forms of capital management. Under such a plan, banks and financial institutions are required to deposit at zero interest rate with the central bank an amount of funds equal to the net increase in foreign exchange. Brazil, Chile, Columbia, and Thailand have adopted URR. It is usually used on foreign loans, but could be extended to trade transactions and portfolio flows. There is also consideration of imposing a “Tobin tax” which is a tax on conversion of forex into the yuan that would discourage short-term capital flows.
Stock market is the path of least resistance. The government believes asset inflation is potentially more destructive than CPI inflation, as Japan’s example illustrated. With inflation concerns, the government will remain vigilant and will continue to tighten controls on property. The relatively tight liquidity condition and increased housing supply, which started construction since 4Q09, are likely to put home prices under pressure especially in 1H11. If excess liquidity has to flow somewhere, the path of least resistance is the A-share stock market, which should perform better given low government intervention.
For more of our 2011 outlook for China, see our recent Bull riding report.
China - MARKET How to play to become No.1? China to rack up more number-ones in consumption-related sectors.
While the credit crisis has slowed growth in developed markets, China’s successful stimulus programmes has propelled the Middle Kingdom in its quest for top status in various sectors. The country’s population remains the largest in the world at 1.3bn; India is the only competition at 1.2bn. With China clinching more No.1 spots, investors should be tilting portfolios to benefit from the resulting consumption shift towards Asia.
Recovery in developed-market banks. We have seen radical shifts in the global financial landscape following the outbreak of the subprime crisis in 2007. China’s banks have underperformed their global peers during 2010, as the developed-market institutions recovered from a low base. Despite these trends, the total market cap of PRC banks (US$965bn) remain well above their US peers’ US$765bn. With forecast 8% GDP growth, the Chinese banks are likely to increase its lead in 2011. In Hong
More capital control to manage hot money An uptick in hot money in September 2010
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Kong, we like Bank of China (HK) (2388 HK - HK$25.85 - BUY). For direct exposure, consider Bank of China (3988 HK - HK$4.22 - BUY) and China Construction Bank (939 HK - HK$7.10 - BUY).
Highspeed rail branches out. China has 7,430km of rail track, more than triple than that of its nearest rival, Japan. Of that, five rail lines, for a total 1,989km, are designed for 350km/hour, with a further 10,000km under construction. The country is embarking on a plan to build a matrix of four major north-south and four east-west routes using high-speed rail to cover 13,000km. The original target was to complete major trunk routes by 2020, but with the acceleration of infrastructure spending this has been brought forward to 2015. For direct exposure, investors should look at China Automation (569 HK - HK$6.39 - O-PF) and Hollysys (HOLI US - US$15.45 - O-PF), but note the theme extends beyond this, to the consumer, hospitality and property sectors, among others.
Gaming bonanza. Macau has been the largest gaming market in the world since it overtook Las Vegas in 2006. We see more room for growth and little concern for saturation in the market, while America’s expected modest recovery in 2011 will mitigate oversupply concerns. The appetite to gamble is much more prominent in Asia versus the USA. In Asia, gaming is mostly either a habit or a business, resulting in a much larger average bet than in Las Vegas, where gaming is a consumer-discretionary item. Meanwhile, the Asian wealth effect should follow the J-curve, and will continue to fuel sector growth. Our top Macau picks are Sands China (1928 HK - HK$16.58 - BUY) and Wynn Macau (1128 HK - HK$17.06 - BUY).
Broadband - High growth, low penetration. In 2009, China attained several world’s No.1s: internet user base of 384m (versus 240m in the USA); mobile user base of 747m; handset shipments of 347m units; and broadband subscriber base of 103m. It was also the second-largest PC installed base in the world with 180m units versus the USA’s 291m. In 3Q10, for the first time ever, China became the world’s largest market for PC shipments. Comparing this to its population, however, we still see low penetration rates. Only 29% of the country is online, 8% has their own broadband connection, 56% uses mobile phones and 14% owns a PC. China still has plenty of room to grow. We prefer internet names such as Baidu (BIDU US - US$106.62 - BUY) and Tencent (700 HK - HK$182.00 - BUY) over the more-capital-intensive telecom companies.
China - A SHARES Will small still be beautiful? Market volatility due to tightening concerns offers buying opportunity.
Manop Sangiambut (86) 2120205910 [email protected] We expect a shift in outperformance from small-cap growth stocks to A-share large caps due to rate hikes and the former’s frothy valuations. The SME Composite has outrun the CSI300 - a key proxy for A shares to the global investment community - this year. A return to a stronger CSI300 would boost sentiment of overseas investors. We see ongoing market volatility due to tightening concerns as buying opportunity. Our picks for an inflation/rate-hike scenario: Ping An, Suning, Shanghai Jahwa and banks.
Small is beautiful. On the face of it, the A-share market has had a bad year in 2010, with the CSI300 down 13% YTD so far this year, significantly underperforming the HSCEI. However, the mood among A-share investors has not been entirely bearish. There has been an extreme split in the way investors view large and small caps. The SME Composite index rose 21% YTD this year, arguably one of the better performing indices in the region. Evidently, the CSI300 turnover also tumbled from more than 50% of market total historically to below 40% this year. What has caused this shift is the tightening policy that restricts property and bank performance and China’s 12th Five-Year Plan to spur interest in small-cap emerging-growth names. All are supported by a wave of small-cap IPOs. Valuation also reflects this contrast. The CSI300 is on 12x 11E PE versus 25x for the SME Composite and 42x for the GEM board.
Rate hike will change landscape. The critical question is whether we will see a shift in the so-called investment style from small caps to large caps. If history provides any guidance, it will depend on the way interest rate moves up. During the last rate-hike cycle, large caps outperformed small caps. With many small-cap names, in particular GEM-listed stocks, having frothy valuations, we believe rate hikes will trigger large-cap outperformance. Our view is that there would be at least one rate hike by year-end and a couple more next year. These should trigger NIM expansion for banks, investment gains for insurance firms and a shift in fund flow to large caps. In addition, history also suggests as rate hikes progress, negative real interest rate widen. Especially this time round, rate hikes started when real rate is in negative territory. With household deposit standing above US$4tn this year, we believe liquidity is still abundant, while concerns about significant new-loan slowdown and asymmetric rate hikes should be overdone.
Positive on A shares. We see the ongoing correction in the A-share market as a buy opportunity. Our index target is 4,200 for 2011. We are Overweight banks, brokers, insurance, consumer, IT, nonferrous metals and coal. We have Neutral/Underweight stance on property, steel, healthcare, machinery, construction, telcos and utilities. Under an inflation/rate-hike scenario, we like Ping An (601318 CH - Rmb60.95), Suning (002024 CH - Rmb14.30 - BUY) and Shanghai Jahwa (600315 CH - Rmb37.13 - BUY).
Hong Kong - PROPERTY Will HK property prices fall in 2011? Upside in residential prices is capped. We prefer landlords.
Residential prices will continue to rise as the purchasing power of cash in Hong Kong-dollar terms is likely to fall further before the USA stops easing. However, the upside will be capped, hence our Underperform call on Sun Hung Kai Properties and Henderson Land. The landlords stand to benefit as this is the only segment that is still a clean proxy for the economic growth backed by China. We prefer Wharf, which should enjoy a structural rerating as it turns into an offshore China-consumption play.
Residential prices - Muted downside but capped upside. Those looking for a substantial residential-price correction will be disappointed. We expect prices in the near term to only dip by 2%. Government tightening measures will reduce short-term investment demand, which we estimate accounts for about 15-20% of total. Note, however, that for the coming year at least, primary supply remains some 30-40% below normal demand level. Meanwhile, secondary-market participants who had planned to sell to move on to the next profitable trade might now just hold on to their exiting property to optimise profit, reducing supply.
Policy moves. On 19 November, the HK government introduced much more stringent property tightening measures than the market expected: the 5-15% short-term resale stamp duty is essentially a capital-gain tax - an unprecedented concept in the property market of Hong Kong. This, along with the raised down payment requirement, will significantly reduce the attractiveness of physical properties as an asset class for short-term investment. A watertight defence: even less expected was the synchronised lift in the down payment requirement for all non-residential properties to 50%, which ring-fenced the commercial properties against a potential liquidity shift from the residential segment.
Sabotaged relationship. Even if the measures cannot dislodge the uptrend in physical prices, they will still damage the prices’ high-beta relationship with demand, which is the key appeal of HK property stocks that trade on the capital-value cycle.
Underweight developers; Overweight landlords. We maintain our Underperform rating on Sun Hung Kai Prop (16 HK - HK$132.40 - U-PF) and Henderson Land (12 HK - HK$53.75 - U-PF). We are SELLers of
property agent Midland (1200 HK - HK$6.36 - SELL), the key loser in the latest tightening given its reliance on market churn (which is fuelled mainly by investment demand) and the lack of NAV for downside protection. Central-office landlord Hongkong Land (HKL SP - US$6.88 - O-PF) is not directly exposed to policy risks but the stock is pricing in high expectations. We recommend Wharf (4 HK - HK$57.55 - BUY) instead, whose shopping malls are honey pots for mainland shoppers and hence deserves a structural rerating as an offshore China consumption play. And of course, it doesn’t hurt as some of the Central tenants are feeling the temptation to move to cheaper decentralised offices. Wharf’s Tsimshatsui office should gain greater bargaining power.
India - MARKET Commodity curse in 2011? Rising commodity prices are headwinds going into 2011.
If Goldilocks were an investor in equities in 2010, she would have had to look no further than India for the metaphorical bowl of porridge. However, after the 23% rebound in the Sensex from its mid-year low, against a backdrop of “just right” conditions, rising commodity prices are set to play spoilsport. The key question for 2011 is whether the market will be able to overcome such headwinds. We are concerned, but to us it appears a tactical issue.
Goldilocks no more? While India’s strong consumer-led rebound in growth has stood out amid an uncertain global outlook, the weak conditions of world markets have, for most part of the year, also helped rein in inflationary pressures. The attraction of growth and expansion in yield differentials lured a record US$29bn of net inflow from foreign institutional investors (FIIs) and pushed up market PE to a 25% premium vis-à-vis the 10-year average. With all commodity classes rallying in response to signals that central banks will support loose monetary policies, the Goldilocks scenario is unwinding.
Inflation fears to resurface. While the pause the Reserve Bank of India (RBI) signals reflects its desire to assess the unfolding global scenario and the impact of an effective 300bp tightening in the policy rate, a rethink on the inflation trajectory could cause the central bank to change tack sooner; non-food inflation has inched up from the August-2010 trough and global commodity-price surges will prompt manufacturers to hike prices of value-added products further. The past few weeks have seen such announcements by Maruti (MSIL IN - Rs1,413.5 - O-PF), Hero Honda and Hyundai India.
Twin deficits. The hardening price of crude oil will also raise the risk perception for the Indian market, given its adverse impact of the current account and the fiscal deficit. India’s dependence on imports for up to 70% of its crude-oil requirement implies that a rise in crude price to US$120/bbl can tip the current-account deficit to 4.5-5% of GDP. In the current scenario, where capital inflows have come predominantly from portfolio investors in equities, risk-aversion can set in quickly. The reluctance of the government to pass on higher petroleum product prices to the consumer will impinge on the fiscal deficit as well, reversing the expectations of a continued improvement on this front in FY12.
Earnings boost, but PE under pressure. With the huge weighting of sectors like oil & gas and metals in the aggregate earnings pool, the initial impact on Sensex earnings could be positive. However, the rising macro concerns will weigh on PE. A flashback to 2007-08 shows commodity price resets fuelled the last leg of earnings upgrades, but multiples started to derate three months before the market eventually peaked. Tactical shifts towards emerging markets like Russia and Brazil, which are more positively geared to strong commodity prices and trade at a substantial discount to the Indian market, are also likely to play out.
Non-food inflation troughed in September
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Where to hedge? While the market looks vulnerable to a tactical correction on a continued commodity rally, the fragile state of some of the largest global economies raises question on the sustainability of high commodity prices. We would thus be less worried about the likelihood of a lasting impact on the market or economy. Meanwhile, some of the best-managed Indian companies are positively leveraged to global commodities. Aluminium play Hindalco (HNDL IN - Rs224.7 - BUY) will see a capacity-driven 23% Cagr in volume from FY12 and enhanced degree of integration through startup of its Utkal Alumina project. Tata Steel (TATA IN - Rs645.5 - O-PF) is directly leveraged to improved pricing in Europe through Corus, but also has wide-margin, integrated capacity coming within India over the next 12 months. Concerns about an acquisition bid by the Vedanta group has hampered onshore exploration and production major Cairn India’s (CAIR IN - Rs336.4 - O-PF) share-price performance, but with visible production rampup and a Rs40 upgrade to fair value for every US$10/bbl rise in the crude price, the risk-reward is favourable.
India - ECONOMICS Will the investment upturn lose steam? Infra spending and private-sector capex to push investments in 2011.
A key concern about India’s macro outlook is whether the ongoing investment cycle will lose steam. This could be a function of a still-cautious corporate sector, political fallout from corruption-related scandals, and/or slower pace of loan approvals by public-sector banks following a recent bribery scandal. However, we expect the investment upturn to further strengthen in 2011-12 due to the combined effect of higher infrastructure spending and an increase in private-sector capex.
Vulnerable to global conditions. In an interdependent world, no economy is immune to a deceleration in growth in developed markets, and India is no exception. If global growth disappoints more than what we expect, the Indian economy will be affected via the financial markets and confidence channels, apart from export transmission. However, India’s real sector impact will be much less pronounced than in other Asian economies because the country is less geared to exports.
Investment spending will rise sharply. The main reason for the collapse in investment spending after the Lehman bust was the lack of available financing as local bank lending tightened, international capital markets froze, and stock prices plunged. Demand dynamics are now compelling and an investment rebound is already underway that should be the start of a multiyear upturn in investment spending. In the first-half of the current fiscal year (FY11), gross fixed capital formation (GFCF) increased 14.9%YoY relative to GDP growth of 8.9%.
Corporate capex will also pick up. The slowdown in some infrastructure contracts, such as in roads, this year is likely to reverse next year. Also, India is a supply-constrained economy that has not added significant capacity in the past couple of years. With GDP growth running at 8-9% annually, further capacity additions by the private sector will have to occur.
Credit availability and bureaucracy are key risks. Additionally, it is important to bear in mind that India has the second-highest GDP growth rate despite having the third-lowest loans/GDP ratio in Asia. This indicates that the economy is less reliant on bank credit compared to other countries, partly because of its heavier dependence on the service sector for growth and a large informal economy. Still, it would be important for the government to ensure that there is no slowdown in either the pace of infrastructure contracts awarded or in credit disbursal to the infrastructure sector, so as to avoid any downside risk to economic growth.
Derating ahead of market peak Market PE
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We project a strong investment upturn India GDP growth versus investment rate
India - POLITICS Is politics a risk? Various sectors see increased government-intervention risk.
As we expected, India has divested minority stakes in profit-making public-sector undertakings (PSUs) in 2010. But there has been no progress on various pending reform bills. We expect the government to be on the back foot in 2011 thanks to alleged scams and scandals, and decision-making is likely to be slow. A busy election calendar at the state level will not help in 1H2011. Thus, politics remains a key risk, with metals & minerals, infrastructure, real estate and banking being the most vulnerable.
Disappointing 2010. We had expected that in 2010 the government was likely to move forward on the various economic bills and relaxing fixed-direct-investment (FDI) controls on certain sectors, such as retail and insurance since this was relatively an election free year with Bihar being the only major state election. We had also anticipated India to push forward with minority-stake sale in profit making PSUs. Lacking political consensus within the coalition, the government did not push through the economic reforms proposals and bills. However, it made good progress on stake sale in PSUs and in the auction of 3G spectrum. In 2H10, the Congress party and the government got embroiled in multiple alleged scams and scandals, which have brought the functioning of the latter to a virtual standstill. Congress is on the back foot due to the scams and persistent high inflation, and the opposition looks reinvigorated. Internal law and order issues like Naxals and separatism in Jammu and Kashmir remain key concerns.
Can the India investment story be dented? Scandals, corruption and uncertainty around policy-making can dent the investment case. The new found enthusiasm of the Environment Ministry threatens to derail numerous large projects, even as it has rightly brought focus on balanced development and environment protection. While it is nobody’s case that environment norms be flouted, companies like Korea’s Posco (005490 KS - 477,500 won - O-PF) have been waiting for more than five years for different clearances. The banking scandal involving a few PSU banks and institutions can result in decision paralysis, especially if a witch hunt commences on past loan decisions and waivers. At its best, the slowdown will last a few quarters and its worst can be longer. At risks are delays in large projects, introduction of the goods & services tax, change in FDI norms in insurance, retail and airline, and key bills in banking reforms, land acquisition and higher education.
Positive message from Bihar. The 2G scam has revived the memories of the Bofors scandal in the late 1980s and the accompanying political uncertainty. We do not see the risk of political instability yet. Meanwhile, the Bihar elections reinforce a positive message being seen in many state elections in recent times - good performance gets rewarded. Hopefully, it will encourage more states to deliver on governance and economic growth, as has been the case in the states of Gujarat, Madhya Pradesh, Delhi, Chattisgarh and now Bihar. Key state elections in 2011 are in West Bengal, Tamil Nadu and Kerala, which also raise the spectre of increased government intervention in various sectors, especially if inflation remains high.
Japan - MARKET Is there “good” and “bad” inflation? A return to inflation could prove to be a true catalyst.
Japan disappointed for most of 2010. More recently, signs of a rebound made heavily underweight investors nervous and a move to neutral levels would trigger a surge that lasts into 2011. The market is also attractive from a fundamental perspective: a strong profit rebound on the back of serious restructuring has pushed margins back to pre-crisis levels, the strong yen notwithstanding. Valuations are undemanding even for quality stocks. But the return to inflation in 2011 could be the true game-changer.
Strength in parliament Number of seats in parliament
SP, 22
BS, 21
JD(U), 20
AITC, 19
DMK, 18
CPI(M), 16
BJD, 14
BJP, 116
INC, 208
Others, 89
Figures indicate number of seats. Source: Election Commission of India, CLSA Asia-Pacific Markets
We were almost there in 2008. Back in 2008, Japan looked set to finally emerge from its decade of deflation, with the headline figure exceeding at one point 2%. Alas, rising commodity prices was almost the sole driver and excluding energy, the return to positive CPI numbers was only marginal. As a result, many observers feared a margin squeeze as higher input costs, not an overheating of demand, created inflation. As such, many economists labelled this type of inflation as “bad” inflation.
Good or bad inflation. It is questionable if inflation can generally be a good thing or if price stability is not preferable. In Japan’s unique situation, however, we would argue that inflation is a positive factor, as the long period of deflation had, beyond the economic impact, also influenced the psyche of the Japanese. As prices for many products have not surged and often not changed over many decades, it is extremely hard for retailers (and indirectly manufacturers) to raise prices. Where input costs rose or selling prices declined over time, a downward spiral of deflation was set in movement via lower wages and downward pressure on input costs. In our view, any factor breaking this downward pressure on prices is welcome.
Déjà vu? With continuous upward pressure on commodity prices, we see again a similar situation as in 2008, when various producers started to hike their prices or reduce package content without lowering package prices. As inflation was set to take off, the missing link to break the deflationary spiral was still a lack of wage growth. Political pressure on companies that were booking record profits at this time intensified - but then the world fell apart with the onset of the financial crisis heralded by the fire sale of Bear Stearns to JPMorgan Chase in March 2008 and later amplified by the collapse of Lehman Brothers.
Will it be different this time? Now, company margins have already reached pre-crisis levels and if revenues continue to normalise, record profits are again within reach in spite of headwinds from a stronger yen and a still sluggish global economy, as corporate Japan has done a fantastic job in lowering its breakeven points. Inflation pressure is re-emerging, mainly through higher energy prices. Not the best type of inflation for sure, but if it will break the deflationary spiral it would be nevertheless welcome. Key this time round will be if corporations will pass on part of their efficiency gains through moderately higher wages. While this is still very much uncertain, investors putting money on Japan are not wagering a too risky bet.
Stockmarket near post-bubble low. Still near 1x understated book (as land value is not adjusted upward and goodwill is amortised), the market is not only cheap but also oversold. The economic recovery is proceeding faster than anticipated and corporate restructuring has shown impressive results. Our 12-month Topix target stands at 1,000, but any sign of higher commodity prices translating in faster inflation with wage hikes dampening the impact for consumers would cause us to raise this target. Plenty of interesting investment opportunities exist.
For more, read our 9 December strategy note, All-star lineup.
Malaysia - MARKET Will the nation push meaningful reforms? The market needs transformation to kickstart an investment cycle.
Eyes start to roll when Malaysia talks about its Economic Transformation Programme (ETP), which details the roadmap to double GNI/capita to US$15,000 over the next decade. Investors should have more faith given the success of Khazanah’s reforms on government-linked companies (GLC) and the ongoing development of Iskandar Malaysia. Effective reforms will kickstart a new investment cycle, triggering a market rerating. Our top picks are Maybank, CIMB, Tenaga Nasional, IJM and UEM Land.
Inflation through higher input costs Corporate goods price index
(10)(8)(6)(4)(2)02468
10
Jan 07 Oct 07 Jul 08 Apr 09 Jan 10 Oct 10
(% YoY) CGPICore CGPI
Source: Ministry of Finance
Top picks Bridgestone (5108 JP) Canon (7751 JP) Fujifilm (4901 JP) Inpex (1605 JP) Japan Tobacco (2914 JP) JGC (1963 JP) Kao (4452 JP) Kawasaki Kisen (9107 JP) Kubota (6326 JP) Kyocera (6971 JP) Mitsubishi Corp (8058 JP) MUFG (8306 JP) Shin-Etsu Chemical (4063 JP) Sony (9107 JP) Suzuki (7269 JP) THK (6481 JP) Tokyo Electron (8035 JP) Yahoo! Japan (4689 JP)
Sceptics abound. The 2000s was pretty much a lost decade for Malaysia. Promises of reforms by the previous administration failed to materialise. As a result, the country’s investment/GDP ratio remains depressed at 20%, with a structural growth story missing, while its weighting in MSCI Asia ex-Japan fell from 10.6% to 3.2%. Therefore, it is not surprising that sceptics are abound when Malaysia talks about reforms again, this time under the Najib administration. Many eyes start to roll when the nation talks about the ETP, which details the roadmap for the next 10 years and aims to double GNI/capita to US$15,000. Most investors prefer to watch for some milestones, prior to making big investments in the market.
Some success stories. However, there have been some successful reforms in Malaysia. The case in point is the 10-year GLC Transformation Programme state investment arm Khazanah has undertaken since 1995. Tasked with improving shareholders’ return, Khazanah’s portfolio has outperformed the FBMKLCI and MSCI Malaysia over the past five years. Iskandar Malaysia is also turning into a success story for Malaysia. The dysfunctional state of Singapore-Malaysia relations over the past 40-odd years has been on the mend, and this should lead to more cross-border investments to drive a long-term structural growth story.
Reforms will trigger market rerating. In short, Malaysia needs to re-engineer its business model to kickstart a new investment cycle. Under Najibnomics, there are various economic, social and fiscal reforms in place to deliver investments of US$444bn over the next 10 years. For 2011, the focus will be on how the ETP sets the stage to enable this. The key focus areas in the immediate term would be the development of Greater Kuala Lumpur and the oil, gas & energy sector. If Malaysia delivers meaningful reforms, this will translate into a structural growth story and trigger a rerating. Our top picks are Maybank (MAY MK - RM8.48 - BUY), CIMB (CIMB MK - RM8.60 - O-PF), Tenaga (TNB MK - RM8.45 - BUY), IJM (IJM MK - RM6.20 - BUY) and UEM Land (ULHB MK - RM2.80 - BUY).
Singapore - MARKET Does a strong currency hurt its status? Still a passport of choice on favourable “pull” and “push” factors.
A stronger currency is unlikely to dampen Singapore’s status as the “passport of choice”. On the contrary, it will accelerate growth of the services sector at the expense of manufacturing, allowing productivity gains to offset inflationary effects. It will also lift the value of real estate and Singapore-dollar assets. But after two years of positive returns, the market is no longer cheap. This warrants a focus on dividends.
Push will meet pull. In addition to the growing “pull” of Singapore’s charms as a good place to do business and live, “push” factors from the West - higher taxes and regulatory impositions - will drive more companies and professionals to adopt Singapore as their domicile, making it the “passport of choice”. Based on our opportunity analysis, sectors set to dominate are commodities, private banking, tourism, maritime and biomedical. Expected growth in tourist arrivals will benefit hospitality, consumer-discretionary, transport and commercial-property (office and retail) sectors, too.
A stronger currency will not derail the investment thesis. The Singapore dollar is likely to appreciate particularly with reference to the greenback and the euro. However, a stronger local currency will trigger a faster restructuring of the economy, favouring the services sector at the expense of labour-intensive manufacturing activity. Consequently, wage growth is likely to match productivity gains, staving off the risk of Singapore becoming a higher-cost economy. A dearer Singapore dollar will be positive for real estate and investments denominated in the currency.
Malaysia needs a new investment cycle Investment/GDP
Enter 2011 cautiously after two years of gains. Following a 49% rally in 2009, the market has risen a further 10% this year. Consequently, market valuation, at 15x forward earnings, is one standard deviation above five-year mean and expensive. As such, we continue to recommend a selective stock-picking strategy and highlight dividends as an attractive theme, especially given the Singapore dollar’s appreciation potential. In US-dollar terms, our dividend portfolio has returned 11.4% since July 2010. Singapore Press (SPH SP - S$3.99 - O-PF), ST Engineering (STE SP - S$3.34 - O-PF), United Overseas Bank (UOB SP - S$18.00 - BUY) and ComfortDelGro (CD SP - S$1.56 - BUY) are key picks.
What to buy and what to sell? Reflecting a bias towards our Passport of choice thesis and dividends-related investment themes, we are Overweight consumer discretionary and defensive stocks. The underperformance of large caps makes them prime beneficiaries of a liquidity-driven rally - which appears likely, particularly owing to their attractive valuations. We like UOB, Genting Singapore (GENS SP - S$2.16 - BUY), Tiger Airways (TGR SP - S$1.86 - BUY), Ezra (EZRA SP - S$1.67 - BUY), CapitaLand (CAPL SP - S$3.68 - O-PF), CapitaMall Trust (CT SP - S$1.97 - BUY), ST Engineering and ComfortDelGro. We dislike DBS (DBS SP - S$14.02 - U-PF), City Developments (CIT SP - S$12.96 - U-PF), Wilmar Intl (WIL SP - S$5.96 - U-PF), Olam (OLAM SP - S$3.11 - SELL) and StarHub (STH SP - S$2.67 - SELL).
Thailand - MARKET Can the SET go up three years in a row? Propensity to disappoint may end if the election works out.
Since 1972, there was only one period when the Thai stockmarket rose three years in a row. As a stockbroker born just slightly before that, I am naturally a little nervous postulating that the market will rise 19% in 2011, following a 63% gain in 2009 and 37% in 2010 year to date. But 2011 is likely to give us a continuation of capex and credit growth, a freshly legitimised government with policies to prolong growth and a market supported by another year of positive earnings surprises.
The election may be the saviour. Assuming there are no black swans around, 2011 will see a general election. The constitution requires one to be held by December, and the Thai people need one to restore faith in democracy and keep people in jobs and, literally, off the streets. We expect an election before May 2011 and the current Democrat-led coalition to receive the mandate from the electorate that it needs to start implementing some growth policies.
Political stability? Only two freshly elected governments have lasted more than two years in the past two decades. Both of them, in 1992 and 2001, implemented growth policies and presided over a doubling of the stockmarket during their term in office. The current government is nearing its second anniversary, suggesting that if it is re-elected it will stay around for another two years at least. This is a time frame required to become bullish about policies to promote growth.
Railways and cities. A re-elected government is enough to see another year of decent growth stemming from the capex and credit recovery that started this year. Earnings growth of 18% should see the market comfortably achieve our index target of 1,200. But if we also see the government announce policies to add railways and grow cities outside Bangkok we may have scope for becoming much more bullish about growth beyond 2011.
Only one major city. Thailand is an odd country in that it has a land mass the size of France and a population the size of the UK, yet it only has one major city. The 2010-11 budget plans to spend 22% more than the previous year, with much of it targeted outside Bangkok. Towns like
Rarely up three years straight SET annual returns
(100)
(50)
0
50
100
150
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
(%)
Source: CLSA Asia-Pacific Markets
Greater swing from investments Private construction and investment growth
Khon Kaen and Nong Khai in the northeast are booming, which you can check if you join our post-Asean Forum tour to the areas and Laos on 12-13 February 2011. Towns becoming cities can simultaneously boost the country’s overall growth and lower risk, as upcountry areas grow a lot more rapidly from a low base than Bangkok.
Stocks to own for the third year of a rally. Our key picks into 2011 are Bangkok Bank (BBL TB - Bt148.5 - BUY), Krung Thai Bank (KTB TB - Bt16.9 - BUY), Preuksa Real Estate (PS TB - Bt19.6 - BUY) and HomePro (HMPRO TB - Bt8.8 - BUY).
Asia - FENG SHUI Will the Rabbit leap into a wall? Embrace the new year and watch out for our 2011 guide.
To prevent the Feng Shui team from casting another year of evil spell on my shipping stocks, I humbly accepted the appointment as the oracle for 2011 - only to find a legacy of high client expectations and forecast track record to exceed. After all, Vonnie Chan had been dictating the woes of the Hang Seng for two years in a row and believe it or not, the CLSA Feng Shui Index has a track record of being ‘largely right’ throughout its history. So before we go into 2011, how did we stack up in the year of the Tiger?
Predictions for 2010 fairly accurate. We were in the money for most of the months having accurately predicted the run in the Hang Seng from June and once again in September. Commodity prices ran hard. Gold didn’t break US$2,000/oz but we were “directionally” correct. Just as we believe we got it all right under our watchful celestial eyes, it turned out the Metal Tiger did not have a fat tail after all. At the time of writing, shells were falling on the unsuspecting island of Yeonpyeong and the Hang Seng dived 600 points on the day. Without certainty on how junior Kim even looks like or his date of birth, Feng Shui, unfortunately, has no telling what he will do.
The Rabbit is no more predictable than the Tiger. We will bid the volatile Metal Tiger farewell on 4 February 2011. While it has been a fun ride in 2H10 in general, most will lament the bumpy ride in the final few months. The last time we had a Metal Rabbit was in 1951, when the Dow was largely volatile throughout the year and hobbling between a trading band of 15%, despite ending slightly up. Markets were sceptical, with seemingly no end to the conflict in the Korean peninsula. The threat of an atomic exchange loomed, while scars from World War II a decade before were still fresh. Fortunately, not all other Rabbit years saw equally unexciting stockmarkets - Dow in 1963, and Hang Seng in 1975 and 1999 all ended the year up. Still, there was one disturbing exception - the 1987 crash. The bunny, by default, is an ecstatic yet unpredictable animal.
Watch out for our 2011 Feng Shui guide. Having incorporated the feedback/requests of one-too-many Feng Shui patrons, we add a number of new features to our 2011 Feng Shui guide, with much extra work devoted to the fortunes of different sectors and whether this stacks up to our sector research views. The most popular sections - HK property-market trend and celebrity fortunes - will of course include more meat than ever. Stay tuned and Kung Hei Fat Choi.
Asia - REVIEW How did our 2010 predictions fare? Our bigger-picture views were fairly accurate.
Below are the key predictions in our Asia Themes 2010, bulleted as they were on on page 3 of last year’s report. We italicise those that did not quite pan out (about one-third). Our general themes for the region were much more accurate but at the country level the ratio of successful preditions falls. The moral? Focusing on the bigger picture appears more reliable, and you can expect brokers’ country views to be biased in a certain direction.
Macro and global - From Beijing to Washington 1) US consumption and employment remain weak, monetary policy
loose and liquidity ample for risky assets including Asian equities.
2) Governments will continue to play an active role with increasing risk of controls to resist the flood of capital.
3) Economic growth will be stronger; inflation will revive.
4) China heads toward a current-account deficit. [Not quite but the current-account surplus has narrowed.]
5) The USA needs to attract capital will require further dollar weakness. [DXY is up 4% YTD owing mainly to euro weakness.]
6) The yuan will recommence its appreciation but at a gradual pace.
Sectors - From banks to technology 7) Banks will see improving margins but may need more capital.
8) Consumer spending rises with incomes and improving confidence.
9) Further upside for resources, eg, coal, gold; watch for M&As.
10) CPO is set to push higher in 1H10, with rising Chindia® demand, seasonal patterns [CPO price rallied in 2H10].
11) Anticipation of higher prices could spike steel prices in 1Q10.
12) Low real interest rates support the property sector, but expect further administrative measures to control price escalation.
13) Tech sector to see enterprise-demand revival [although consumer demand wobbled], rising share of China sales and Japan outsourcing to the rest of Asia.
14) Momentum post-Copenhagen for renewable equipment [solar-panel demand strong but wind ex-China stagnated] and operators, electric vehicles and nuclear power.
Markets - From North Asia to India 15) China emerging as the No.1 market, providing upside for its leading
companies.
16) Unloved Japan has upside potentially driven by yen weakness.
17) Cleaner corporate structures in Korea could lower its discount.
18) Taiwan to benefit from M&As from China, and FAI pickup.
19) Singapore’s casino openings will impact the domestic economy.
20) Indonesia’s momentum to be sustained by commodity prices.
21) India’ investment cycle kicks in leading to earnings upgrades [upgrades have not been major].
Dollar strengthened, yuan resumed its rise Rmb/dollar and dollar index
6.56.66.76.86.97.07.17.27.37.4
Dec 07 Aug 08 Apr 09 Dec 09 Aug 10
(Rmb)
70
75
80
85
90
Rmb/US$DXY (RHS)
Source: Bloomberg, CLSA Asia-Pacific Markets
CPO up mainly in 2H10 Prices of crude palm oil and crude oil
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