There seems to be a lot of debate right now about the P/E gap between growth and value stocks. The fact of the matter is most value stocks have very little growth and now most growth stocks offer very little value.
In my view, we are at the point of the cycle where you want to avoid “value traps” but you also want to avoid massively overpaying for near-term growth. In Australia and globally, there is the clear ability to do both right now and it requires discipline to avoid making investment mistakes.
Growth at a reasonable price (GARP)
I don’t really believe in growth or value investing as such. I believe in buying structurally growing businesses at fair prices. I’m more of a GARP investor, or Growth At a Reasonable Price. Not a GAAP investor: Growth At Any Price, which could describe the pricing of many disruptive tech equities at the moment. Netflix (NFLX), the “N” of the FANG’s, for example, is up +110% this year alone and now has a market cap of US$176 billion and 2018 P/E of 121 times (see Roger Montgomery’s note today).
I also like being contrarian but not contrarian for contrarianism sake: that can be a very expensive mistake.
In my view, the place where growth and value come together remains China. It’s a bit lonely being bullish on China right now but being a lonely bull is ok, if your conviction on the fundamentals is unchanged. Short-term sentiment can swing on a dial in markets that seem to change on the next Twitter headline from the US President.
Yes, we have “trade wars” and a currently strong US dollar hurting sentiment towards Chinese companies but to me both of those negative influences will remain transitory.
The Shanghai Composite Index closed at a two-year low this week, while the Hong Kong based HSCEI Index has retraced 18% from mid-January highs.
However, the pattern of underlying White House policy initiatives is clear. We see a bold, usually negative headline, followed by a walking back and softening of rhetoric. It seems clear that Trump’s new “$200 billion” of extra tariffs, which equates to only $20 billion more at the 10% traffic rate, was a direct response to the senate over-turning his pardon of Chinese telecom equipment maker ZTE. It’s all noise and giving you a chance to buy both Chinese equities and the Australian dollar at oversold levels.
And just to be clear, that Australian dollar weakness has clearly been driving the S&P/ASX200 up. If I am right and the AUD/USD bottoms around here (US73.50 cents), then I’d expect the S&P/ASX200 rally to run out of puff as it’s simply not driven by earnings growth. Telstra’s profit warning yesterday reminds you of fundamentals versus currency weakness driven buying of growthless yield stocks.
The chart below inverts the AUD to USD/AUD then overlays ASX200 SPI Futures. This shows you the very clear correlation between a weak Australian dollar and a strong S&P/ASX 200 and vice versa. I say again, if the Aussie dollar bottoms here, the S&P/ASX 200 will retreat. I remain tactically bearish on Australian equities (S&P/ASX 200) above 6000.
S&P/ASX200 vs USD/AUD is just a currency game, not a fundamentals game. Be careful.
The bigger picture
To me, it’s very, very important not to lose sight of the bigger picture in moments of short-term negativity. In fact, these are the times you actually have the ability to find undervaluation and the ability to generate strong returns in the future.
Today I thought I’d run through some big picture medium-term China facing themes I believe in, by using some text and slides from my current investor presentation.
I believe you buy companies that can deliver compound earnings growth over multiple decades. I call them structural growth stocks. The biggest driver of structural growth stocks is the size of their addressable market. And the biggest addressable market I can find is Asia: but particularly Asia’s rising middle class. This is where technology and population growth collide.
With 60% of the world’s population and over 1 billion millennials, China’s rising middle class is already the same size as the entire population of the USA. By 2026, we forecast that the Chinese middle class will be over 500 million people. There is empowerment by mobile data and generic/cheap smartphones. Asia is rolling out 4G and 5G networks. Australia is rolling out an NBN. Asia is all about mobile data: they skipped the desktop era and are leading the world in e-payments and e-commerce through Tenpay and Alipay. In Asia, your smartphone is your wallet, your sole form of communication and effectively your shopping mall. Of WeChat’s 1 billion daily users, 55% open the app more than 10 times a day. The average user spends 220 minutes a day on WeChat. It’s fair to say that Tencent controls China’s eyeballs.
I have always believed the rise of the Asian middle class is the biggest event of our investing lifetime. Back in the broking days I was an outspoken bull on Australian resource stocks, forecasting a super-cycle in commodity prices that continues to this day. I was also the first broker to back Fortescue Metals Group on the basis that we were seeing a steep change up in iron ore demand but no supply response from the incumbent producers. That was the first leg of Asian growth, fixed asset investment in metals-intense infrastructure projects. The next leg of Asian growth is consumer spending, as incomes rise and behaviour westernises.
New consumer demand
It is a new source of consumer demand that will reprice a wide spectrum of products and services. What started in iron ore and coal a decade ago, will eventually affect everything as 4.5 billion people seek and achieve a higher quality of life. This is already happening before our eyes as we watch categories such as baby milk powder, vitamins, fine wine, medical devices and Hermes handbags being repriced by this new demand factor. In Australia, we have seen huge revenue growth and associated share price gains from companies like A2 Milk, Bellamy’s, Blackmores, Treasury Wine Estates, Costa Group and Cochlear, to name a few. Just a small proportion of the Asian population has discovered Australian milk powder, vitamins, wine and hearing aids but look at the effect it’s had. My view is that this will now spread to a variety of different consumer-facing sectors listed here, many of which would be currently considered “commoditised products”, just as iron ore was 15 years ago.
Mobile telecommunications and data is clearly seeing structural demand uplift. There’s no turning back now and I am of the view that over the next decade industry leader Tencent will become the most valuable company in the world by market cap, as they monetise Asian eyeballs. I also believe that an increasingly cashless Asian society will drive strong demand for e-commerce offerings. It’s worth remembering the two biggest retails in China, Alibaba and JD.COM, don’t have physical stores. Compare this to the USA, where Walmart still generates three times the annual retail sales of the fast-growing Amazon. I believe Alibaba will be more valuable than Amazon over the medium term, due to its addressable market advantage.
That e-commerce growth then drives demand for offshore goods and produce. This may sound somewhat crazy, but I believe what we have seen in milk powder through to premium wine is coming to ALL AGRICULTURAL PRODUCTS. I believe a premium price is coming for agricultural products from “clean and green” provenance. This is good news for Australia. My view is over the next decade the price of beef, lamb, pork, fish, grain, fruit and vegetables will rise sharply as rising Asian incomes and associated dietary changes drive a step change in demand. Yes, my millennial friends, the price of smashed avocado will become prohibitive!!
The sector I am most bullish about is tourism. I believe the rise of the Chinese tourist, in particular, will be a multi-decade event. China’s travel industry grew at a compound average growth rate of 21.5% from 2009 to 2016. This is structural growth. We are seeing supportive government policies, such as reducing visa restrictions, as well as rising disposable income, an expanding middle class, improved infrastructure – such as China’s 22,000km high speed rail network, where the Shanghai- Beijing line now carries 160 million people per annum – and a growing number of airports and airlines. Again, where technology meets population, we are seeing an increase in internet and mobile internet services that are facilitating travel bookings.
The best thing about investing globally is you can go straight to the most direct exposure you can get to the given structural growth theme. In this case, not Star Casino or Sydney Airport, which are highly diluted ways of playing Chinese tourism, but the monopoly airline booking system in China called Travelsky (696 HK).
Travelsky is a global distribution system (GDS) booking system, which connects airlines, airports, travel agents and passengers. Think of it like a toll road for airports that clips the ticket for every airline passenger in China. Unlike Australia, where Sydney is getting a second airport after 50 years, and Melbourne is getting a train line to the airport, China is building civil airports at pace. China currently has 229 civil airports and another 47 are being built by 2020. By 2035, there will be over 400. A classic example of the “law of big numbers” and big addressable markets.
All things being equal, Travelsky should prove a compound growth stock to this structural growth theme. We forecast Travelsky to grow earnings at 15%ps for the foreseeable future, yet we can still buy this HK listed mid-cap stock at what we believe are cheap multiples of around 19 times, remembering that unlike Australian transportation infrastructure stocks, Travelsky has 20% of its market cap in cash.
So, in summary, I think the future lies directly to our North. I believe in an Asian future and I believe the rise of the Asian consumer is the best structural growth theme you can invest in over the next 20 years.
You have a choice. Tencent or Telstra? Ping An or AMP? Alibaba or Woolworths? Travelsky or Transurban? Don’t stand in the way of 4.5 billion people moving in one direction. Join them.
It’s time to buy China and the Australian dollar, while it’s on sale.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.