Smartkarma Originals

China has been the fastest growing auto market in the world. Over the last 2-3 years China’s auto component industry is going through a tumultuous period – not only due to the volatility in demand (due to the auto downturn last year and corona-related lockdowns this year), but also due to two mega-trends that are providing risks and opportunities to the industry – NEVs and autonomous driving. In addition, there are 3 other less-discussed drivers of change in the industry   (emerging localization requirements, junior JV partners becoming leaders in their own right, international expansion). We look at the key A-share (MSCI A-share) listed players in the industry through the lens of these five trends/drivers of change. 

We prefer Passenger vehicle(PV) part suppliers over commercial vehicle (CV)part suppliers.  Among PV parts suppliers, our top buy is Changzhou Xingyu (601799.CH), followed by Ningbo Joyson Electronic(600699.CH),Fuyao Glass (600660.CH/3606.HK) and Huayu Auto (600741.CH). Our main underweight Wanfeng Auto Wheel (002085.CH). In Commercial vehicle (CV) part segment, we prefer Wanxiang Qianchao (000559.CH) and Linglong Tyre (601966.CH). We suggest investors to avoid  Weifu High-Tech (000581.CH).

What’s Original?

The recent tumult in the auto sector creates significant opportunities and risks for the companies involved – however companies/equities that are driving these trends are largely listed in the A-share market.  Lack of market communication, limited financial and operational disclosure and low breadth of analyst coverage in these markets has meant that there are quite a few underappreciated companies in these markets which have been overlooked by international investors.

While companies like Ningbo Joyson and Fuyao Glass enjoy some international investor recognition, we believe under-appreciated stocks like Wanxiang Qianchao and Linglong tyres are not well-covered by the market and this report provides a rationale for investors to look further into those names. We also highlight the risks to (relatively) popular names like Weifu Hi-tech (due to structural issues in the industry) and Wanfeng Auto wheel (due to management pursuing non-core acquisitions).

Note that in this report, we do not include the possible impact from Coronavirus on the industry and companies. This is because 1) it’s difficult to quantify the impact at current moment; 2) even if coronavirus impact might last for months, it’s still a relative short period compared to the 5-year time horizon we focus on. In addition, once coronavirus is gone, market demand on autos and auto parts would rebound quickly. 

• China specialist, Auto and Industrial specialist • (Opens in a new window) ⧉

• China Analyst – Onshore Credit, Equity Long-Short • (Opens in a new window) ⧉

Digital payments in Southeast Asia are expected to grow in the double-digit range per year, exceeding $1 trillion in gross transaction value (GTV) by 2025, based on Google-Temasek’s eConomy SEA 2019 report. Within this pie, e-wallets GTV has the potential to increase more than fivefold, from $22 billion to $114 billion. In India, digital payments are expected to grow 20.2% CAGR between 2019 to 2023, based on a projection by KPMG. 

In this piece, we explore 10 e-wallets that are emerging in Southeast Asia and India due to their phenomenal growth and picked them for in-depth discussions due to their unique ecosystems that can support their GTV growth. We will discuss their original vertical, features, growth plans, and hurdles to their growth, before picking out the potential winners.

Sections:

1. An introduction to major e-wallets in Asia, and definitions
2. Driving forces that led to wallet ecosystems 
3. Summary of the wallets’ strategic roadmap, growth, and hurdles
4. Common hurdles faced by e-wallets
5. Medium-term catalysts  
6. Conclusions

• Asia Ex-J Consumer/ Transport analyst • (Opens in a new window) ⧉

With a relatively full slate of large value takeovers in Developed Asia in the past year – often by parents but also by buyout funds – and the availability of significant credit to finance such takeovers, this Smartkarma Original insight looks at what constitutes an attractive target for takeover, and seeks to construct a framework for screening and filtering companies for further study. 

The filtering is conducted across two basic measures which seek to answer two basic questions:

1. What might supply look like?
2. What might demand look like?

The first basic problem with creating such filters is that on the Supply side, using databases to determine whether a controlling shareholder wants to sell is almost a lost cause from the beginning. But the exercise throws up some interesting case studies, and it is important to understand why such screening could lead to interesting results. 

On the demand side, it is a difficult and complicated exercise because financial data moves around, shifting through time and relative price because competitors also shift in time and price. A clear example of a company which might have been “relatively” attractive vs peers a month ago might not be after the market ructions at the end of February 2020 when this was written. Prices were, of course, lower, which means that a good screening process is dynamic, both in relative and absolute measures. It is also somewhat difficult to create a one-size-fits-all screen for attractive targets because in certain countries, certain industries (telecom, airlines, social infrastructure, defence) are covered by foreign ownership limits, other industries (banks, brokers, insurers) rarely see leveraged buyouts, and takeovers in other industries (Chinese homebuilders) are, for lack of a better word, simply off the table at certain times.

In addition, there are lots of ways in which companies might present themselves as attractive targets. If someone controls a company, and wants to sell it cheaply, there are lots of potential buyers who will fall all over themselves to get in line to buy it. But companies can be attractive targets because of the potential for changing profit metrics and multiples through restructuring, asset reorganisation, industry reorganisation, or simply waiting for the cycle to change. 

Using valuation metrics with a cutoff line can be challenging because common multiples such as PER, PCFR, PBR, EV/EBITDA may ignore significant value available from longer-term securities holdings, non-operating real estate assets which are not managed in optimal fashion, etc. 

In short, screening can only go so far. But we try.

At the end, we take a brief look at 10 companies from Developed Asia which show up as a result of our screening efforts. The resulting list is dominated by Japanese companies because some of the companies which show up from other countries fit the “no-go” categories above (airlines, financial companies, defence technology subject to foreign ownership limits, Chinese homebuilders subject to skepticism, etc.). Some are also clearly Emerging Asia businesses with Developed Asia listings. Screening for Emerging Asia got a few companies which are high on anyone’s target list, including one which saw an unsolicited takeover approach earlier this week (end-Feb 2020), and another which has been in acquisition mode for years. 

We find the thinking process and screening technology has thrown up some previously less-than-obvious candidates which deserve further work.

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

In this Smartkarma Original, we bring to you a forensic analysis tool that scores companies across Developed Asia on their accounting risk. We use 25+ accounting parameters in our framework to come up with an accounting risk score. Our tool is based in Excel and is linked dynamically to Capital IQ for fetching latest data.

Insight Flow

1. Forensic Analysis Framework
2. Excel Model
   1. How to Download and Use the Tool
   2. Steps to Run the Model
3. Target Universe
4. Companies with Highest Accounting Risk 
5. Summary Statistics from our Analysis
6. Key Model Limitations and Risks
7. Appendix
   1. List of Companies in our Target Universe with Accounting Risk Score >= 8
   2. Glossary
   3. Snapshot of Capital IQ Screener Used for Filtering Universe
   4. Switch Formula Calculation Option in Excel
   5. Refresh Worksheet Option in Capital IQ Plugin

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

Several countries are pushing for more M&A in Asian banking as a way to ameliorate risks (India) or to possibly compete more regionally (Malaysia), with even some rumours resurfacing of further activity in Australia. We have reviewed all major banking transactions in the Asia Pacific region over the past 10 years which involved consolidation and we summarise our findings below.

Summary findings

We find that most banks lose market share after a merger when we consider total assets.  This is usually due to depositors moving to reduce concentration risk and loan rationalisation by the merged entity. 

Overlapping banks allow for more synergies and there tends to be better performance, especially if management is able to achieve the synergistic gains quickly.  Mergers aimed more at revenue synergies or entering new markets appear to have lukewarm benefits.

A long drawn out merger process with unambitious long term synergistic benefits are penalised by markets.  Delays can be cultural, labour union led, government led or legal.

Clearly the lead in any transaction tends to impose their will on the combined entity.  We find that performance suggests that investors are better owing targets rather than acquirers.

Inteqres • • (Opens in a new window) ⧉

Ever since Alibaba successfully completed its secondary listing in Hong Kong in Nov 2019, markets have been abuzz with news of other companies that are planning to follow in Baba’s footsteps.

However, not all US listed China ADRs are eligible for undertaking a secondary listing and not all are likely to make as big a splash.

In this insight, we’ll aim to shortlist the ones that are most likely to undertake a secondary listing by highlighting: 

1. The recent factors that have been creating a pull effect, as well as the factors creating a push effect in the US

2. The additional incentives provided for a Hong Kong listing via the South-connect trading

3. Eligibility as per HKSE rules for a secondary listing 

4. Short-list of ADRs that meet the requirements and a ranking based on our quantitative criteria

5. A look at how Alibaba and Beigene traded and lessons from the same

Aequitas Research • Head of Research, IPOs & Placements • (Opens in a new window) ⧉

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) ⧉

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) ⧉

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) ⧉