China, India attractive markets in Year of the Sheep
"While 2015 is the Year of the Sheep for the Chinese community, investors need to resist adopting a herd-like instinct," says Josh Crabb, head of Asian equities at Old Mutual Global Investors at a press briefing on the investment outlook for global and China markets. "Chinese equities remain attractive despite the recent moves, but India still holds appeal if you know where to look."
"If our experience in Asia has taught us anything, it is not to blindly follow the herd. Chinese equities still look attractive on a 'top down' valuation basis, especially the H share market, trading on just 7.3x forward prospective price/earnings for forward 12 months earnings growth of 12.8% and we see many possibilities there. However, even in markets that are expensive, such as India, opportunities still exist for investors who are prepared to steer away from the well-trodden path. The key thing is to remain flexible."
Crabb notes that China's relative cheapness to other Asian markets reflects investor fears that while the country attempts to rebalance away from growth in fixed asset investment (FAI) to consumption-led growth, the overall rate of GDP growth remains vulnerable. However, he adds that infrastructure investment niches, as highlighted by the government's pledge to modernize its New Silk Road rail network, also create niche investment themes. The network, linking East and West China, will benefit select companies in the capital goods sector. Years of R&D spend is also culminating in increases in intellectual property rights filings (one third of the 2.6 million patents applied for were from China in 2013). This, together with the manufacture of more advanced products and more flexible export financing, is creating globally competitive companies at reasonable valuations.
"Nevertheless, the move towards 'made in China' consumption will be vital if the world's second largest economy is to sustain growth in GDP of 7% or more per annum. Chinese brands are on the up, with the price bracket of home-grown brands tending to be much more palatable to the country's growing middle class."
Crabb took local Chinese brand Anta Sports as an example, selling its sports shoes at around US$20 a pair, compared with the upmarket Nike models selling at US$170 or higher.
"Looking at India, careful stock selection is critical in maximizing returns," he comments. "Certain shares, particularly in the consumer goods sector, cannot compensate investors sufficiently for the risks of holding them. Several of the well-owned consumer names such as ITC and Hindustan Unilever, for example, have very stretched multiples. However, if investors move away from the herd, there are still interesting opportunities in the India market. Many of the middle sized companies in India have been hampered by a lack of political connections and access to infrastructure, headwinds which will decline under Premier Modi's leadership. These companies also account for most of those establishing businesses in the 'new economy' and the associated growth".
Crabb highlighted India's infrastructure sector, a sector that has been subjected to decades of underinvestment, and continues to be largely overlooked by investors. As a result, several of the stocks trade below book value. "With inflation on a declining trend, those companies with large fixed asset bases, such as power generation companies and steel companies, could also be attractive," he said. "Foreign firms are more open to investing in India's capital goods sector. Delhi-based Amtek Auto secured a long-term loan of 235 million euros (US$272 million) at the end of 2014 from Kohlberg Kravis Roberts. If Modi realizes his election promises to accelerate economic reform, further interest in this sector should increase."
Looking ahead, Crabb believes that the Chinese market looks attractive as an investment from an absolute and relative perspective, with fears of a slowdown in growth more than discounted in share prices. Recent tailwinds such as the fall in commodity prices and the cut in interest rates should propel the market higher over the medium term. Moreover, the introduction of the Shanghai-Hong Kong Stock Connect further provides an opportunity as it enables foreign investors to access over 500 mainland Chinese companies with a total value of over US$2 trillion. On the other hand, although Indian equities appear expensive in the short-term, opportunities still exist once the country has delivered on earnings growth.