Close

Specialist in Asia Pacific, Japan, China, India and South East Asia and Global Emerging Market equities.

Discover more
Close

Stewart Investors manage investment portfolios on behalf of our clients over the long term and have held shares in some companies for over 20 years. They launched their first investment strategy in 1988.

Discover more

FSSA Asian Growth Fund Manager Views

FSSA Asian Growth Fund Manager Views

July 2021

“Revenue is vanity, profit is sanity, but cash is reality.” Anon

In boom times like today, when cash costs nothing and capitalisation rates are zero, everybody is focused on growth and the future. Revenue is vanity in the sense that entrepreneurs, thank goodness, dare to dream and build businesses. We too, spend much of our time looking for the next opportunity and indeed thinking about how much businesses can grow.

But, valuations are most often anchored by current profitability, while businesses are theoretically worth only the present value of the cash that can ultimately be returned to shareholders. It has been said that in theory there is no difference between theory and practice; but in practice we know that this isn’t true. It is largely a matter of risk appetite, which has lately been in retreat.

Recent rotation has witnessed the markets shift from their obsession with the vanity end of the spectrum to a more considered interest in profits, but there is still not that much regard for cash. These moves have been prompted by a very modest (from nothing) uptick in interest rates in response to inflation pressures. The political and economic environment has deteriorated too.

There is really nothing much to see. But, these moves have prompted us to think all over again about cash generation as a leading signifier of quality. Moreover, I wanted to look more closely at how our portfolio companies behaved collectively through Covid. After all, in terms of stress, a pandemic is surely many multiples beyond a sharp negative reversal of the inflation and interest-rate cycles. In particular, I am interested in how our companies treated shareholders.

Portfolio resilience and quality markers

Their dividend payments should tell us a lot about their underlying resilience and persistency versus our expectations, as well as collectively about the overall quality of the portfolio. A plethora of emergency cash-calls would, for instance, suggest that we hold too many cyclical and lesser quality balance sheet businesses, providing something of a scorecard in terms of whether we are walking our well-rehearsed (and increasingly common) quality-talk.

Reviewing the portfolio and looking back through Covid, I was surprised to learn that the overall dividend amount paid to the strategy (on a holding-weighted basis) declined by only 5% over fiscal year (FY)2020. That is better than expected, as 15 companies reduced dividends, but clearly not that substantially. The overall figure was also underpinned by a sharp increase in dividends from Mediatek in particular. Even excluding that, though, the overall decline is still quite modest.

Out of roughly 40 companies (with some change in holdings), only four cut the dividend entirely. These were HDFC Bank, Axis Bank, Kotak Mahindra Bank and Shanghai International Airport (SIA). The Indian bank cuts, as around the world, were regulatory driven with policy-makers fearing another financial implosion. That SIA cut is hardly surprising, but the company has net cash and the reduction reflects prudence, as well as the fact that it is an SOE (state-owned enterprise).

That, as we have remarked before, is a double-edged sword. The state stands behind the business, but clearly, shareholders are not necessarily always in the vanguard of decision-making. At present the company is in negotiations to buy Shanghai’s other domestic airport. It is a state-driven left-pocket, right-pocket type of deal. We assume that shareholders will be treated fairly, but this latest deal illustrates why the company accounts for just a 1% holding.

Limited capital raisings (only the banks)

Through the very worst of Covid, globally, the Indian banks collectively fell to 10-year valuation lows. We have always regarded these banks favourably in terms of risk appetite and lending prudence. This seems to have been borne out by their subsequent bad-loans experience.

That said, many of them (including Axis Bank, HDFC Bank and Kotak Mahindra Bank) raised capital during this torrid period. In hindsight, this was probably unnecessary and somewhat dilutive, though perhaps urged by the regulator. Outside of the banking sector, none of our companies had to resort to highly dilutive rights issues and capital calls. This was a relief.

Obviously, this is somewhat due to governments coming to the rescue across the world, with sharply-higher fiscal deficits a consequence of employment and rental subsidies. We do, however, regard the lack of capital raisings as a quality-marker in terms of balance sheet strength. We have always highlighted that most of our portfolio companies have net cash balance sheets. As has been said before: Most of the time it doesn’t matter, until it’s the only thing that matters.

Though cash is reality, it is true that dividends have always been something of an afterthought in Asia as well as in Emerging Markets generally. This is unsurprising, because investors rightly look to this part of the world for growth. There is not much point diversifying and taking on more, or at least different risks (currency, political, policy and legal to name some), without recompense. That said, we always engage on dividends, particularly if we believe companies are being churlish.

Dividends as a component of returns

We consider dividends an important component of investor returns. Looking back, dividends have amounted to around 20% of the overall portfolio return in the last decade. In the last five years it has been lower (at about 15%), as capital returns have surged with strong markets. The historic contribution from dividends has been much lower than in the West, with dividends being a very substantial component (40-50%) of overall returns in a market like London. That said, capital returns have powered the US markets in the last decade.

Looking forward, we expect dividends to grow at circa 8-10% per annum (p.a.) from here, roughly in line with earnings growth. If we look back, the portfolio’s actual compounded dividend growth has been 7% and 8% p.a. respectively over the last five and ten years. We expect the strategy to (and has historically produced) real underlying earnings growth of circa 8-12% p.a., with an additional dividend yield on top of around 2-3%.

In the context of other alternatives, such an outlook seems reasonably attractive in our view. Of course, it always matters what you pay for that expected growth. In that respect, the overall portfolio price-to-earnings ratio (PER) valuation of 23-25x, for a return on equity (ROE) of 20% does not seem unreasonable either.

Lessons learnt

If Covid can be rightly seen as an extreme version of a market quality assurance stress test, then in hindsight the portfolio appears to have earned a pass mark. That is, at least, reassuring. With the benefit of hindsight, the lessons learnt are mostly familiar and we have continued to concentrate the portfolio and eliminate some of the smaller peripheral positions.

Of course, we have no idea what happens next. That said, we would not be at all surprised to see markets continue to tilt more broadly in favour of reality over vanity. This trade-off is after all what makes us human, as markets always move from greed to fear and back again. We hope that we are firmly anchored in reality, while we believe that the portfolio is well balanced irrespective of the coming market season.

 

 

Source: Company data retrieved from company annual reports or other such investor reports. Financial metrics and valuations are from FactSet and Bloomberg. As at 30 June 2021 or otherwise noted.

Important Information

This document is prepared by First Sentier Investors (Singapore) (“FSI”) (Co. Reg No. 196900420D.) whose views and opinions expressed or implied in the document are subject to change without notice. FSI accepts no liability whatsoever for any loss, whether direct or indirect, arising from any use of or reliance on this document. This document is published for general information and general circulation only and does not have any regard to the specific investment objectives, financial situation and particular needs of any specific person who may receive this document. Investors may wish to seek advice from a financial adviser and should read the Prospectus, available from First Sentier Investors (Singapore) or any of our Distributors before deciding to subscribe for the Fund. In the event that the investor chooses not to seek advice from a financial adviser, he should consider carefully whether the Fund in question is suitable for him.  Past performance of the Fund or the Manager, and any economic and market trends or forecast, are not indicative of the future or likely performance of the Fund or the Manager. The value of units in the Fund, and any income accruing to the units from the Fund, may fall as well as rise. Investors should note that their investment is exposed to fluctuations in exchange rates if the base currency of the Fund and/or underlying investment is different from the currency of your investment.  Units are not available to US persons.

Applications for units of the Fund must be made on the application forms accompanying the prospectus.  Investments in unit trusts are not obligations of, deposits in, or guaranteed or insured by First Sentier Investors (Singapore), and are subject to risks, including the possible loss of the principal amount invested.

Reference to specific securities (if any) is included for the purpose of illustration only and should not be construed as a recommendation to buy or sell the same. All securities mentioned herein may or may not form part of the holdings of FSI’s portfolios at a certain point in time, and the holdings may change over time. In the event of discrepancies between the marketing materials and the Prospectus, the Prospectus shall prevail.

In Singapore, this document is issued by First Sentier Investors (Singapore) whose company registration number is 196900420D. This advertisement or publication has not been reviewed by the Monetary Authority of Singapore.

First Sentier Investors (registration number 53236800B) and FSSA Investment Managers (registration number 53314080C) are business divisions of First Sentier Investors (Singapore). The FSSA Investment Managers logo is a trademark of the MUFG (as defined below) or an affiliate thereof.

First Sentier Investors (Singapore) is part of the investment management business of First Sentier Investors, which is ultimately owned by Mitsubishi UFJ Financial Group, Inc. (“MUFG”), a global financial group. First Sentier Investors includes a number of entities in different jurisdictions.

MUFG and its subsidiaries are not responsible for any statement or information contained in this document. Neither MUFG nor any of its subsidiaries guarantee the performance of any investment or entity referred to in this document or the repayment of capital. Any investments referred to are not deposits or other liabilities of MUFG or its subsidiaries, and are subject to investment risk, including loss of income and capital invested.