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Coronavirus: Crisis and Opportunity in the China Market

Coronavirus: Crisis and Opportunity in China’s Economy

By | General

As shocking as the outbreak of the 2019-nCoV novel Coronavirus (or Wuhan virus) is, it has been less shocking to see it eclipse all other market concerns and dominate the conversation. Nothing gets the markets fidgety like a potentially major, potentially global health scare – it transcends industries, it doesn’t follow predictable patterns, and it doesn’t stop at borders.

While the situation is still developing, with more deaths and infected cases within China and a number of cases throughout the rest of the world, it’s hard to have a firm grasp of the actual impact. Nevertheless, Smartkarma Insight Providers have attempted to piece together some conclusions based on their specialist areas.

Dropping Prices

Vincent Fernando offers a view into China’s tech sector, with a look at 10 tech stocks that have seen large sell-offs since the virus news broke.

It’s no big surprise to see the impact on travel stocks like Trip.com and Travelsky Technology: with travel bans and strict restrictions in place, as well as a large segment of their clients being Chinese travelers, their shares dropped by 12 percent and 13 percent, respectively.

Less obvious might be the hit on stocks like cloud computing company Xunlei (19 percent) and image editing software maker Meitu (14 percent), but Fernando notes this is most probably due to broader market fears, with such stocks being collateral damage. 

Read Vincent Fernando’s full Insight: Coronavirus Casualties: China Tech’s Ten Biggest Losers

The sheer size of China’s market makes it impossible to not have ripples out to the global economy. For example, China is the largest consumer of commodities in the world, notes Gaius King. In a flash note on Smartkarma, he outlines how commodity prices have experienced a significant drop over the past few trading days. This includes iron ore (25 percent drop), zinc (9 percent), copper (11.6 percent), and nickel (11.3 percent). 

“In anticipation of lower economic growth, commodity prices have fallen and we expect prices could fall further as it becomes increasingly evident that the Coronavirus will eventually spread globally,” King writes.

Read Gaius King’s full Insight: Coronavirus & Commodities – What to Do?

Coronavirus: Crisis and Opportunity in the China Market

Most impressive of all – but perhaps expected – has been the Chinese government’s response to help shield the economy from the slowdown caused by virus concerns. On 2 February, the People’s Bank of China undertook a whopper of a liquidity injection, pouring RMB 1.2 trillion in the market (US$172 billion).

To put this into perspective, Michael J. Howell says the liquidity boost “represents in size roughly half the huge net liquidity injection undertaken by the US Fed since early September 2019, but taking place in just one day” – which, in turn, was one of the Fed’s biggest injections ever.

Read Michael J. Howell’s full Insight: China Hits Warp Speed …Risk On Again?

Howell notes that the lifeline should boost short-term business activity in China and around the world. Although it won’t do the yuan’s currency stability any favours, keeping up the momentum behind its economic growth might be more important to China, he adds.

Crisis = Opportunity

It’s not all bad news for everyone, however. Ming Lu points at internet companies, specifically ecommerce websites, which stand to gain from people staying indoors and doing their shopping online. 

“Since 23 January, when the Chinese government sealed Wuhan, the epicenter of the coronavirus, people all over China began to snap up and hoard fast-moving consumer goods,” Lu writes.

Lu used ecommerce giant JD.com as an example case, and found that the website raised prices on several of its goods – in some cases, as high as 127 percent. “JD can surely defend themselves with the excuse that they just provide less discounts than before. However, they had kept those large discounts for a long time,” he says.

As a result, fast-moving consumer goods sold online due to virus fears could compensate for slowdown in other product categories in 1H2020. The crisis might even help pave the way for more mainstream drone delivery adoption, writes Fernando in a separate note.

Read Ming Lu’s full Insight: JD.com (JD): Raised Goods Prices Significantly After Wuhan Was Sealed as Epicenter of Coronavirus

And how about a startup that basically predicted the Wuhan virus spread within China and to major cities around the world? Blue Dot, a Canadian startup backed by Hong Kong magnate Li Ka-Shing, claims to model the spread of infectious diseases with the help of artificial intelligence. 

As Douglas Kim outlines in his Insight, the company first sounded the alarm about the Coronavirus on 31 December 2019, several days before official authorities. While Blue Dot is still private, it’s perhaps worth keeping an eye out for, especially since the new visibility the outbreak has given it.

Read Douglas Kim’s full Insight: Blue Dot: Li Ka-Shing Backed AI-Powered Startup Warned About Wuhan Virus Before WHO Warning

Another name that stands to benefit investors is, interestingly, in the very sector getting pummelled by travel bans and virus fears: online travel. Tongcheng-Elong is a Chinese online travel agency whose stock suffered, dropping 11 percent from 16 to 20 January. But the company’s long-term fundamentals are strong, Fernando says

It should “generate strong returns in the long run due to its combination of a high potential userbase paired with increasing OTA penetration in lower-tier cities throughout China, rapidly improving travel infrastructure & connectivity, and rising disposable incomes,” he writes. The same could be true for beleaguered Trip.com, he adds in a separate Insight. The company has announced refunds and assistance schemes for affected travelers, which should go a long way towards building customer loyalty and good will.

Read Vincent Fernando’s full Insights: TCEL: China’s New Virus Is Scary, But One Chart Shows How You Can ProfitHow Trip.com (TCOM US) Is Actually Getting Stronger During the Coronavirus Crisis

Lead image by Macau Photo Agency on Unsplash

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Forensic Accounting Analysis on JD.com

By | Smartkarma Originals

This insight has been produced jointly by Shifara Samsudeen, ACMA, CGMA ​and Supun Walpola ​at LightStream Research ​

This report investigates potential downside risks to JD.com’s shareholders extending from its accounting and corporate governance practices. Our accounting diagnostic review identified several red flags pertaining to revenue quality, off balance sheet liabilities and undisclosed investees in the company’s financials and notes to financial statements. 

We have concerns about the quality of JD.com’s revenue. Our analysis shows that c.15%-20% of JD’s revenue is coming from accrual accounts, but this is not reflected in the financial statements since the company is moving its accounts receivables off balance sheet in a “factoring-like” arrangement through a related party.

We also think that the company may be indirectly assuming the solvency risk of some of its related parties like JD Digits and JD Logistics Properties Core Fund L.P (JD LPC) but this liability is not recognised in the balance sheet. The size of these “indirect” liabilities seems quite large; JD.com’s exposure to JD LPC’s debt is currently c.35% of the company’s net cash.

We are also not satisfied with the depth of the company’s disclosure on its equity investees. Equity investees are responsible for c.40% of JD.com’s net loss but there is little to no disclosure about them in the company’s financial statements.

Moreover, we believe that the impact of JD.com’s accounting issues are exacerbated by its weak corporate governance practices. The company’s founder, CEO and chairman, Mr. Richard Qiangdong Liu, has extensive influence on the company through his c.79% voting power, which puts minority shareholders at risk. We also observe that the company often adopts the Cayman Island’s corporate code instead of instituting the typically stronger corporate governance practices recommended by the NASDAQ exchange. 

We don’t see the impact of these accounting and corporate governance issues materialising in the short-term. However, we find the potential income statement and balance sheet impact of these issues to be large enough for investors to pay close attention.

LightStream Research • Equity Analyst • (Opens in a new window) ⧉

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Corporate Governance In Japan

By | Smartkarma Originals

If effectively implemented, the Japan Corporate Governance Code, the Japan Stewardship Code, the Engagement Guidelines and the CGS Guidelines would also represent a sea change in the role of Japanese boards in terms of management selection, management compensation, and capital deployment. If. This is largely a ‘soft” law rather than a hard regulatory change, limiting the regulator’s power to address minority rights.

There is a need to see improvement in governance, independence, board structure, and capital stewardship by a very large number of companies in Japan. Enhancement of diversity on the board will enable increased effectiveness and also strengthen companies’ governance structure.

Investors are calling on companies to hire outside board members and tackle cross-holdings. The TSE-mandated Corporate Governance Code seeks at least two independent outside board members for listed companies and preferably a third, a majority, and provides an example of “at least one-third independent directors”. But these examples, and other much-needed changes, remain inadequate.

One of the fundamental problems with the combination of the Japanese Corporate Governance Code and the Companies Act, and the lack of liability of directors for their own decisions, is that they can hang their hat on irrational economic arguments and there are no repercussions. 

Investors want better “governance”, however, international investors seek more than improving the box-ticking form prized by many Japanese companies. Analysing non-box-ticking ESG/governance is difficult. It is difficult to track and analyse. And even if box-ticking is evident, it is not necessarily true that doing so will raise long-term equity returns. It is possible it will raise costs, which would lower profit growth – this may be good for society, it may not be good for valuations.

International investors are more concerned with improving information access, management responsiveness to investors, and management efforts to make companies become better economic engines. International investors would like to see companies concentrate on their business rather than see them run long-short funds (i.e. hold cross-holdings) with investor capital, hold excess cash, or invest in real estate as an alternative source of income.

A Consultation Paper reviewing the TSE cash equity market – first mentioned in December 2018, followed by a Market Consultation, culminating in four documents posted on the FSA’s website last November – make it clear to the TSE, governmental, and regulatory authorities that existing governance and stewardship levels don’t cut it.

For now, there’s a lot of technocratic navel-gazing.

Quiddity Advisors • Pan-Asia Catalysts/Events • (Opens in a new window) ⧉

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China Semiconductor Progress & Opportunities Review 2020

By | Smartkarma Originals

Since the launch of China’s ‘Made in China 2025’ strategic plan in 2015, billions of dollars have been invested to bolster the country’s self-sufficiency in ten key technology sectors. Five years on, we review the accomplishments, challenges and, in some cases, downright failures from the perspective of the semiconductor industry. We examine in particular China’s efforts to develop their own supply of DRAM and NAND chips and opine on both their progress and the risks they pose to the leading incumbents.

While China’s memory ambitions attract the lion’s share of the limelight, we think it’s important to look at the broader semiconductor ecosystem. To that end, we examine China’s progress terms of silicon wafer manufacturing, foundry and semiconductor equipment manufacturing. 

Our conclusion is that the the best investment opportunities relating to China’s semiconductor push may be found in lower-profile, less glamorous segments of the broader ecosystem. Here’s where we think they might be. 

Note: This Smartkarma Original is a collaboration between Jim Handy and William Keating. Jim contributed the initial sections on the background to China’s semiconductor investment plans, DRAM, NAND and their impact on the incumbents while the remaining sections were contributed by William.

Ingenuity • Semiconductor & Technology Specialist • (Opens in a new window) ⧉

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Private Credit Opportunities in Emerging Markets – Focus on India

By | Smartkarma Originals

Private credit is booming across emerging markets, after rising as a formidable asset class in Developed Markets (DM) post Global Financial Crisis (GFC).

In this Smartkarma Original, we assess the private credit space across emerging markets (EM) and demonstrate India’s attractiveness as a top destination for private credit opportunities. Within India, we pick Edelweiss as our top recommendation to participate in the private credit space through public equities. Edelweiss – Edelweiss Financial Services (EDEL IN) – is likely to not only benefit from the booming private credit space but is also transitioning from fund-based business model to fee-based business model, which should unlock significant value for the company.

This Smartkarma Original is divided into two parts, Part 1 and Part 2. Below is the Part 1 of this Original and it focuses on the private credit theme covering below topics:

  1. Introduction to Private Credit
  2. Private Credit: Prefer Emerging Markets (EM) vs Developed Markets (DM)
  3. The Menu of Private Credit Opportunities across EM
  4. India – Among the Most Attractive EM Markets for Private Credit

The Part 2 of this Smartkarma Original is a follow-on insight, titled as “Edelweiss – A Turnaround Idea Shifting from Fund-Based to Fee-Based Business Model”. It discusses our investment thesis on Edelweiss – our Top Pick for benefiting from the booming private credit space in India.

What’s Original:

  • Insights into why private credit is better than traditional balance-sheet driven funding for certain credit opportunities across EM.
  • Compare and contrast various private credit investment opportunities available across EM for institutional investors and why India stands out as a compelling opportunity.
  • Estimate the size of the Total Addressable Market (TAM) of such private credit opportunities in India to demonstrate the high growth potential

• India Focused Equity Analyst • (Opens in a new window) ⧉

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Investing into China’s Growing Onshore Bond Market

By | Smartkarma Originals

In this Smartkarma Original, we dig into the onshore bond market of China, covering key topics include historical background, market structure, market segments and key participants, growth drivers, evolving trends, market dynamics around foreign participations and challenges for foreign investors. The Chinese onshore bond market is a complicated one. This Smartkarma Original does not attempt and cannot cover all areas in the market, but is expected to highlight the most important areas that global institutional investors need to know in their decisions to make investment in this gigantic and rapidly-growing market. 

What’s Original?

The China onshore bond market, with outstanding notional value of RMB95.7trn, is now the second largest in the world. However, foreign ownership of onshore bonds is outrageously low at just 2.3%. In this Smartkarma Original, besides exploring the key facets of this market, we discuss the key trends in the future and the main challenges faced by global institutional investors.

This Smartkarma Original draws views from rating industry, institutional investors and the banking industry and local resources to provide a comprehensive picture on the development of China’s onshore bond market. More importantly, we look at the market from the perspective of investors, which is different from the perspectives of the issuers and investment banks.

We believe there is no way to stop the growth of China’s onshore bond market and more will be done by the regulatory authorities to improve the appeal of the market to foreign investors – this is a market that foreign institutional investors simply cannot afford to ignore.

• Equity Long-Short Analyst • (Opens in a new window) ⧉

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Thailand: A Two-Player Retail Market? – CPALL and Berli Jucker

By | Smartkarma Originals

In this next part of a Smartkarma Originals Series on ASEAN Retail, we look at Thailand and specifically two companies including CP All PCL (CPALL TB), the operator of over 11,600 7Eleven stores in the country, as well as cash & carry operator Makro and, Berli Jucker (BJC TB), a relative newcomer and owner of number two hypermarket operator Big C Supercentre.

In this report, we take a deep dive into both CP All PCL (CPALL TB) and Berli Jucker (BJC TB) having had face to face meetings with the management of both companies in Thailand, as well as visiting a number of their stores in Bangkok.

Both companies are pushing forward with innovative strategies in their own sub-segments, with CP All PCL (CPALL TB) gradually increasing the size of its convenience store offering and adding to the services side of its revenue mix. It is also exploring some higher-end offerings, with a greater range of ready-to-eat options in a new clean shiny environment.  

Big C rapidly pushing out it’s Mini Big C offering, with larger size convenience stores, more like mini-markets, targetting top-up shoppers in residential areas. It has also introduced a new Big C Food Place concept targetting more affluent customers in urban areas. Its other major business is consumer packaging and consumer supply chain, which are stable growth businesses with significant synergies with its retail business. The company’s aluminium can business has growth potential given a switch from other packaging mediums to cans.

The other major player in Thailand is TESCO through its TESCO Lotus stores. It operates around 400 supermarkets and hypermarkets and 1,500  Tesco Express convenience stores and recent newsflow suggest that it is looking to sell those assets together with its 74 Malaysian stores for a price tag of US$9bn.

A potential front-runner to buy those assets is Berli Jucker (BJC TB), which would further transform that company’s business towards being a purer retail play and the number one player in the hypermarket space by a significant margin. Should this transaction take place, it would likely narrow the valuation gap between the two players, though CP All PCL (CPALL TB), would likely continue to trade at a premium, given its higher ROE and pure retail status.

In terms of upside, both companies look attractive versus there 3-year average PER multiples. CP All PCL (CPALL TB) trades on a forward PER of 25.9x FY20E versus a three year average PER multiple of 29.4x implying upside of 13.5% or a target price of THB85.00. Berli Jucker (BJC TB) looks even more attractive, trading on a forward PER of 21.8x versus a 3-year mean forward PER of 30x implying upside of 37% to a target price of THB56.70.

CrossASEAN Research • ASEAN Insight Provider • (Opens in a new window) ⧉

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Minimarkets: Mini Is the New Big

By | Smartkarma Originals

In a Smartkarma Originals Series of Insights on ASEAN Retail, we seek to determine which retail formats are winning out in the battle for consumer attention. The Indonesian grocery retail industry is changing over the past decade. Traditional retail share, which is dominated by over 5mn Warung (traditional mom-and-pop shop), is declining from a dominant 90% to 80% (including cigarettes). FMCG companies that we speak to gave us a rough range of 20-30% of sales derived from modern retail outlets. This change is driven by the rapid growth in the minimarkets, a duopoly that are expanding 3,000-4,000 outlets per year at its peak.

In this insight, we will discuss the reason to minimarket successes, the players in the industry, impact from e-commerce expansion, and the minimarket growth potential going forward. We also spent time speaking with Nielsen to understand the latest consumer behavior and made several visits to different minimarket, supermarkets, and hypermarkets, as well as Warungs to understand the dynamics offered by each format. 

The minimarket concept is grown locally and were first seeded by two of the most prominent FMCG players in the market Hm Sampoerna (HMSP IJ) and Indofood Sukses Makmur Tbk P (INDF IJ) back in 1990s. Knowing the Indonesian shopping habits in the traditional mom and pop shop (Warung), the minimarket is created as an improved version of the local warung, focusing on daily necessities (egg, rice, oil) and the fastest moving goods (instant noodle, cigarette, bread).

Our channel checks with the neighbors suggest that key reasons for them to go to minimarkets are: 1) convenience / location, 2) pricing / promotion, 3) queue time, and 4) less temptation. With a smaller more nimble format, minimarket can open literally anywhere in the neighborhood, close to the residential area. The duopoly structure between Alfamart and Indomaret give them a lot more bargaining power compared to the super/hyper. Minimarkets have been able to secure cheaper prices even compared to hypermarkets that often offer bulk discounts. 

The minimarket share is currently led by Indomaret (INDF affiliated company). As Alfamart started to streamline their expansion to lower down their debt level, Indomaret is currently leading with over 17k outlets nationwide. Alfamart is lagging behind at 15k outlets and has cut back expansion to below 1,000 stores since 2018. The biggest barriers to entry is location. With Alfamart and Indomaret seemingly present at every corner, it would be hard for any new brand to penetrate the market.

With Indonesia entering the digital era, and online retailing is rapidly gaining share (between 4-6% of retail sales based on various sources), the minimarkets can both benefit and lose from the aggressive expansion of the e-commerce giants. The easiest benefit to tap from the e-commerce player is through cash payment handling. Top C2C e-commerce Tokopedia for example accepts all types of payments, including cash, from all major minimarket outlets. 

As the e-commerce players are looking for new source of growth, the third largest e-commerce Bukalapak.com is branching out to directly supply goods to over 5mn Warungs across the country. The initiatives are popularly known as the Mitra (partner) program. The Mitra program aims to cut the distributor and wholesaler role by providing an online ordering system through the Mitra program app. The Mitra program unfortunately can be a threat for minimarket growth going forward as it empowers the traditional Warung with better product selections and cheaper pricing. 

Other than the Mitra program, the e-commerce players also offer wider selection of FMCG products in their platform at very lucrative prices as traffic puller. In the past 12.12 National Online Sales (Harbolnas) day, we can see up to 80% discounts on some of the FMCG products.

A bulk of the discussions below will be on Sumber Alfaria Trijaya Tbk Pt (AMRT IJ) as we have very limited information from Indomaret’s operation. Indoritel Makmur Internasional (DNET IJ) owns 40% of Indomaret and does not consolidate their books. DNET is a holding company owned by the Salim Group that has stakes in the KFC franchise Fastfood Indonesia (FAST IJ) and Sari Roti Nippon Indosari Corpindo (ROTI IJ).

AMRT is on track to achieve 8% SSG in FY19, a major recovery from the decade low 1.5% in FY17 and 5.5% in FY18. As AMRT streamlines their store expansion, cutting store openings to 400-600 stores per year over the next 3 years, we expect SSG to remain strong and hovers between 5-10% coupled with 2-3% spatial growth.

AMRT’s EBIT margin has been slipping from 2.7% in 2014 to 1.8% in FY18 as opex growth exceeds SSG. To fully pass on fixed costs increases, we estimate that AMRT needs to book at least 7% SSG. FY19 is the first year since 2014 for the SSG to exceed the 7% mark, hence the year to expect EBIT margin to improve. Given the steep seasonality, 9M19 consolidated EBIT margin is recorded at below 1%. A big chunk of the supporting incomes from suppliers’ rebate will come in the fourth quarter of the year.

AMRT’s fee-based income has been growing by more than 40% Cagr over the past 5 years, contributing to more than 30% of EBIT. As more services are added, and as consumers adopt digital transactions, AMRT’s fee-based income growth still has a long way to go. 

Negative FCF has been a problem in the past where net gearing reached 1.3x in FY17 and net interest expenses make up more than 60% of EBIT. As AMRT streamlines their store openings and close down non-performing stores, we saw a big jump in FCF in FY18 that allows AMRT to deleverage their balance sheet. AMRT paid almost IDR3tn worth of debt in FY18, reducing their net gearing ratio to 0.4x in FY18 and to 0.2x in FY19.

We expect SSG to moderate to 6% level while store expansion is kept at 2% addition every year, resulting to a total of 8% revenue growth until 2022. This, coupled with 10bps expansion in GPM every year, and 8% opex growth is on track for 17-19% EBIT growth per year. We expect fee-based incomes to continue its high teens growth trajectory, lifting net profit growth to 21-25% over the next three years. Risk to our numbers is working capital and economic growth. A 1-day swing in the company’s cash cycle affects its working capital by about IDR200bn. 

We have a buy recommendation with 19% upside to our blended target price.

CrossASEAN Research • ASEAN Insight Provider • (Opens in a new window) ⧉

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