Aug 31, 2017

Christine Tan's Top Picks: August 31, 2017

BNN Bloomberg

Christine Tan , BNN

Christine Tan, chief investment officer of Excel Funds
FOCUS: Emerging market stocks
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MARKET OUTLOOK

Eight months into 2017, our view on the global economic outlook remains cautiously optimistic. In the July 2017 GDP growth forecast, the IMF increased global growth expectations slightly for 2017 and 2018, primarily because of an improved outlook on Europe and China, which offset a downward revision in U.S. GDP growth expectations. Commodity prices have recovered and stabilized at moderate levels that are good for producers as well as consumers. This improved growth outlook is compelling central banks like the Federal Reserve (Fed) and the European Central Bank (ECB) to commence a gradual reversal of the extraordinary monetary policies implemented post-2008. We expect this "normalization" to be gradual, especially with inflation still muted and below central bank targets.

The three key risks we are watching closely are: i) geopolitical tensions (e.g. North Korea), ii) any potential sharp increases in inflation which could steepen yield curves suddenly, and iii) the impact of Fed and ECB balance sheet normalization on global asset prices. Our base case is for ongoing tensions in North Korea, but not a direct conflict since most parties involved are focused on de-escalation rather than escalation. The lack of inflation in the U.S., Europe, Canada, and globally continues to puzzle many given the improvement in economic activity.

We believe there are two key developments that are capping inflationary pressures. First, increased automation and the use of technology has resulted in very little upward wage pressures. Second, the rapid growth of e-commerce is increasing price transparency and competition for the benefit of consumers. A perfect example is the dramatic price cuts to Whole Foods produce announced by Amazon. This low level of inflationary pressures will cap any steepening in yield curves but we continue to monitor it very closely. Last, but perhaps most important, is the impact of balance sheet normalization. The Fed will be gradually unwinding its US$4.5 trillion balance sheet and the impact on equities and the bond market will depend on how gradual, orderly, and transparent the process is.

Despite these macro risks, we are positive on the outlook for most EM countries. The recent earnings season was the strongest for most of our portfolio companies in years, driven by a recovery in global growth, stabilization in currencies, lower cost of capital, and continued strong domestic consumption. The ratio of companies beating earnings estimates has increased significantly in the last few quarters and we expect further earnings upgrades, which is ultimately what drives equity performance. From a valuation perspective, EM is still valued at a considerable discount to the U.S., Europe, and developed world equities. We remain focused on investing in strong businesses benefiting from secular growth drivers with experienced management teams and underlevered balance sheets. We have been opportunistic buyers in any recent pullbacks, especially in the Asia region.

TOP PICKS

SAMSUNG ELECTRONICS (005930.KRX)
Market cap US$267 billion. Last purchased July 25, 2017 at KRW 2,518,104.
Samsung Electronics is a repeat Top Pick because the stock has pulled back recently despite another strong earnings report - this in part because of North Korean jitters and the final sentencing of the Vice Chairman JY Lee. Our base case is that North Korea tensions may remain elevated but unlikely to break out into full conflict. We believe the management team at Samsung is broad and deep; therefore we do not anticipate a shift in the strategy. We also saw some profit taking in Samsung and rotation into other more cyclical stocks in Korea on expectations of a domestic pickup with the new government's domestically-focused policies. It continues to be our largest holding because of two key reasons: 1) better earnings visibility due to multiple earnings drivers, and 2) significant positive change in shareholder policy. Samsung has historically been valued at a very discounted P/E multiple, but these two factors have resulted in a re-rating of the company's stock.

Samsung is valued at approximately 7.1 times 2018 consensus earnings. With improved earnings visibility, 13 per cent earnings growth and a return on equity (ROE) in the mid-teens, we value Samsung at approximately 10 times earnings. The key risk this year is a significant decline in memory pricing in the second half of 2017 and into 2018 with more investment in additional capacity.

PING AN INSURANCE GROUP (2318.HKG)
Market cap US$151 billion. Last purchased July 25, 2017 at HKD 57.65.
In Chinese, Ping An means "safety," a very appropriate name for the largest Chinese insurance company by market cap. Ping An is also the most diversified with around 50 per cent of its revenue from life insurance, almost 20 per cent from non-life, around 10 per cent from Ping An Bank and around 20 per cent from others including Ping An Securities. For most of 2015 and 2016, Ping An lagged its large cap peer, AIA Group, because the moderation in Chinese economic growth raised concerns about the capital ratios for Ping An Bank. Conversely, AIA is a pure play insurance provider with a dominant presence through Asia, not just China, with solid NBV growth. Year to date, Ping An has outperformed, in part from the result of management's focus on derisking non-core/non-insurance businesses and as well as an improvement in the Chinese economic outlook, removing the concerns about Ping An Bank.

There are two key industry factors that will drive a further re-rating of Ping An who already holds a dominant position among China's affluent mass/high net worth: i) government focus on shifting more investor savings towards protection / health insurance from a very low penetration, and ii) a shift in Chinese consumer behaviour where increasing wealth is driving higher awareness of need for life/critical illness protection. Company specific catalysts over the next 12-18 months are i) strong and profitable acceleration in Ping An's agency based insurance business, ii) continued focus on risk control at Ping An Trust and Ping An Bank, and iii) streamlining of non-core insurance businesses, which may include an IPO of Ping An Securities.

We really like the structural growth potential of the insurance sector in China and believe the industry is still in the early stages of strong growth. Ping An is well positioned as a dominant insurance brand and attractively valued around 11.5 times 2018 consensus earnings with expected earnings growth of 13 per cent.

NASPERS (NPN.JSE)
Market cap US$99.6 billion. Last purchase on Feb. 29, 2016 at ZAR 1,865.
Naspers is the largest publicly listed company in South Africa. It was founded in 1915 and has grown into a large group of internet, e-commerce and entertainment investments. Management follows a simple three-pronged strategy of allocating capital in a disciplined manner to target high growth technology opportunities and build valuable technology platforms. Naspers’ investee companies benefit from three key secular themes: i) the internet creating new business models for traditional sectors, ii) the rise of the EM consumer and iii) the internet’s role in replacing the need for physical infrastructure to accelerate growth (for example, e-commerce proliferation in emerging market countries reduce the need for bricks-and-mortar locations).

The majority of Naspers’ enterprise value is attributed to its 33 per cent stake in Tencent, China’s dominant mobile gaming and chat company as well as China's largest technology company by market cap (US$399 billion). It also owns a 29 per cent stake in Russia’s Mail.ru, a provider of internet services, instant messaging, e-mail, online gaming and social networking. Once we account for the public market value of Naspers’ stake in Tencent and Mail.ru, the rest of its businesses are valued as negative value. We expect that as these businesses achieve scale and begin to generate positive returns on invested capital, we will see a significant rerating of this “rump” from negative to positive enterprise value. Two such businesses we would highlight are Flipkart, a dominant B2C e-commerce player in India, and OLX, a mobile classified advertising business with 14 brands covering 40 countries. Naspers now owns 16% of Flipkart, which was valued at US$11.6 billion after the latest round of venture financing earlier this year. OLX brands are ranked the #1 app on the Google play store for shopping/lifestyle in 22 countries and have >330 million monthly active users. Currently 10 of these countries are profitable while the others are still in growth phase.

We have owned Naspers for a while and we had it as a Top Pick last year. Although it has been the best performance on the South African market, it has lagged the performance of Tencent because of its listing in South Africa and investor outflows on concerns about the outlook on South African economy. However, most of its businesses are outside of Africa and not directly impacted therefore we believe this valuation gap to its underlying sum of parts is very compelling, especially in a market environment where many technology companies are valued at premium valuations for their growth potential.