A top-down perspective on profitability in Asia ex Japan

EPIC Oriental Focus Fund
July 2023

A top-down perspective on profitability in Asia ex Japan

The second quarter earnings season is looming and we intend to publish a full portfolio profitability analysis towards the end of August which will incorporate H123 results. However, in advance we have undertaken an analysis of profitability across the region which we intend to use to test and challenge many of the traditional (and long standing) preconceptions. The MSCI data used in this analysis was sourced from Bloomberg on 12 July 2023.

It is no surprise to us that IT (innovation) and consumer staples (brands) score well. We suspect that energy and utilities respectively overstate and understate the underlying longer-term ROE due to recent events in Ukraine. The real estate sector is dominated by China and Hong Kong so, again, no surprise. Healthcare has a notably low ROE despite a significant uplift in per capita GDP across the region in recent decades, coupled with an aging population, supportive of increased health care requirements and consumption. Profitability is elusive.

Taiwan and India outperforming (and ahead of Developed Markets) and South Korea underperforming is consistent with our expectations. It is interesting to note that China’s ROE is broadly double that of Hong Kong, but we acknowledge that it has been a difficult environment period for the former territory in recent years. While the plaudits clearly go to Indonesia, it is notably that ROE is so consistent across the rest of ASEAN.

Taiwan has been dear to our hearts for some years now and, at nearly 30% of the portfolio, is the second largest country allocation after China / Hong Kong. Illustrating and understanding the historic ROE trend over time is incredibly useful whether one is considering a stock, sector or market. We are, however, confused by the 2023 forecast which is likely to be way off the mark given the broad decline we have observed in H123 revenues. For example, TSMC saw sales in the period decline by 3.5% year-on-year while eMemory’s sales in the period declined 10.5% year-on-year. A more-probable reduction in 2023 ROE is supported by chart below.

The Information Technology sector accounts for 71.5% of MSCI Taiwan! The forecast decline in ROE in 2023 and a decent recovery in 2024 led by the widely anticipated cyclical recovery in the semiconductor industry makes much more sense. A good example of “garbage in, garbage out” and a useful reminder to always apply common sense checking when using datasets for analysis.

Finally, a look at operating profit margins. In a nutshell, we believe this chart gives a fairly useful indication of the competitive conditions in the various domestic economies. The Chinese domestic economy is notoriously competitive, as is that of India. Taiwan and South Korea’s low operating margins must also reflect the export-orientated nature of their economies. ASEAN’s domestic economies are, arguably, rather less competitive with specific sectors controlled by a smaller number of players but, again, that is somewhat subjective and open to debate. We are unclear why Thailand stands out like a sore thumb but, at a stock level, this broader point makes sense.

Portfolio holding Yadea Holdings is China’s leading manufacturer and distributor of electric motor bikes and scooters.  Recently announced plans to expand into markets such as Indonesia and Vietnam over the next few years have, in our view, been behind the decent performance of the stock. Why? Analysts expect (correctly we hope!) that operating margins in these new markets will be eye-wateringly high.

With the caveat that dataset-based analysis is not always correct or easy to comprehend, there is one preconception which remains unchallenged. The profitability of listed Korean companies appears to be below par. We retain a significant position in Samsung Electronics but note that it is difficult to find many other compelling investments in the country when profitability is at the heart of our stock selection process.

Our latest internal weekly update (10 July 2023) shows the Fund’s portfolio to have a negative net debt to equity ratio (-6.5%) and a Return on Equity of 19.7%. We will find out how the latter number moves subsequent to the second quarter results!

Henry Thornton
Fund Manager, EPIC Oriental Focus Fund