Daily Hong Kong: Screening the Silk Road: Q1-2019 Small-Mid Cap GARP (Zulu Warrior Screening) and more

In this briefing:

1. Screening the Silk Road: Q1-2019 Small-Mid Cap GARP (Zulu Warrior Screening)
2. Chinese Telcos: 5G Launches in 2019. Buy the 5G Beneficiary (China Tower).
3. Are Chip Oligopolies Real?
4. Global Banks: Some New Year Pointers
5. Extraordinary Fiscal and Monetary Policies Have Disrupted the Global Economy

1. Screening the Silk Road: Q1-2019 Small-Mid Cap GARP (Zulu Warrior Screening)

• Value made a comeback, but growth remains core: In May 2018, we examined the divide between value and growth stocks, ( Notes from the Silk Road: Small-Mid Cap Screening for Zulu Warriors). As Q3 unfolded, this eventuated with a +7.5% reversal in favour of value stocks, only to see growth resume dominance in October and November.
• The optimal value/growth style dynamic: We feel exposure to growth at a reasonable price (GARP) coupled with a healthy FCF yield (via our amended Zulu Screen) should provide some healthy medium to long term returns for investors.
• The Screen’s Risk: The Zulu Screen relies on analyst estimates. When market sentiment is weak and forecasts are not amended in a timely manner, the screen is susceptible to mis-selection.
• Q2 2018 screening list succumbed to volatile markets: This was seen in our May screen with our list posting on average a 30% decline in share price, relative to the broader Asia-Pacific Ex-Japan declining 13.6% and the Asia Pacific index by 11.8%.
• Are there reasons for the underperformance? 10 of the 19 stocks in the May screen were from Hong Kong, which saw the Hang Seng Index (HIS) decline 16% over the same period. The decrease seems due to concern over trade wars and doubts about the China economy. Our key approach to stock selection is to take a medium-to-long-term view as well as focus on quality ranked stocks relative to their peers. This is highlighted via the average stock rank of the group declining only 15.8% from 89.6 to 75.5 points.
• Our Q1 2019 screen selected only 9 stocks. Of the 9 stocks identified, the average PEG Ratio was 0.4x, the price to FCF yield was 11% and ROCE was 25%. Stocks were selected from Australia, New Zealand, India, Korea, Japan, Hong Kong, Taiwan and Singapore. Cowell Fashion Company from Korea was the only remaining stock from our May screening.

2. Chinese Telcos: 5G Launches in 2019. Buy the 5G Beneficiary (China Tower).

We highlighted in a recent note Chris Hoare‘s positive outlook for China Tower (788 HK). Our view takes into account the 5G build-out commencing this year, improved capex efficiency from using “social resources”, the rapid growth in non-tower businesses that lie outside the Master Services Agreement (MSA), and the valuation benefit from what looks like surprisingly investor friendly management. 

This note focuses on four key issues facing the Chinese telcos in 2019:

• 5G capex (March) (this is by far the most important),
• Regulatory newsflow (February/ March),
• Operating trend improvements (August), and
• Emerging business opportunities driving future growth (August).

We remain positive on the telcos which trade at low multiples. China Unicom (762 HK) continues to trade at a discount, yet is most exposed to the positive story emerging at China Tower. We switch our top pick among the telcos from China Mobile (941 HK) back to China Unicom as a result. Alastair Jones thinks China Telecom’s (728 HK) premium multiple is at risk if management execution on the cost base doesn’t improve. It is our least preferred telco at this stage. Overall, we expect China Tower to outperform all telcos and it is our top pick.  The upgrade to China Tower flows through the telcos (valuation and costs) and our new target prices are as follows: China Unicom to HK$14.4, China Telecom to HK$5.4 and China Mobile to HK$96. 

3. Are Chip Oligopolies Real?

In the semiconductor industry, particularly in the DRAM sector, there has been significant consolidation leading some to hypothesize that there’s now an oligopoly that will cause prices to normalize and thus end the business’ notorious revenue cycles.  Here we will take a critical look at this argument to explain its fallacy.

4. Global Banks: Some New Year Pointers

Here is a look at how regions fare regarding key indicators.

• PH Score = value-quality (10 variables)
• FV=Franchise Valuation
• RSI
• TRR= Dividend-adjusted PEG factor
• ROE
• EY=Earnings Yield

We have created a model that incorporates these components into a system that covers>1500 banks.

5. Extraordinary Fiscal and Monetary Policies Have Disrupted the Global Economy

In their public presentations, central banks seem to be contemplating the use of neutral interest rates (r*) in addition to unemployment/inflation theories. R* has the advantage of appearing to be subject to mathematical precision, yet it’s unobservable, and so unfalsifiable. Thus, it permits central banks to present any policy conclusion they want without fear of verifiable contradiction. R* is the policy rate that would equate the future supply of and demand for loans. It rises and falls as an economy strengthens and weakens. Long-term observation during the non-inflationary gold standard, period indicated that r* in an average economy was 2% plus, which would become 4% plus with today’s 2% inflation target. The Fed may soon end this tightening cycle with the fed funds rate at or near 2¾%, which would be r* if the rate of lending and borrowing in America remained stable thereafter. Rising (falling) lending would indicate a higher (lower) r*.