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August 2021

The crackdown against internet companies in China carried on in August with the State Administration for Market Regulations issuing a consultation paper proposing stringent rules to regulate internet platforms and prohibit unfair competition. The proposed measures go far beyond anything seen anywhere in the world. The 7-page document includes a ban on misleading advertising, on fake reviews, on the use of card coupons and red envelopes (equivalent to cash discounts that can be used at a later date), on the use of algorithms to deviate traffic from one platform to another, on the use of frequent and intrusive pop-up screens, on failing to provide uninstall buttons, on preventing certain viewers from participating in promotions, and on using transactions history, browsing patterns and individual preferences to influence consumers by adjusting prices. These are measures that would give goosebumps to Facebook, Google, Amazon and all other western internet giants if they were to be enacted in the US and in Europe, even though they make plenty of sense to us. As expected, Chinese investors hated it: Alibaba corrected by 12.4% in August. It is now down 46.2% since its peak reached on 28th October last year. We find this correction unfounded even though we admit that short term growth will likely be penalised. On a longer-term basis, having a fair playing field among competitors abiding by the same rules is probably a more sustainable proposition than a lawless internet where anything and everything is permitted.

Another crackdown seems to be brewing, this time on Variable Interest Entities (VIE), i.e. these legal structures that have allowed internet companies (and education companies) to circumvent Chinese laws since the year 2000 when Sina.com invented the concept. In these days of crackdowns against all shady practices, we believe it is prudent to stay away from all VIE structures.

The other unfettered crackdown is on escalating property prices and on the extended use of leverage by certain property developers. The results announced by listed property developers for the first half of the year have shown the impact forced deleveraging has had: the gross profit margin of developers has been cut by approximately 3 percentage points over the past year, from an average across the sector of 26.7% to 23.6%. The latest measure taken in August is about land auction: A piece of land can no longer be sold by a local municipality at a premium higher than 15% over the starting bidding price.

This forced deleveraging is impacting the entire economy as loan growth is slowing down sharply: Loans extended by the banking sector in July were 18% lower than it was same time last year while M2 growth dropped from +8.6% YoY in June to +8.3% YoY in July. Most recent PMI numbers also painted a gloomy picture, the official manufacturing PMI being down from 50.4 in July to 50.1 in August, and the Caixin manufacturing PMI that focuses more on the private sector having dropped from 50.3 to 49.2, moving into contraction territory.

We want to highlight that the severity of the slowdown of the Chinese economy that we had been expecting for quite some time and that is finally happening is entirely man-made. It is by and large the result of decisions made by the Central government and by the top of its leadership, i.e. the State Council, as opposed to being the result of exogenous circumstances imposed on the country.

The best illustration of this fact remains the zero-Covid policy that is still strictly enforced by China (and by Hong Kong, to our own regret) when the rest of the world, including former hardliners such as Singapore and Australia, has woken up to the reality that vaccination is the only way to resist the Delta variant and that any zero-Covid policy is doomed to fail. China is now running the risk of completely isolating itself from the rest of the world, with the economic impact one should expect from a policy based on fear, on hard lockdowns of entire cities and on the stoppage of critical operations such as the shutting down in August of the third largest container port in the world, Ningbo-Zhoushan, and in June of the container port of Shenzhen – Yantian.

This is in sharp contrast with countries that are living with Covid the way they can, with a large human cost but with no hard lockdown simply because they cannot afford it, and with relaxed monetary policies that are diametrically opposed to China’s rigorous austerity.

The best example is India, which saw its Nifty Index outperform the MSCI China index by 60% over the past 12 months, by 41% since the start of the year, and that is at par with the S&P 500 YTD. The Indian real GDP grew by a surreal 20.1% YoY in the quarter from April to June 2021, inflated by a low base of -24.4% a year before. Citi expects the Indian GDP growth to be 9.5% YoY in FY2022, higher than the 8.7% forecast it has for China.

A question that investors ask themselves often is why is China always cheap and India always expensive? The events of the recent months have highlighted to us how important the difference in risk premium is. The recent unannounced measures taken by the Chinese government against entire sectors of its economy have boosted the risk premium of China whereas the risk premium of India is at an all-time low for the reason that the Indian government does not have the political means to take the kind of radical actions China is taking almost on a daily basis. The Indian government does not and cannot surprise the market the way the Chinese government does. China is taking earth-shattering actions when India is dealing with circumstances in a rather passive manner, the best way it could. In this context, the austerity program of China coupled with what looks like a never-ending stream of crackdowns and reform policies has turned the Chinese market into the worst performing market in the world so far this year, and by a wide margin. While Beijing does not seem to bother about the dismal performance of its financial markets, it has started to take note of the steep economic slowdown. Judging from the minutes of a recent State Council meeting, the Chinese government has pledged to stabilise employment and maintain a satisfactory level of economic growth. This probably means that fiscal and monetary policy relaxation should be anticipated in the coming days or weeks, possibly through another RRR cut or even a cut in interest rates. That would likely give a boost to Chinese financial markets that badly need it.

PORTFOLIO REVIEW

 

Source: Bloomberg, JKC – September 2021

August is typically a busy month as it is the interim results season. This past August was overwhelmingly busy with unexpected intensive policy releases coming from all directions. Since the fall-out of Ant Group IPO in November last year, we have seen policy pressure or crackdowns in the fintech, internet, e-commerce, property, education, gaming, cloud computing, entertainment, pharmaceutical, medical device, and medical services sectors. At the system level, there are also news or rumours about personal income tax reforms, about the implementation of nationwide property taxes and/or of a property vacancy tax, of a reallocation of wealth with internet giants donating billions to the society (Alibaba just announced it would give USD15.5bn over the next five years to ten different government initiatives), and of an acceleration in the development of affordable rental housing. One could not help asking: what’s next and what’s left? We don’t have a crystal ball, but we feel transformational reforms related to national security and ‘common prosperity’, which is the focus of the government, are largely rolled out. We might still face some policy headwinds for the rest of the year, but we start to be hopeful of 2022 with fewer policy uncertainties.

Our portfolio companies reported very good results in general except a few: the Chinese healthcare names that have been going through reform storms (Hengrui Medicine and Hansoh Pharmaceutical) and the exporters that have been suffering from global shipping bottlenecks (Shenzhou International and Linglong Tyres). We will continue to gauge such external impact to the companies’ business fundamentals and will adjust our exposure when needed.

CHINA PORTFOLIO

La Francaise JKC China Equity saw its NAV per share drop by 0.3% in August (I USD share class) when the MSCI China Free index remained flat. The cash position of the fund stood at 9.6% at the end of the month. Year-to date, the fund is down by 0.5% when the MSCI China Free index is down by 13.0%.

The lack of Alibaba that went down 12.5% with an average 12.5% index weight was the biggest contributor to the relative performance. Techtronic Industries, going up 24.7% with a 5.5% average weight, followed by Li Ning, going up 27.5% with an average 4.8% weight, were the other two top performance contributors. On the negative side, Shandong Linglong Tyre going down 19.9% with a 5.6% average weight, followed by Will Semi, going down 19.8% with an average 4.5% weight, and Hefei Meiya that went down 13% with a 5.2% average weight dragged the performance.

During the month, we exited C&S Paper as we hinted last month, and we continued to build positions in Naura Technology, Nari Technology, Sanhua Intelligent Controls, and Meidong Auto. We added a bit to Shenzhou, which reported weak results due to one-off items. We exercised stop-loss and trimmed Shandong Linglong Tyre, Hengrui Medicine and Hansoh Pharmaceutical as external headwinds had a bigger impact on their businesses than we expected.

On the results front, BOC Aviation reported its 1H results. Revenues grew by 7% YoY as the fleet grew by 13% YoY. Pretax profits (before impairments) increased by 5% YoY. Net income declined by 20% YoY while recovering 51% HoH. SITC’s 1H21 results marginally exceeded their profit alert guidance. Revenue growth was driven by a 29% volume growth, and gross margins improved from 21.3% in 1H20 to 41.8% in 1H21, with gross profits growing by 251.5% YoY. The company posted a net income growth of 407% YoY.

Techtronic’s 1H21 revenues grew by 52% YoY, driven by solid growth across geographies and products. Gross profit margin continued its upward momentum for the 13th consecutive first half, increasing 58bps YoY from 38% in 1H20 to 38.6% in 1H21. Gross profits grew by 54% YoY. Net income posted a growth of 58% YoY.

CICC’s revenues for 1H21 grew by 36% YoY, and profit before tax grew by 60.7%. Attributable net income grew by 64.1%, and earnings per share increased by 44.8% YoY. All business segments posted strong growth for 1H21.

ASIA PORTFOLIO

La Francaise JKC Asia Equity saw its NAV per share increase by 1.2% in August when the MSCI Asia ex-Japan index rose by 2.1%. The cash position of the fund stood at 6.0% at the end of the month.

Year-to date, the fund is up by 7.3% when the MSCI Asia ex-Japan index is down by 0.6%.

Techtronic Industries, going up 24.7% with a 4% average weight, was the star performer of the month. The lack of Alibaba that went down 12.5% with an average 4.9% index weight was the second biggest contributor. Indian Energy Exchange, going up 19.8% with an average 4.7% weight was the third largest contributor. On the negative side, Shandong Linglong went down by 19.9% with a 4.5% average weight, followed by Poya International, going down 11.6% with a 5.3% average weight, and Will Semi, going down 19.8% with an average 3.2% weight, dragging the performance.

During the month, we exited C&S Paper as hinted last month and we added a bit to Shenzhou International, Aavas Financiers, and China Resources Beer and we took some profit on Voltronic and Techtronic. We exercised stop-loss and trimmed Shandong Linglong Tyre in our Asia fund as well. 

In Hong Kong, AIA reported a strong set of numbers for 1H21. The value of new business (VONB) grew by 22% YoY and surpassed pre-pandemic levels for all geographies except Hong Kong. VONB growth remained extremely strong in ASEAN with Thailand (+52% YoY), Malaysia (+89% YoY) and Singapore (+32% YoY) growing at a very healthy pace. China remains a key geography contributing 28% of the VONB during 1H21. Southeast Asia and India now contribute together nearly half of the VONB (46%). Group operating profits grew by 8% YoY.

In Thailand, Muangthai Capital reported its 2Q21 results. Overall, the earnings growth remained muted but were largely in line with expectations. Loans grew by 27% YoY. Interest income grew by 9% YoY. Pre-provision operating profits grew by 8% YoY and net income was flat YoY.

In Taiwan, Voltronics’s 2Q21 results showed strong sequential recovery. Revenues grew by 5.3% YoY and 17.2% QoQ. Operating income was down 19% YoY but improved by 39% on sequential basis. The gross margin that troughed at 24.5% in 1Q21 has started to show recovery with gross operating margin improving by 213bps to ~26.7% in 2Q21. Net income showed a similar improvement with net profits declining by 22% YoY while growing by 46% HoH. Net margin improved by 298bps to reach 15.2% for 2Q21.

The information contained herein is issued by JK Capital Management Limited. To the best of its  knowledge and belief, JK Capital Management Limited considers the information contained herein is accurate as at the date of publication. However, no warranty is given on the accuracy, adequacy or completeness of the information. Neither JK Capital Management Limited, nor its affiliates, directors and employees assumes any liabilities (including any third party liability) in respect of any errors or omissions on this report. Under no circumstances should this information or any part of it be copied, reproduced or redistributed.

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