A quick look at four Chinese stocks in the portfolio.
PICC – PICC is one of China’s big three property and casualty insurers. It has a dominate position in auto insurance and is well-placed to expand into other lines such as home and contents. The company is currently growing at mid-teen rates and there is scope for this growth to continue for many years to come. Growth will be driven by increased car ownership (China has 6 cars per 100 people versus 60 for Korea) and greater acceptance of non-auto lines in China (home and contents insurance accounts for 5% of premiums in China versus 25% in the West).
In addition to the market growth, PICC will benefit from a number of internal improvements which will support future profitability. A new chairman appointed in 2009 is a 20 year insurance veteran (rather than a political appointment) and has clearly emphasised profitability rather than chasing market share. Also the company has recently upgraded its IT systems which allows it to centrally underwrite and price policies, as well as grow the number of policies they sell direct (via phone or internet rather than an agent).
At the time of our buying, PICC traded on 10x P/E, making a 24% return on equity (ROE) and paying a 5% dividend. At this valuation PICC is one of the more compelling investments we can find in global financials and is now the largest holding within the Platinum Unhedged Fund (30 September 2014).
Kweichow Moutai - Moutai make Baijiu, a Chinese white spirit made predominately from sorghum. Moutai is the premium national brand in the space, with a retail price approaching US$160 a bottle. It enjoys a fabled history that includes everything from being Mao’s choice of liquor to serve to heads of state, to having a formulation so pure that it won’t leave you with a hangover!
Given Moutai’s prestige, consuming it was a must when negotiating business deals or trying to win the favour of local bureaucrats. Hence the conclusion, in theory, that demand for Moutai would plummet under the current corruption crackdown in China. While the retail price of a bottle of Moutai has fallen from $300 at the peak in 2012 to $160 today, the wholesale price at which Moutai sells to its distributors has actually risen from $110 to $130 (i.e. it was the distributors that were making out like bandits during the peak, not Moutai). In addition, while the government channel is certainly consuming less, the middle class is responding to the lower retail price and are actually consuming more! The net result is the company has continued to grow sales and earnings throughout the crackdown period.
Given Moutai’s heritage, its place as a luxury item in the minds of Chinese consumers should be enduring and it has plenty of scope to grow with the Chinese economy. Moutai has a market cap of $30 billion, with net profits of $2.7 billion and a full $5 billion of net cash on the balance sheet. At this valuation (11x P/E) Moutai trades at roughly half the price of global peers, and we continue to add to our position, with the Fund having just under 3% invested in the Chinese Baijiu makers.
China Mobile – At the time of purchase China Mobile was one of the world’s cheapest mobile telecommunications stocks, trading at an enterprise value to cash flow multiple of 4x. The company was relatively disadvantaged compared to its competitors during the shift from 2G to 3G. A drawback was the regulator wishing to support the competitors in order to foster competition. The second obstacle was that China Mobile was forced to support the Chinese developed ‘Time Division (TD)’ network standard, rather than the more globally-accepted ‘Frequency Division (FD)’ standard. At that time, China Mobile’s 3G TD network was inferior and only supported a limited number of handsets. This resulted in China mobile losing its premium customers to the competitors who were operating FD networks. With the current shift to 4G the tables have been turned. It is now China Mobile who has the fastest, gold plated network and early subscriber trends show that the premium customers are returning.
Weichai Power – Weichai is China’s dominate producer of heavy duty diesel (HDD) truck engines. In the context of autos, the design and production of HDD engines is a good business as the purchase consideration includes reliability and running costs rather than just price. In the short-term, the company does have some cyclical exposure. In the longer term, however, Weichai will benefit both from underlying market growth and customers upgrading to more technically advanced engines. With Weichai trading on sub 9x mid-cycle earnings, the stock is simply too cheap.
DISCLAIMER: The above information is commentary only (i.e. our general thoughts). It is not intended to be, nor should it be construed as, investment advice. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information. Before making any investment decision you need to consider (with your financial adviser) your particular investment needs, objectives and circumstances.