What’s piquing our interest? #2
In our last instalment, Peter Sackmann, CFA, analyst and portfolio review committee member at Davis Advisors (Davis), provided some thoughts and insights about the US, providing the Davis view of markets, sectors and companies. In this second instalment, we cover the Davis view of Europe and Asia.
“There are 50 markets in the global economy – we aim to find the top 10, 12 or 20 in terms of liquidity, transparency of financial information, and professionalism of management and also at the margin, countries that support, encourage and celebrate entrepreneurs and capitalist success.” Peter Sackmann
According to Peter, the Davis team are currently ‘Eurosceptics’ and have sold off a number of European multinationals over the past eight months, mainly on the basis of valuation and slow growth.
Davis sees Europe as being challenged in a number of ways:
- Anaemic growth – this reflects soft underlying employment numbers; while Europe’s overall unemployment rate has come down since the GFC, in the periphery and especially among younger workers, unemployment is still stubbornly high, creating a headwind to economic progress.
- The negative interest rate experiment – with $14 trillion of bonds globally trading at negative interest rates, they cease to have the features and benefits of real bonds. How will investors respond? It’s unchartered territory and just who will unwind the trades at the end of the experiment?
- Inflation – the whipsaw effect that inflation would cause, as well as the capital flight out of bonds that rising yields (and declining bond values) would cause.
- Company valuations are showing paltry growth rates, and a lot of the margins for European multi-nationals are a little too full. Slow growth can work against a company – a 1% decline in growth can result in a much larger decline in operating earnings.
Despite being Eurosceptics, Peter acknowledged there are some strong businesses in Europe and, as always, Davis keeps an eye on those it considers solid long-term opportunities that it would consider at a different price when the risk/reward trade-off is more favourable.
The Davis team travels extensively to visit companies and get a first-hand feel for economies. Danton Goei, portfolio manager of the Pan-Tribal Global Equity Fund, recently returned from China and found there had been a lot of evolution in the market over a short time scale, that innovation and entrepreneurship were encouraged and supported.
Davis retains a strong focus on the Chinese consumer, a segment that continues to grow. A consumer-facing company that Davis likes is Vipshop Holdings. It is a business model that has no comparable models in other parts of the world, a trend becoming more prevalent in China.
Vipshop is a shop clearance for the big brand shops. It takes high brand merchandise at the end of the season and holds three-day flash sales during which goods are sold at a 70% discount. The warehouse is full on day one and empty by end day three.
Customers like it because it’s like a treasure hunt, new stock keeps arriving. The merchants involved like it because they need to clear their shelves for the next season’s merchandise and they need the cash to do this; therefore they are willing to sell unsold inventory at cost to fund the purchase of the new season’s inventory. Whatever is left unsold goes back to the merchant, Vipshop does not carry the risk.
Another thematic gaining traction in China is for-profit education companies that provide after school tuition. China has a cottage industry of tutors – if a family has the means, their children attend after-school supplemental education programs. In large part, these are run by teachers who would privately tutor the students.
Both TAL Education Group and New Oriental Education have about 2% combined market share; they each run a professional operation, with a good business model. These businesses have professionalised the sector and removed conflicts of interest associated with teachers providing tutoring out of hours. The share price for both stocks has performed strongly since they were introduced into the portfolio.
Japan and Korea
Davis has recently revisited both Japan and Korea, but finds no compelling rationale for investing in these markets. By and large, it is a matter of opportunity cost rather than opinion on company fundamentals. Davis found inertia and institutionalised hidden agendas in companies in these markets, and in some, a tendency to treat minority shareholders unfairly. There are also a lot of cross holdings between large companies, which reduces transparency of financial information.
With 2015-16 GDP growth of 7.6%, and a population exceeding 1.3 billion, India is outpacing most other economies at the moment. One business Davis is watching closely is Interglobe Aviation which owns IndiGo Airlines, a low-cost no-frills airline that is the largest airline in India in terms of passengers carried, with a 39.8% market share as of July 2016.
IndiGo owns one-third of planes in India, all Airbus 320 narrow bodies. By focusing on one model of plane, managing parts and maintenance is very streamlined – the company doesn’t have to hold lots of different inventory, it runs a lean and efficient operation.
IndiGo has locked up significant capacity on the Airbus production line – it takes years of production time to get delivery of an aircraft, and IndiGo’s orders are at the front of the queue. While other businesses are trying to get into the Indian market, it will be years before they have the craft to do so. This is quite a competitive moat for 3-5 years.
Note: stocks in bold are those held by the Pan-Tribal Global Equity Fund at 31 October 2016
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