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July 2020

Key takeaways:

After what had been a very strong month of June for equity markets across Asia, July was equally strong. This strength was largely located in China, both offshore and onshore (the CSI300 combined index of A shares listed in Shanghai and Shenzhen gained as much as 12.7%, the MSCI China was up 8.9%), in India (Sensex was up 7.7%), in Korea (Kospi index was up 6.7%) and in Taiwan (Taiex index was up 9.0%). In other words, the strongest performance was in the most liquid markets. This is the result of the unlimited money printing exercise of the Fed and the ECB that we commented repeatedly over the past months.

A historical event occurred in July that only accelerated the process of pouring liquidity on Asian emerging markets, and that event did not happen in Asia but in Brussels: We are referring to the agreement reached by the European Union to issue for the first time debt that will be collectively guaranteed by all member states. This is the first step towards fiscal union. Monetary union without fiscal union had always been the reason why the European project and more specifically the euro had always been fragile, and even at risk of collapsing during the sovereign debt crisis ten years ago. With fiscal union in sight, the euro is now on a much stronger footing. It gained almost 5% against the USD in July. Combined with a surge of Joe Biden in polls and a 9pts gap between him and Trump (source: Financial Times) that makes a democratic win and higher corporate taxes more and more likely, it all explains why the dollar has embarked lately in a precipitous fall against all major currencies. The dollar index that measures the greenback against a basket of 10 leading currencies lost 4.6% in July. The RMB gained 1% against the USD in July. It had the automatic impact of pushing gold to new highs and sending flows in the direction of emerging market equities.

It is interesting to notice that the increasingly hostile stance of the US, and particularly of its Secretary of State Mike Pompeo against China that have reached unprecedented levels in July had literally no impact on stock markets beyond one day of kneejerk reaction at most. As we are moving closer to the US presidential election, we remain of the view that Beijing would prefer Trump to be re-elected for the reasons that by leaving numerous international organisations America has left countries around the world without global leader, paving the way for China to fill the gap. Also as an individual, Trump is highly unpredictable and easier to swing over a dinner table than Biden would be, given that Democrats and Republicans are on the same page when it comes to expressing anti-China views.

Moving away from currency-driven and political considerations, China’s economy remains on the rebound, to the point that we have started to see cooling-down measures being implemented targeting the property sector in the cities of Shenzhen, Hangzhou and Ningbo that had started overheating. By implementing local restrictions on a case by case basis, the Chinese government managed to avoid boom and bust situations ever since access to private property became a reality in China in the late eighties.

Following a -6.8% yoy contraction in Q1, the GDP of China rebounded to +3.2% yoy in Q2, well ahead of the +2.5% yoy consensus estimate of analysts as gathered by Bloomberg. The GDP of China, in absolute terms, in now back to its previous high that had been reached in Q4 2019, led by a push in industrial output and construction activity. Looking into details month by month, a clear acceleration could be seen in June vs May across the service industry, the retail sector, and the industrial sector. Capital Economics, a reputable macro consultancy based in London estimates that “GDP [of China] will return to its pre-virus trend by the end of the year, faster than in any other major economy”. The V shape rebound of the Chinese economy combined with strict measures taken each time there is a new cluster of Covid-19 (as most recently seen in the cities of Dalian and Urumqi) could be a reason for the very strong performance of the A share market in July. This market being largely retail-driven, the risk of a correction is now very high, in our views.

Moving away from Mainland China, the most important corporate event of July within our universe was Intel’s announcement that it would delay the launch of its latest generation of microprocessors for laptops and servers due to research and development issues, and that it was considering giving up the manufacturing of chips altogether to become a pure design house. This is a USD18bn annual business that will need to find subcontractors able to make the 7- nanometre chips (7nm is the distance between two contact points on a chip) that Intel has difficulties developing. There are only two such companies in the world: TSMC in Taiwan (annual sales: USD42bn) that is about to kickstart its 5nm production line and that is already developing a 3nm technology, and Samsung Electronics in Korea which only recently started manufacturing 7nm chips and that always gives priority to Samsung orders. Following Intel’s announcement, TSMC which was already Taiwan’s largest company saw its share price shoot up and gain 36% in July. TSMC is now the 10th largest company in the world by market capitalization with a stock market value of USD375bn, and the first Taiwanese company to make it to the top ten. It is also one of our top positions in our Asia funds.

CHINA PORTFOLIO

The fund performed well in July (+7.2%). However, the index performance was even more potent (+9.5%). Top attribution contributors were China Resources Beer, Xinyi Glass and Heifei Meiya, in that order. The cash position and our structural underweight in Tencent that gained 16.4% with a 18% benchmark weighting (UCITS funds are capped at 10% on any single name) hurt the relative performance against the benchmark by 1.2%. SITC and China property names (China Jinmao and Times China) also lagged. 

During the month, we added to Shenzhou, to Inner Mongolia Yili, and we trimmed Techtronic ahead of its 1H results announcement after reviewing its supply chain and its peer group’s performance in Q2. We also cut ASM Pacific and exited Minth. We have had ASM Pacific and Minth on our internal review list for a while: we like both management’s operational track records, but we are getting less convinced on the medium to long term outlook. We also added Bilibili and Will Semi in our high growth basket.

Bilibili is an online entertainment platform for young generations in China who were born between 1990 and 2010. It started as a content community inspired by Japanese animated cartoons, comics and games, and then evolved into a full-spectrum online entertainment platform covering a wide array of genres, including music, dancing, science and technology, movie, drama, fashion, and daily life, using various media formats that include videos, live broadcasting and mobile games. We like the structural growth of China’s online entertainment industry, and we believe Bilibili is well placed to capture opportunities with its ever-growing supply of creative user-generated content and its fast-growing pool of young users that will be the driving force and the trend-setters of online entertainment consumption in China as they grow older.

Will Semiconductor is a leading semiconductor distribution and IC design company in China. With the acquisition of OmniVision and SuperPix, Will Semi has become one of the world’s top three CMOS image sensors (CIS) designers. CIS is the photoelectric device that captures the image at the end of the lens. It is the core component of any camera as it defines the quality of the image, including its resolution. We like the structural growth of the global CIS market thanks to the stable smartphone shipment trend and the improving camera functions (higher resolutions, multiple cameras). We believe Will Semi is equipped with the right know-how to gain market share from Sony and Samsung, its top competitors by grabbing the supply of CIS for the top-of-the-range Chinese smartphones.

News wise, Minth announced a profit warning, expecting net profit for the first half of 2020 to decline by 55-60% YoY. The profit warning did not come as a complete surprise to us, but we were disappointed at the severe impact of Covid-19 on Minth’s business.

One of our core positions, Hangzhou Tigermed listed in Shenzhen, launched its Hong Kong dual-listing IPO to raise about USD1.2bn. We expect more and more private companies apply for dual-listings as Tigermed just did. For quite some time having a dual listing of A and H shares had been the privilege of state-owned companies. These days are clearly over.

In July, Yum China that operates Kentucky Fried Chicken, Pizza Hut and Taco Bell announced its second quarter earnings, and a 26% YoY decline with sales having dropped by 11% YoY. This drop is largely due to the reduced traffic in train stations and at touristic sites where KFC has approximately 10% of its stores located.  We expect Yum China to carry on its sound localisation strategy and to recover gradually from the hit of the pandemic.

ASIA PORTFOLIO

The fund continued to do very well in July in both absolute and relative terms. Top attribution contributors were China Resources Beer, Hansol Chemical, and Hefei Meiya. Performance detractors were SITC International, the cash position of the fund and Muangthai Capital. During the month, we added to Chroma ATE and to Shenzhou International while we trimmed further Muangthai Capital and ASM Pacific. We exited Minth and Hynix, and we initiated Reliance Industries and Meituan Dianping, both for benchmark hedging purposes.

Our investment in Reliance Industries (RIL) is an interesting one. Having seen what happened in China, we sense the enormous potential of RIL being the most influential Indian conglomerate, equiped with what would be in China a combination of China Mobile, Tencent, and Alibaba, together with strong connections across the full Indian political spectrum. RIL is the only conglomerate with the muscle power that is required to lead the digital transformation of India, leaping forward from 3G to the 5G era. While a large share of RIL’s earnings and cash flows is derived from its refining & petrochemicals businesses, the consumer businesses of telecom & retail have now become significant drivers of both earnings and value. RIL has been under massive spotlights due to the high profile stake sales in Jio Platforms to high quality strategic & financial investors globally such as Google, Facebook and KKR. Since all the cards are now on the table, execution in new areas is now the key to watch. It is anything but certain whether RIL could realise its grand ambition. But if RIL could not, especially by leveraging the strength of a group of top global leaders and with a government that is now increasingly protective for RIL to fence off foreign competitions (i.e. Chinese companies), no other company in India seems to have a better chance.

News wise, the Government Savings Bank of Thailand (GSB) announced that it plans to enter the collateralized lending business in Thailand and would bring the rates 8 to 10% lower than the current market rates to support the access of the mass market to financial services. We believe this could negatively impact Muangthai Capital over the long run.

Bank BTPN Syariah, the Indonesian micro-lender reported that its net margin income for the first half declined by 7% YoY and pre-provision operating profits went down by 3% YoY. Its loan loss provisions for the period grew by 175% YoY, but the Capital Adequacy Ratio (CAR) remains extremely robust at 42.3%. The business is seeing a visible recovery trend as the “Red Zone” where full lock-up is in force and no face-to-face meeting can take place is now only impacting 5% of its network compared with 50% a few months ago. This name remains one of our highest conviction names in our portfolio.

Both Samsung Electronics and TSMC reported stellar second quarter results. Samsung’s 2Q20 revenue went down 7% YoY, yet operating profit went up 23% YoY driven by the recovery in consumer electronics and memory demand from the ‘stay at home’ economy. TSMC’s 2Q20 revenues went up by 28.9% YoY, and EPS went up by 81.3% YoY driven by ongoing High-Performance Computing and 5G spending. For the full year, TSMC revised its growth outlook for the global semiconductor market (excluding memory) from flat-to-slightly-down to flat-to-slightly-up. TSMC is the largest chip manufacturer in the world.

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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