Value still available amid Asian consumer boom

Supported by strong GDP growth rates, favourable demographics and rapid urbanisation, the domestic consumption growth story remains the main driver for investing in Asia.

But with consumer stocks believed to be expensive, what is the best way to play it today?

“People stereotype that the Asian consumer sector is expensive, but that is only when looking at the consumer index, where big names in particular do not offer a high earnings growth,” explains Joohee An, senior portfolio manager at Mirae Asset Global Investment, the Korean fund firm with $60bn (€44bn) in total assets under management.

In the MSCI AC Asia ex-Japan consumer index, for example, of the 30 stocks with market cap larger than $10bn, there are five stocks with trailing price to earning (P/E) ratio larger than 30x but one year earnings per share (EPS) growth estimates are less than 10.

Therefore today, it is very important to be very selective and pick the “potential future leaders” in each segment of this broad sector, she explains.

In the more developed Northern countries, including Korea, Taiwan, Hong Kong and China – the companies to look for are those able to ride or anticipate the next trend in consumption behaviour, linked to the tourism and travelling industries, entertainment, gaming, or internet mobilisation.

In Southern Asia, however, comprising more emerging countries like the Philippines, Thailand, Indonesia and India, interesting investment opportunities can still be found in the sectors of necessity goods. “If you go to Jakarta, even 7-Eleven is very underpenetrated,” says Ms An.

“We want to figure out which sub-sector is the most promising and the most
underpenetrated, and then have the conviction that this is a long-term story.” In fact, even big and growing leaders operating in a sector that is already saturated have a much lower growing potential.

In emerging markets, much more than in developed markets, real value comes from good management, superior business strategy and brand, which enable the firms to deliver sustainable earnings growth for the long term, she says. “Our philosophy of equity investing is all about earnings and figuring out which companies’ earnings will be resilient.”

Consumer strategies managed by Mirae Asset represent around $1.7bn, of which more than half is invested into Asian consumption growth stories.

The Mirae Asset Luxembourg-domiciled Asia Great Consumer fund, which manages $140m, invests in roughly thirty companies having an average P/E ratio of 21x. They are not cheap, but those companies are expected to deliver EPS growth of around 22 per cent over the next three to five years, she says, and that is what matters.

Tourism is one of the most promising sectors, particularly in North Asia and China, as it has just started developing and has a huge growth potential. For example, latest figures from Euromonitor show only 3-4 per cent of mainland Chinese are outbound travellers, meaning there are only around 40m unique visitors out of a 1.3bn population.

Linked to the growth of the tourism sector are the Macau gaming stocks. They have risen so much over the past couple of years that they represent 16 per cent of the overall MSCI HK index, but they are still seen as offering good growth potential. Sands China and Galaxy Entertainment are included in the top 10 holdings of the Korean firm’s fund.

Other names Ms An likes include duty free shop operator Hotel Shilla in Korea, which can benefit from rising Chinese tourism in the country, as well as an international hotel company based in Thailand, Minor International.

Local brands having the potential to become the leaders of the future, for example in the IT sector, are being closely monitored.

“Twenty years ago, nobody expected Samsung TV to become number one ahead of Sony TV, in the US,” she says. In China too, rich Chinese used to shun local brands, but now they have started to accept them. When it comes to IT goods, consumers want value for their money, as long as the quality is good.

In Asia, and emerging markets in general, competition is much higher than in developed markets and the biggest competitors are global brands, she states.

Ms An generally aims to pick regional companies more competitive than global brands in each specific consumer sector, but this is very difficult in the luxury space, where global brands have the upper hand.

“In the luxury space, it is all about emotional value and it is difficult for Asian brands to beat the European ones,” she says, explaining her holdings in Prada and Brilliance China, the BMW JV in China.

In other sectors, however, the ability of a firm to cater to the local taste is key. In China, for example, the snack segment is attractive because it is very underpenetrated. Snacks, being discretionary items, are not included in the CPI basket of goods and services whose prices are controlled by the government.

Local snack brands have been hit by some safety issue scandals and Chinese parents prefer to buy their children “the mid to high end snack segment” offered by Asian companies. “The customer experience is an important part of the brand loyalty,” explains Ms An.

A Korean snack company, Orion, is achieving good results in the premium snack segment in China, having built its brand on the Choco pie success story. The brand image of Korean products at global level too has improved, adds Ms An, and the management of the company should benefit from this cultural trend.

One of the fund’s top holdings is internet company Tencent which launched Weixin, the Chinese version of Whatsapp. While e-commerce is one of the most promising themes in Asia, the biggest beneficiary, Alibaba, is yet to be listed, she says.

Global players

Major private banks, however, are more sceptical about playing the consumption growth story through local firms.

HSBC Private Bank prefers to play the emerging markets or Asian consumption growth story through global brands, which tend to be based in the US and Europe, explains Olivier Pacton, co-head of the bank’s Investment Group in Hong Kong.

This way of playing the consumption theme somehow leverages on the Asian or Chinese consumers’ behaviour with regards to global brands, whose products they tend to buy when travelling overseas. This is particularly true for luxury goods, but also impacts positively companies in other sectors, such as for example coffeehouse chain Starbucks. 

Global brands cater to the needs of Asian consumers, anyway, as they represent such a large important segment for them, says Mr Pacton. And investors can benefit from the better corporate governance of these large firms and be exposed to both the emerging and developed consumer markets, with the latter benefiting from the recent improved economic outlook. From a top down allocation view point, HSBC favours developed to emerging market equities.

Geographically, in general, undervalued companies can be found more in Asia and Europe than in the US, states Harald Espedal, CEO at Norwegian fund firm Skagen.

Investors’ fears about declining corporate earnings in Asia and fears of China having a hard landing are overstated. The Chinese economy is stabilising, and the tapering of the US bond buying programme, which took investors by surprise last spring causing turmoil particularly in Asian markets, is less of an issue now, as it is being very well communicated by the Federal Reserve.

In Asia, attractively priced companies are found in all sectors, but Skagen’s main holdings are Samsung, and car manufacturers Hyundai and Great Wall. The consumption growth story is played mainly through global companies based in Asia that can also export and compete beyond their domestic markets.

“These three companies have been very good contributors of returns for us in 2013 and we are happy to hold them further too,” says Mr Espedal. Car manufacturers are a good way to get exposure to the emerging market consumer, as people are increasingly buying their first and second cars in developing countries, he explains. Although Samsung is at much more advanced stage of development, Great Wall and Hyundai are also strong companies globally, gaining competitive advantage from low cost technology.

The chart on p11 shows that in Asia per capita GDP remains very low compared to developed countries. As auto penetration levels are higher in higher income populations, demand for cars in Asian economies is expected to grow, as Asian incomes are forecast to rise.

China, Indonesia, the Philippines and India are all below trend and can be expected to react much like other economies. In Hong and Singapore, car ownership is more costly due to land scarcity.

Cyclical stocks - China

Asian equities in general are attractive from a valuation perspective, in terms of price to earnings (P/E), price to book (P/B) and also earnings growth, according to East Eastspring Investments, and are trading significantly lower than Europe, US, Japan or even parts of Latin America.

China is one of the most attractive markets today, with companies trading at a P/B of 1.4 versus 2.4 in the US and 1.6 in Europe, says Ken Wong, Asia equity portfolio specialist at Eastspring Investments, Prudential’s asset management business in Asia. And with the structural reforms announced by the Chinese government, consumption is expected to be a bigger driver and a key leading factor of the overall GDP growth.

In China, cyclical stocks are the most attractive at the moment, including materials, consumer companies, as well as some of the financial stocks. Banks are trading at attractive multiples and their P/B is back to the end of 2008 levels, around 0.7/0.8x book, versus their historical 2x book.

Increased transparency in general and more disclosure on the banks’ NPLs (non-performing loans) will drive a rerating of the banks and a general rerating of Chinese stock market. “Chinese stocks can rerate to closer to their historical levels, only if banks rerate,” says Mr Wong.

Less attractive are emerging sectors like Chinese IT and healthcare companies, which have seen their P/E multiple expand substantially versus cyclical sectors. Firms like internet service portal Tencen and online gaming companies are trading at very high multiples, he says. The valuation premium spreads between cyclical and ‘sensitive’ stocks (in emerging sectors) are close to historical highs and there is a good chance to see a reversal of this premium spread.

 “Cyclical stocks have been challenged and are underinvested, as market expectations were too high,” says Mr Wong. The Chinese equity market was down 15 per cent in the first months of last year, following a very strong Q4 in 2012 and too high valuations, but it went up in the second part to finish 2013 pretty flat. “Any turnaround within the Chinese economy is going to be a cyclical turnaround.”

Higher valuations and higher expectations always tend to lead to bad outcomes, says Mr Wong. As long as Asian corporates continue to grow by about 10 per cent, they should perform better relative to other markets around the world. “For Asia, lower valuations and low expectations should lead to a better outcome for 2014.”