Introduction
In the hope of learning more about the pace of change in Asia, we arranged a series of meetings with companies and fund managers based in Singapore. It was a fascinating few days. Our aim was to get a better understanding of the durability of the earnings power of companies in different sectors, to understand the required conditions for continued growth in the stock markets and economies and to try to assess when the current bull market might turn.
Markets
After a strong run across all of the Asian indices over the last few years we have become conditioned to good news. We witnessed nothing to dispel this notion. Current market and economic conditions – liquidity from the Sovereign Wealth Funds, Chinese participation in equity markets, appealing valuations, strong economic growth - provide sufficient comfort that we will continue to enjoy growth in these markets in the near term. However, we are aware that, as in all stock markets, there will be periods of weakness. This is part of the cyclicality of the markets and stems from excess capacity which will no doubt be witnessed in many different areas of the market from airlines and hotels to power generation and chemical plants.
Economy
When we were last in Singapore in 2005 the perceived threats to the economy centred around macro factors and in particular the threat of a wide-spread bird flu pandemic loomed very large in people’s minds. This time around the threat of bird flu had been replaced by worries about the US and the valuations of Chinese shares.
In 2005, company managers and fund managers made constant references back to the Asian economic crisis of 1997 and the impact of Severe Airborne Respiratory Syndrome (SARS) at the start of the decade. While the mood was not especially pessimistic, the focus was clearly on the short term and a desire to get through the period unscathed. We highlight this to illustrate what a low base, both in terms of economic activity and stock market levels, Asia has come from in the last two years.
In marked contrast this time around, only half the conversations touched on the Asian crisis and SARS and nearly everybody was forward looking and positive in their predictions for the future of the Asian economy. This was both a positive and a negative.
All the positive thinking has translated into a rush for resources and infrastructure spend. This is highlighted by talk of “double ordering of oil rigs” – much of which we suspect is speculative - and although expansion is fully justified at the moment it does not take much to tip the balance.
On a personal note, it was fascinating to see the extent of the price differentials between London and Singapore. The official exchange rate is three Singaporean dollars (SG$) for every one pound, but in some bars and restaurants the exchange rate was parallel, and occasionally it was below parity. While this was indicative of the wealth accrued in Singapore in recent years it still came as a shock and deserves watching.
Company Meetings
The primary purpose of our trip was to confirm the earnings power of each of the companies and the durability of these earnings. The fund managers, company management and industry representatives all had a great deal of information to pass on and were keen to help us understand their businesses and future ambitions.
Prior to our trip, we identified some of the key players in different sectors which we hoped would give us a good insight into the workings of their industries. Among the most enjoyable meetings was the time spent with Mr Quak Hiang, whom we have met before, the head of Investor Relations at United Overseas Bank (UOB) (Price SG$20, Mkt Cap SG$32bln, calendarised PE Dec 2007 14x, PE Dec 2008 12x.). We have traditionally spoken to UOB as they have a well deserved reputation for the conservative nature of their lending.
Mr Hiang spoke of the manner in which UOB has often refused to become involved in some of the lending practices seen in the last few years in Asia - an acknowledgement of some of the loss of discipline. In Singapore, the Government has recently taken action to dampen property speculation and is now waiting to see if their actions have had the desired effect. In the meantime, UOB told us how many people are being refused loans, “especially foreigners….when you have land values which have risen from SG$1,500 to anything between SG$3,000 to SG$4,500 per square foot even a 50% loan is 150% of the price two years ago.” Tales of rent for residential properties doubling and trebling in the last few years were also commonplace.
Mr Hiang spoke about Singapore in an upbeat tone arguing that in 2008 alone, “the building of the new casino, the staging of the Formula One Grand Prix and additional construction and housing will boost the economy…..we have pent-up demand from ten years of depression.”
UOB is confident about the long term outlook for Asia and the bank’s focus on small and medium sized businesses in Singapore is likely to reap substantial rewards. To date they have successfully avoided the pitfalls of significant exposure to issues such as large sub-prime bond holdings encountered by their rivals. The steady pace of their investments in countries such as Thailand, China and Vietnam will pay off at some stage in the next few years as overseas earnings rise to 40% of overall profits. UOB also offers tremendous opportunities as a proxy play on both Singapore and Asia.
Another financial institution we saw was the Singapore Stock Exchange (Price SG$13.10, Mkt Cap SG$14bln, calendarised PE Dec 2007 37x, PE Dec 2008 25x). The Investor Relations team were very welcoming and proud of their achievement in establishing the exchange as a powerful presence in Asia. They explained the problems they encountered post SARS in persuading investors that the Singapore Exchange was a viable entity for both domestic and foreign companies to list on and also for banks to launch new products for trading purposes. They were very proud to report that turnover on a daily basis had risen to SG$2bln a day.
As with so many of the companies, the representatives of the Exchange were very open and honest in admitting how fortunate they had been to have benefited from the trends put in place by the Singapore Government and its various Development agencies. They openly acknowledged the concerted push the Government has made to turn Singapore into a country specialising in wealth management.
Looking to the future, the Exchange has some ambitious plans and the speed at which they are moving is impressive. They are seeking to introduce a number of new products, indices, listed sectors and trading platforms to their own market as well as seeking alliances with regional and international exchanges: “its all about continual evolution….and adding to the pool of liquidity….we’d like to become the Asian gateway.”
Raffles Education (Price SG$3, Mkt Cap SG$3.5bln, calendarised PE Dec 2007 51x, PE Dec 2008 33x) was another genuine growth stock, trading on an earnings multiple that reflects the growth of recent years. The company is a leading provider of private education services in a number of Asian countries, serving differing segments of the education market place and attracting its students from domestic and international recruitment drives. They have consistently sought to extend the range and breadth of their activities and courses.
The majority of the meeting with the CEO, Mr Chew, was dominated by the news of their recent major move into China and the reaction of investors. They have taken hold of a green field site with a large campus and with even larger ideas to “create a new stream of revenue….it’s all about enhanced streams of revenue.” They showed an acute awareness of the importance of keeping the Chinese authorities on their side and admitted that they had studied all aspects of the deal very hard, “yet it’s important to realise the Government does not want you to fail….they don’t want to throw the good sentiment of foreign investors away.”
A very impressive company which has clearly achieved a great deal and is keen to continue its fast pace of growth. The expansion into China does pose a risk but there is sufficient momentum in the business for the shares to carry on attracting investors and they show no signs of wanting to slow down - they want to be in India, “….within two years.”
Sembcorp (Price SG$ 5.30, Mkt Cap SG$10.1bln, calendarised PE Dec 2007 19x, PE Dec 2008 16x.) was formed as a result of a merger between two state owned Singaporean companies at the ‘request’ of the Government in 1998. After the merger, the company consisted of a number of diverse businesses but it has since disposed of most of them leaving it focused on utility services. It also retains a stake in Sembcorp Marine, a builder of oil services related equipment such as submersibles.
The majority of Sembcorp’s business activities are based in Singapore. It has a waste water treatment plants and bio-fuel activities in addition to its utility division. The strategy for their utility business has been well thought out and the differing industrial and infrastructure segments they serve are responsive to their services. As with most of the domestic Singapore companies, expansion overseas has been slow but considered and in addition to their moves into the UK and China, Sembcorp are breaking ground on developments in Vietnam and the United Arab Emirates.
CapitaLand (Price SG$ 6.70, Mkt Cap SG$21bln, calendarised PE Dec 2007 22x, PE Dec 2008 21x) is one of the largest real estate owners and property developers in Singapore. Its activities spread all through Asia, Europe and Australasia. It has benefited from shrewd capital allocation in differing parts of the world and from clever partnerships with Governments and local bodies. Like so many other companies, CapitaLand have approached China in a tentative manner and been rewarded so far, but they are clearly ambitious to increase the speed of their development in the country.
There is no doubt that the business has benefited from the liquidity boom but they said that they would not chase profits in sidelines but would instead stick to their core skills, “at heart we are developers…we are not property hoarders”.
The Government of Singapore spends a large amount of time planning and detailing what sort of developments are to be encouraged. At the same time, they try to ensure that companies such as CapitaLand receive all the assistance they need to complete their projects. The current, ‘build-up and build-out’ of Singapore is clearly something that occupies a large amount of Government thinking and is communicated not just to CapitaLand but all the commercial developers at all times. This presents some interesting opportunities.
Venture (Price SG$13.3, Mkt Cap SG$3.6bln, calendarised PE Dec 2007 13x, PE Dec 2008 11x) is an electronics manufacturing company. It is currently working to impress upon investors their move into higher margin services and away from their legacy base in hardware products. “We don’t just fulfil orders anymore….we have a lot of capability in research and intellectual property.”
The move towards partnering with major businesses such as Hewlett Packard will attract scepticism but does appear to be working. The search for higher margin goods and faster growth areas, such as medical equipment, is sensible and the comprehensive nature of their approach to servicing their larger Original Equipment Manufacturer (OEM) customers has taken them into the area of professional services, offering consulting, e-fulfilment and forecasting services.
They face all the traditional problems of scale, price attrition and innovation “at every turn” to satisfy their customers and their achievements should not be overlooked. They shed Motorola as a customer in their mobile business two years ago and pulled out of the tape drive business, causing a significant drop in revenue. This revenue has now been replaced by significantly higher margin business and fully vindicates their strategy. “We have become a technology business led by us, not our customers….nurturing second liners has paid off for us.”
Olam (Price SG$3, Mkt Cap SG$5bln, calendarised PE Dec 2007 40x, PE Dec 2008 31x) was the only company we saw involved in the headline-grabbing agriculture sector. It has a considerable amount of potential and has confirmed our interest in this sector. Olam is one of the few companies we can find in this sector that actually owns and trades physical commodities. While it is not a farmer/ producer, it does source and store almost all of its products: “we extract margin from our supply chain management…from village agents to crop advances, warehousing, storage, deposit and depot facilities.”
Among the various soft commodities they trade in, ranging from cocoa to wool, Olam place huge emphasis on their understanding of the crop calendar. They have no “Prima-donna traders,” and the aim is to make sure their products get to the end customers as quickly as possible and in the best condition. Their largest dilemma remains the price/ volume trade-off in the markets in which they operate, a tricky problem which results in “net contribution per tonne” being the over-riding criteria by which all their divisions are judged.
XP Power (Price 245p, Mkt Cap £48mln, calendarised PE Dec 2007 8x, PE Dec 2008 7x) is a UK listed provider of electronic components which has moved to Singapore, both at the behest of their major customers but also to allow them to benefit from “the joined up thinking of the Government of Singapore.” A recent poor trading statement stemming from a disappointing order profile from three key customers has hurt the shares. XP had flagged that trading in their market place had slowed but the impact of de-stocking by the three customers has clearly hurt them.
While they are working hard to rectify the disappointment of the last few weeks they are also trying to make the most of the benefits following their move to Singapore. This should help them get into new products areas and get put on new customer lists: “the manufacturing base will help us enormously…there are big benefits from being here.” The company said that they have been surprised by the amount of help they have received from the Singapore authorities.
Fund Management Meetings
The meetings with fund managers in Singapore also proved rewarding. It is always interesting to hear Alistair Thompson’s views at First State Asia Pacific Leaders. Alistair said First State were conscious of just how well Asia had performed in recent years and commented how the valuations could no longer be deemed “cheap.” Despite adopting a slightly more defensive posture in the portfolio, Alistair admitted that the longer term positive trends are still firmly in place. They continue to move the geographic allocations around in the fund and there has been a significant amount of fine tuning but the overall impression continues to be extremely favourable.
We also saw Mr Seng Chong at Yeoman Capital. Mr Chong runs a value based fund, focusing on “working the numbers at all times.” Over the last decade Mr Chong has accurately read many of the trends and changes among investors in Asia. He focuses on those companies which are not price takers, have appealing levels of cash flow historically and which may be suffering from a disruption to their operating fundamentals or may have become de-rated by the stock market. Mr Chong assesses each investment from a “bottom-up” perspective, “ignoring market fashions….we don’t own over-ripe securities.” Mr Chong proved to be a sensible and perceptive fund manager and we found his views on value investing interesting.
Conclusion
Despite the strong rises in the stock markets of central Asia in recent years, we believe there is still good money to be made in the next eighteen months. We are using the Chinese Olympic Games in 2008 as our proxy for a potential short term top in the markets.
Liquidity, momentum and fashion investing are currently driving the markets upwards but we will approach a time when valuations become too stretched and earnings start to disappoint. At this point we will look to move into more defensive investments. It is important to lock in gains on the way up as it is almost always impossible to call the top.
Although we will significantly reduce our exposure to Asia in the next eighteen months or so, in the long run we are great believers in the Asia story and will continue to look for ways to make money by investing in the region.
