Thu, 8 Nov 2012
As investment in fixed assets declines, consumption will drive GDP growth in China, and consumer cyclicals offer high yields and good valuations, says Matthews Asia's Jesper Madsen.
Jeremy Glaser: For Morningstar, I am Jeremy Glaser. I am speaking today with Jesper Madsen. He is the lead portfolio manager of the Matthews Asia Dividend fund and also the Matthews China Dividend fund.
Jesper, thanks so much for talking with me today.
Jesper Madsen: Well, thank you for having me.
Glaser: Let's start off with talking a little bit about the economy. There has been a lot of talk about a slowdown or potential slowdown in Chinese growth. What are you seeing, or what you're hearing from some of the companies that you follow?
Madsen: It is correct that there is a lot of concern in the marketplace generally about China, and as a result, you can also look at the valuations and see that is very much reflected in I would say a quite cheap valuations for the Chinese equity markets in general. As for the slowdown, this is not a potential slowdown; there is a slowdown in the economy in China, and it's fairly broad-based. However, it is still in the economy that is in spite of this slowdown still growing in excess of 7% a year by the public numbers given. So, again it is something that we're seeing both from a top-down, but also from a bottom-up perspective.
We have seen some impact to more industrial-based companies in China and also those that sell into China in terms of the coal raw materials. China is a large consumer, one of the largest, if not the largest, depending on what category you're looking within base metals and other raw materials. We have seen some impact there as well and that reverberates all the way down to places like Indonesia and Australia for instance. But all that said, we also have to keep in mind that there is very little correlation if none between GDP growth and equity market performance. I know a lot of people, a lot of investors, like to latch on to a headline number like GDP. But what's more important is to understand the composition of GDP growth and also how the company is actually generating earnings and free cash flow behind those numbers, as well.
So, if you look at the composition--and that's what I think is important to not miss sight of in China--much of this slowdown has been engineered. If policymakers in China wanted faster growth, they could have had it, but they've been very targeted in terms of restricting investments in certain parts of the economy, especially real estate. And as a result, they have been very heavy-handed with the banks and the real estate companies trying to shut down some of the flow into that sector. And that is a very important sector in terms of GDP contribution. So, if you look at it, in 2011 about a quarter of the GDP contribution actually came one way another from fixed-asset investments into the real estate sector. So, again it is very much a slowdown that's been engineered and that also means that there is some room for loosening. That's also important to understand that there is room for both fiscal and monetary loosening in a place like China.
Glaser: So, you're focused on those dividend-paying stocks. Do they tend to be in sectors that the government is still favoring that are still expanding, or are they kind of stuck in some of that fixed investment that is slowing down somewhat?
Madsen: So, for the China Dividend Strategy that that we manage here at Matthews, we focus I would say quite broadly across the universe, because when you invest one is you invest with what you have in front of you and then also you invest for what you believe the future will look like. And the fact is there are still plenty of investments needed in a place like China. There is a massive catch-up that still needs to take place. That's not to say that there hasn't been perhaps missed investments throughout and so on, but if you look forward, there is still very much business to be had for companies within the industrials sector, for instance. This is generally for Asia and the global equities market, as well.
Right now, investors are running scared from most things that look like they're tied to the cyclicality of the economy. And obviously when people look at headline numbers of GDP growth coming off in China, they equate that with these companies being unattractive, anything that is related to the economic cycle.
Now, I will go in the direction and instead focus especially on the leaders, those companies that can generate very high returns throughout the economic cycle and that can pay a growing dividend throughout the cycle. So, that's actually also where we've been focusing. We have our foot in both camps, both with the consumer staples and the discretionaries--the consumer-focused companies--in China but are also looking with more I would say keen interest to more of a cyclical part of the economy there because of the valuations that are being offered at these times.
Glaser: When you look at the consumer names in particular, do you find that Chinese firms have a leg-up there in the consumer market, or are you also looking at multinationals that might sell into China?
Madsen: We currently are not invested in any of the multinationals, except for if they are originating in Asia. So, for instance you could be with a Japanese multinational instance that's selling into China. So, we actually do both. We look for well-managed companies and we are a little bit less I would say concerned about the ZIP code or the postal code. So, if it happens to be a company that's residing in Tokyo, but if most or at least most of the growth of the business is coming out of place like China, then those are also interesting companies.
For instance, we have a baby-care product manufacturer in the portfolio. It's seeing most of its growth coming out of China again because it's perceived to be of higher quality than the locally manufactured baby-care products. And if you only have one baby and you have now the financial means to pay up for higher quality, especially when it comes to product safety, then you will do so, and that's what we've seen in the results of this company. We also obviously invest more directly straight into the equity markets in China. Now, I should say that does not include the Asia market where we do not currently invest in. But we access it through Hong Kong, we access through ADRs, and that's our main path into the Chinese companies.
Glaser: So, looking on it a bit more broadly, which countries in Asia do you really see the best opportunities right now and do you see the cheapest stocks?
Madsen: I think we are talking about one country right now--China--that does offer a lot of potential, and I know there are a lot of worries--we have a leadership change there--but these tend to be quite orchestrated, well-managed. So, there will be a lot of continuation in policy. And also, if anything, I believe that the economy there is going to have to be shifted increasingly and then that's what the policymakers are also focused on, toward the domestic consumption. There is plenty of domestic consumption being had and already happening in China, it is just such that right now, it's being depressed in the overall scheme of things because of the higher fixed-asset investments that have taken place. But as fixed-asset investments might come off as a proportion of GDP growth, we should see GDP growth being more driven by consumption. So, companies that can cater to that future I think will be well-placed.
Elsewhere in the region, I would say [we're seeing opportunities] with consumer staples to consumer discretionary and so, companies that are catering to the rise in household wealth that we've seen across the region, not just in China. And I should say that those companies have been bid up, especially within the staples segment, and as a result we're actually looking more at the cyclical elements. So, again quality cyclicals, or what they would call leaders within their various segments, but they are more exposed to the economic cycle. And as a result, they have been also sold down quite severely and look very cheap compared with I would say the more accepted staples within the equities space. As a result, you can get them at higher yields and at valuations on a price/book ratio basis that you can't normally find these kinds of companies at. So, that's why when we look at it from a valuation/growth potential, I would say the more cyclical parts of the equities space are looking more interesting.
Glaser: Jesper, I really appreciate you sharing your thoughts with me today.
Madsen: Thank you.
Glaser: For Morningstar, I am Jeremy Glaser.