November 02, 2012

By Derek On November 2, 2012 Under November 2012


There were times my pants were so thin I could sit on a dime and tell if it was heads or tails.” – Spencer Tracy

Observations

As New York and the rest of the east coast recover from the savage ravage of Hurricane Sandy, I am feeling pretty safe here in Seattle on the opposite side of the country, staring at my ballot that just arrived in the mail. Today, I pick up my pen and carefully vote in the next leader of the free world. Held once every four years – like the Olympics used to be when they were cool – US presidential elections are a pretty big deal. Aside from obnoxious political commercials (“Mitt Romney kicks puppies!”), there is endless debate on whether it really matters who occupies the Oval Office. This is a good question, to which I don’t have a good answer but what about markets as discounting mechanisms; can they predict the outcome of the election?

The New York Times investigated using the Dow as election indicator. Since 1900, there have been 28 US presidential terms and, although statistically these numbers are insignificant, it is interesting that over the last century, when the Dow has risen more than 5% a year during a president’s four-year term, he is usually re-elected. The actual numbers are 11 wins and just three losses. Hmmm, 11 to 3, not bad. How has the Obama administration fared on that basis? The DJI is up an annualized 9%: Obama wins. Recent surveys show Romney gaining but my view is consistent: this race is Obama’s to lose and the hurricane just gives him another chance to look presidential.

Wall Street may hate him as banks are pummeled left, right and center and the industry is continuously painted as greedy and villainous. Yet, in 2008, Goldman Sachs donated more than any US company, to the Obama campaign; over $1 mn. So far, during this election they have ponied up just $136,000. Those meager pickings are less than the Obama campaign has collected from employees of the State Department, according to the WSJ. That’s a drop of 86% (almost mirroring the size of the collapse of Goldman’s stock during the GFC). Romney, on the other hand, has received $1.8 mn from GS for his campaign. In 2008, no other firm did more to get Obama elected. In 2012, no other firm is doing more to get him defeated. Maybe it would help if Mr. Obama banked with GS, like Romney does. But considering Romney’s account would have several more zeroes on the balance, I kind of doubt it.

According to statistics from the Center for Responsive Politics, which has tracked campaign donations since 1989 (and has the intriguing website url of “opensecrets.org), Goldman employees in total have donated more than $22 mn to the Democratic party and its candidates. That is more than ANY other US company.

Red vs Blue

Since Obama was elected in 2008 there has been a great polarization of political views in this country. States have been divided up as either “Red” (Republican) or “Blue” (Democrat).

Urban Dictionary (to which I defer for the finer points of usage of the modern vernacular) lists the following as the preferred pastimes of people who live in “red states”:

Buying guns, lynching, book-burning, obesity, incest, ignorance and hubris. And guns.”

What about “blue states”?

Home to a buncha, whiney, cheese lovin’ Francofiles who can’t wait for the USA to become subservient to any other nation. Like Lithuania.”

It now seems the political division extends to the dating game too, according to an article in the WSJ. One professional matchmaker noted that in past election years about a quarter of her clients wouldn’t date a member of the opposite party. Now it is three quarters. As one lonely (and likely to stay) single woman put it,

I will only date a Republican – or a Democrat who has come to his senses and is now a Republican.

This reminds me of why Taiwan failed right at the finish line. In the 1990s Taiwan, not China held all the cards. It was rich, respected (kind of, well, more than China at any rate) and the island was desperately needed by the Mainland. Then the Taiwanese became introspective and started dividing everyone on the island up into two groups: Blue (again), which represented the ruling party KMT, and Green, which represented the “real” Taiwanese who only voted for the opposition Democratic Progressive Party (DPP).

Attitudes became more extreme when the betel nut chewers and duck farmers down south managed to propel one of their own sons of the soil into the presidency. I was “in country” during that period and the election of the greasy kleptocrat, Chen Shui-bian was the biggest sell signal I had ever seen. I left Taiwan to disintegrate not long afterward.

I started out as a stockbroker in Taiwan in 1993 and, I know it sounds funny today, but my skill set was in good demand for a long time as an “expert” on that market. However, in the last several years, the number of clients who have asked me anything about Taiwan I can count on two fingers. I see this as evidence of either my complete professional incompetence or the island doing an Atlantis and just disappearing off the map. Maybe a bit of both.

Halloween has come and gone. Our neighborhood was full of trick-or-treaters.

Research

Last week we looked at Korean carmakers with Hyundai Motors being my preferred pick. October sales for HMC numbers are just out, surging 14% y-y and 11% m-m. Overseas sales, including exports jumped almost 16%. 60% of production for Hyundai is now outside of Korea.

Kia just announced Q3 results that were below all forecasts. Revenues were in line but OP margin fell due to higher fixed costs deriving from the summer strikes and weak domestic demand. Kia was more affected than HMC due to a greater proportion of production (62%) occurring in Korea. Looking outside Korea, the news for Kia continues to look bad. Brazil, which has just overtaken Germany as the fourth largest auto market in the world, has extended temporary import duties of 35% – for another five years. Auto manufacturing in Brazil makes up about a fifth of that country’s manufacturing base and President Dilma Rousseff is claiming higher duties are necessary to protect jobs (and keep the powerful unions at bay).

According to José Gandini, head of Kia’s Brazil operation, Kia had expected to sell 100,000 cars this year but now it will be less than half that amount. The new tax is in addition to already existing duties and fees which means imported vehicles could suffer a total tax penalty of up to 340%. Active in the Brazilian market for 20 years, this hits Kia particularly hard. In order to meet local content rules of 65% or more, Kia will have to consider investing in manufacturing in Brazil where manufacturing costs are high, or find a buyer for another 55,000 cars.

Everything we have done in Brazil has been thrown in the trash.” – José Gandini

Analyst Yumi Park has downgraded Shinsegae (004170 KS) from a Buy to a Hold and slashed her target price from 300,000 won to 200,000 won (note). There were two catalysts for her abrupt change in view on the company:

1) Lousy September numbers
2) The unexpected acquisition of a 60% stake in Central City

Operating profit last month cratered 46% to KRW 6.4 bn. Shinsegae explained the disappointment as due to sales of lower margin products and increased SG&A costs related to new stores. Yumi’s view here is since the new Uijeongbu store essentially broke even, the earnings miss is more likely due to weak performance in other stores. Looking deep into the numbers, it seems that women’s panties and earrings were the weak spot, with sales down 11% and 7%, respectively. Food sales, which are lower margin items, were up however, leading one to assume Korean women are eating more and wearing less.

Yumi is now forecasting SSSG of 0% growth for the second half of this year, vs. her earlier view of a modest 1.5% increase.

Probably the bigger shock was the sudden announcement that the company is going to spend KRW 1 tn to control the Central City site in the trendy Gangnam area. The price appears excessive at a FY11 P/B of 1.3X, given an ROE of 3.6%. The other annoyance is Shinsegae will not fund the purchase through disposal of its Samsung Life shares but will take on more debt. Yumi believes that funding costs (at an interest rate of 3.5%) will be KRW 35bn, or 1.7% of operating profit. Post transaction, Shinsegae’s net debt to equity ratio will almost double, from 41% to 70%.

All this indicates a tougher operating environment for Shinsegae and one where costs are going to be difficult to control. Yumi much prefers competitor Hyundai Dept. Stores (069960 KS), penny pinchers extraordinaire and which has a more robust balance sheet.

Mirae held a China Property and Financials Day this week in Hong Kong where 10 Mainland Chinese companies presented their prospects to valued clients. While the sector has done well from a share price performance perspective the outlook remains sketchy.

Policy?

Most developers and industry insiders believe that there will be no change in policy status. The bad news is no relaxation is likely but for Pollyannas it also means no further tightening. (Pollyanna was an orphaned girl in a classic children’s book written 100 years ago. For Christmas one year she was hoping just for a doll. Instead, she got a pair of crutches, which made her glad: “At least I don’t have to use them!” Close proximity to people like this can be very wearing).

Property Tax?

The representative of the China Real Estate Information Corporation, Mr. Robert Fong, believed that the implementation of a nationwide property tax was unlikely in the next three to five years. He cited three reasons for his optimism:

1) Lack of comprehensive data to collate all residential units
2) Difficulties in applying the appropriate rate to assess the tax
3) Difficulties in appraising the correct value of units using existing databases

Pricing?

Several corporates commented that government officials were “very vigilant” when it came to price rises. Prices in Tier 1 and Tier 2 cities have been flat for the last 12 months but in Tier 3 cities they are still below 2010 levels. Developers have lost pricing power with strict implementation of Home Purchase Restrictions.

Regarding land acquisitions, most of the presenters said they will buy more land next year but will keep it low profile so as not to attract too much unwanted attention. Full year land transactions this year are likely to be down, year on year.

Red Flags?

There are some worrying sings as gross and net margin compression has become a common theme due to HPRs and the higher cost of financing. Net gearing levels have also climbed up to 56.4% from FY11’s 53.6% – despite less land purchases.

If you would like to be invited to future corporate events in Hong Kong, please contact our Head of Marketing, Isabella Kan.

Early signs are of China turning a corner with the official PMI for October climbing into “expansion territory” off 50.2, from 49.8 in September. Yes, it is a tiny improvement but worth noting and markets certainly used the 40 bp expansion as a reason to celebrate as Shanghai rose the most in 3 weeks. New orders rose above 50 for the first time in 6 months. As Mirae China Economist Joy Yang says, “The worst is behind us.”

The rush of liquidity into Hong Kong continues as the HKMA is now intervening on a daily basis to maintain the peg. Hong Kong-listed H-shares are still cheap, trading at 8.5 X PER with a 3.6% dividend yield. The FTSE is 16% from its 2007 highs and the S&P only 8% while H-shares are still only at half their 2007 levels. With the macro picture for China improving and compelling valuations, the Buy argument is not difficult to make.

Sinorama

The big news out this week from China, again seems to come from the NYT and their eyebrow-raising exposé on Wen Jiabao’s alleged family fortune (here). The interesting part is not that his nearest and dearest have secretly amassed a fortune of $2.7 bn, an amount somewhat above per capita GDP levels of $5,413. Rather, we should look at why the story was printed at all. The Chinese all live with “public secrets,” and see it as a normal part of existence in a complicated world. Yet, there is a line that is crossed only with great danger. I don’t think anyone in China will be surprised that Wen’s family is rich, über rich. Nor will they be surprised most of the family’s wealth was created during the last ten years after Wen became premier. The surprise is that this information was made public and just two weeks before the November 8th transition of power in Beijing and right before the expected sentencing of one Bo Xilai, archenemy of Mr. Wen. Are the supporters of the Bo faction gaining the upper hand? Does it mean Hank Paulson’s buddy, Wang Qishan is ascendant? Does the timing of this further weaken the Hu faction? My view: Hu cares?

I like drinking tea but reading the leaves bores me. When dealing with an organization as insecure and opaque as China’s Communist Party what this latest kerfuffle leads to is anyone’s guess. The continual upsets in the carefully planned puppet show in Beijing clearly indicate a smooth transition of power, this ain’t. This also somewhat puts at risk my view that the new leadership will be able to prime the pump without a struggle and get the equity market off its death bed, now languishing at a psychologically important level of 2,000. After the soon to be über rich next generation gathers the reins of power, will they have enough consensus of opinion to pursue such policies?

Jiang Zemin and Hu Jintao were weak rulers of strong factions. They were weak because of their lack of “revolutionary” credentials, unlike Mao and Deng who had that in spades. The new Xi Jinping and Li Keqiang are, due to their tender years, even further removed from the glorious revolution and are likely to be weaker still. Factionalism in the halls of power in Zhongnanhai is nothing new; it just seems to be gaining strength. My view: We should expect more public divisions of opinion to come but the market is ready to rally.

Finally, what do ordinary Chinese think? That’s a hard one to answer because ordinary Chinese are not encouraged to voice their ordinary opinions. Sina’s Weibo is the go-to source for journalists in need of quick verification of the “public view.” Predictably, references to Premier Wen and the NYT were blocked on this service, as was internet access to the NYT website inside China. In the absence of facts, rumors and non-facts proliferate and this latest scandal just adds another layer of heavy cynicism found among Chinese.

Earlier this month, Pew Research published results from surveying 3,177 adults across China, in a document titled, “Growing Concerns in China about Inequality, Corruption,” (here). This is perhaps more relevant than the odd Weibo post that squeaks passed the thought police. According to Pew, a full 50% of those surveyed in China believe corrupt officials are a major problem, up from 39% four years ago. Does the average Wang on the street believe there is a level playing field in China? No. Eight-in-ten agree with the view that in China the “rich just get richer while the poor get poorer.” But from that do we conclude the average Wang wants to roll back reform and re-embrace Mao’s “Little Red Book”? No way José, 70% say they are better off financially than they were five years ago and three quarters of Chinese agree most people are better off in a free market economy.

One shouldn’t hate the rich as they have their problems too. The recently released Hurun Luxury Consumer Price Index (here) makes an interesting read. Measured from June to June, the “Luxury CPI” is compiled of a basket of 62 luxury goods and services popular with China’s nouveau riche. Year on year it has risen almost 5% and is 2.74% higher than the national Consumer Price Index. The luxury segment has witnessed price rises outstripping that of the more pedestrian CPI by 38% over the last six years.

This year, all categories were up except for luxury property, which experienced a 2.42% decline. Luxury travel prices increased the most, up almost 12% year on year. This is reflected in the price of first class return airfare from Beijing to Paris, which now costs your garden-variety comrade and his mistress RMB 250,000, up 12%. If she likes Chanel, that’s more bad news as the classic Chanel bag has doubled in price over the last five years to RMB 37,800. While the rest of the country worries about what fruits and vegetables cost in the wet market, save some pity for China’s billionaires who are also feeling the pinch.

Ruminations

Late last week, Laos finally saw its application to join the WTO formally approved after a 25 year wait. Accession to the WTO is big news for developing countries as it “puts them on the radar.” China won this distinction only in 2001 and Vietnam in 2007. While we are talking about a much smaller country, poor, land-locked and with a population of just 6.5 mn, Laos does have a stock exchange.

The Laos Securities Exchange, based in the capital city of Vientiane, only came into existence last year through financial support from Korea Exchange, which holds a 49% stake. The stock market boasts two listed companies and trades only half days. The two listed companies include the state-owned power utility and the largest bank in Laos.

The tiny country’s only internationally recognized brand is probably “Beerlao,” a favorite among cost-conscious backpackers. Further evidence Laotians know how to have a good time is obvious with a visit to the stock exchange website. Not only do we learn,

“Think, speak out, and perform efficiently and harmoniously then the greatest achievement”

but we can also download riotous stock market songs, all in Lao. (We love emerging markets). The good times continue because, although US markets were closed for two days this week because of a Hurricane Sandy, the Laos Securities Exchange has taken half the week off for a “Boat Racing Festival.” This is surely good news for the brewers of Beerlao and I eagerly await its listing.

EDL, the listed state-owned power utility has 100% Buy recommendations due to the efforts of the single analyst who covers the stock, one “Jakapong Chawengsri.” You are really taking a flyer, however, if you punt on the other listed stock, BCEL Bank, which has zero research coverage. What I like about this market, aside from the blue sky potential, is total market capitalization is 7.1 bn kip (Laotian currency), or around US$900,000. Daily turnover sometimes is LESS than US$1,000, which means that even my PA can move this market. Laos is definitely worth taking a punt, having a Beerlao and enjoying a kip.

On the Book Shelf:

The Last Page

An unemployed man applies for a job with Microsoft as a cleaner. The manager there arranges for an aptitude test. After the test, the manager says: “You will be appointed on the scale of $30 per day. Let me have your e-mail address, so that I can send you a form to complete and advise you where to report for work on your first day.”

Taken aback, the unemployed man protests that he is neither in possession of a computer nor of an e-mail address. To this the manager replies: “Well then, that really means that you virtually don’t exist and can therefore hardly expect to be employed.”

Stunned, the man leaves the Microsoft office. Not knowing where to turn and only having about $10 left, he decides to buy a 10kg box of tomatoes at the supermarket. Within less than 2 hours, he sells the tomatoes singly to office workers in the city for their lunch, at 100% profit. Repeating the process several times more that day, he ends up with almost $100 before going to sleep that night. That is 3 times what he was offered as a cleaner, so it dawns on the man that he could quite easily make a living selling tomatoes.

Getting up early and earlier every day and going to bed late and later, he multiplies his hoard of profits in quite a short time. Not too long thereafter, he acquires a cart to transport several dozen boxes of tomatoes, only to have to trade it in again shortly afterwards for a pick-up truck. By the end of the first year, he is the owner of a fleet of pick-up trucks and manages a staff of several hundred former unemployed people, all selling vegetables.

Considering the future of his wife and children, he decides to buy some life insurance. Calling an insurance adviser, he picks an insurance plan to fit his new circumstances. At the end of the telephone conversation, the adviser asks him for his e-mail address in order that he might forward the documentation.

When the man replies that he has no e-mail, the adviser is stunned: “What, you don’t even have e-mail? How on earth have you managed to amass such wealth without the Internet, e-mail and e-commerce? Just imagine where you would have been by now, if you had been connected from the very start!” After a moment’s silence, the tomato millionaire replied: “Sure! I would have been a cleaner at Microsoft!”

Derek Hillen, CAIA

Mirae Asset Securities

 

 

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