A bull in a China drop: hunting for value inside a deflating giant

This article appeared in The Australian Financial Review on 28 August 2023, reproduced with permission.
Author: Joshua Peach, Market Reporter

Overseas investors are fleeing China, but this Sydney portfolio manager from Maple-Brown Abbott is buying up.

With deflation officially under way in China, and the nation’s protracted property woes extending, there’s reason to be bearish on the world’s second-biggest economy.

Amid the turmoil, equities investors are fleeing in their droves.

Earlier this month overseas funds dumped the equivalent of $US9.3 billion ($14.5 billion) from blue-chip China stocks in just 12 days of trading, according to Bloomberg data.

And the MSCI China Index remains more than 50 per cent down from its February 2021 highs. But while many are fleeing the wreckage, Will Main of Maple-Brown Abbott has been busy sifting through the rubble.

“When you have market moves like that, there are going to be opportunities for cheap stocks, or at least what we think are cheap,” Main says in an interview with The Australian Financial Review.

“At the moment, given the level of poor sentiment, we can pick up world-class businesses at pretty attractive prices that are still growing earnings despite the headwinds that the economy is facing.”

Few have weathered the region’s recent downturn as well as Maple-Brown Abbott’s Asian equities division. The boutique’s two-decade-old Asian (ex-Japan) Equities Trust, now headed by Main, is sitting on an 18 per cent one-year return, against its benchmark’s 10 per cent.

Perhaps more impressively, given the substantial index losses, the fund has returned 9.7 per cent over the past three years. That compares with a measly 2.5 per cent return from the MSCI Asia ex-Japan benchmark.

Main recently took the reins from the head of Asia Pacific equities and Maple-Brown Abbott veteran, Geoff Bazzan, who stepped away earlier this year. He helps oversee about $700 million that is invested in the region.

Speaking in the Maple-Brown Abbott Sydney offices, Main says the fund’s success isn’t as simple as taking advantage of the drop in company ratios.

“We have a value investing background and when it comes to the Asia funds, there’s such a huge range of companies and quality of companies, we’re really looking more for intrinsic values,” he says.

No ‘China apologist’

“We could run a screen tomorrow and pick half a dozen stocks that are screening cheaply, but when you do a bottom-up company analysis, you’d be turned off pretty quickly.”

The portfolio manager cautions that the fund has “by no means been a China apologist” during his 16 years working in the Asian equities division.

“We’ve been underweight China and overweight China. When I first came in we were maximum underweight China because the broader market was trading north of 20 times earnings,” he says.

“We were also underweight China back in early 2021, when everyone was super bullish, and now we’re overweight as the market, as people are selling.”

That resistance to rush in with the crowd also means the fund has held off participating in one of the region’s most notable trades – until recently, that is.

“We stayed out of Alibaba for a long time. That was obviously painful on the way up. We didn’t have a single share when it peaked at $HK320 ($63.30) a share,” he says.

“But now we’ve been buying in as it’s been falling, and buying more aggressively as it’s gone under $HK100.” The tech giant’s shares are now trading at around $HK87.75.

A series of new bottom-up valuation buys over the past two years has the fund once again overweight on China, but that doesn’t mean Main is taking this most recent downturn lightly.

“How does it rank versus other periods of disruption? I think back to 2015, when [the Chinese government] devalued the currency. I mean, this has got to be right up there.”

“We view the current situation in China as a policy mistake, withdrawing what little stimulus they had and then, when the spy balloon incident came through, well, there’s been this slow grind down from there,” he adds.

But despite the doom and gloom narrative, Main thinks the image on the ground may be a little different.

“You can’t pick up a newspaper without seeing a negative story on China. We think there’s a lot of fear and poor sentiment out there,” he says.

“The deterioration seems to be quite fast moving. Our sense is that things aren’t as bad on the ground as they are reported in the press.”

Managing the portfolio positions from the boutique manager’s Sydney offices may seem like a difficult task, given the situation in China, but Main says it also presents advantages.

The big question

“We really value people going and getting on the ground, but at the same time though, we like sitting outside that market because I think you can fall prey to groupthink.

“We’ve had successes in stocks that were very much anti-consensus.”

One example, NARI Technology, which provides power equipment to China’s electricity grid, was picked up by the fund a few years ago. The shares are up 8 per cent year to date.

“That was very much out of consensus. It was trading on a mid-teens multiple, so it wasn’t immediately screening as cheap but the share of its capex was swinging in favour of the company.”

That ability to take the contrarian view is one of two skills that Main believes are integral to being a good Asian equities investor. The second is being able to take a longer-term view.

“It isn’t about who do we think will beat next quarter’s earnings. Quite frankly, it’s hard to have a sustainable edge in that space,” he says.

“We’re looking beyond just a low PE or price-to-book. We’re looking for companies on a four-year view that look grossly mispriced relative to their fundamentals.”

Looking ahead, Main says the question on everyone’s lips is “when will the Chinese government step in?”

“The government authorities have lots of policy tools at their disposal. But as of today, they’ve been reluctant to go down the path of large-scale fiscal stimulus.

“It has been a surprise they haven’t stepped in earlier, so what’s the pain point at which they do step in more forcefully and try to stabilise the system?”

If, or when, that stimulus does eventuate, Main says there’s a lot that can go right that many may not have considered.

“Looking from some distance, things are never as good as people think. At the same time, it’s likely never as bad.

“If there’s some sort of stabilisation in the property market and a more pro-growth stance from the government, locals will start buying again. The idea that people are never going to buy another apartment in China is probably on the more extreme bearishness side.”

Taking a longer view on the Asian giant, Main highlights the cyclical and the structural division in China’s outlook.

A happy hunting ground

“From the structural element, we wouldn’t deny that China faces headwinds, and GDP growth is going to be lower over the coming years.

“But there is very much a cyclical element and our best guess is that’s passed now, and growth will turn up in the second half and beyond.”

But even if “peak China”, a term Main weighs with some trepidation, has passed, he says it’s far from the “death knell for Asian equities”.

“China will grow slower over the coming years. You don’t need to be an economist to know that. If GDP growth is population growth times productivity growth, with the population now peaking, GDP will grow slower.

“But the other thing I would say is a country that has $US18 trillion GDP and is growing at 4 per cent adds more in dollar terms than a $US5 trillion economy growing at 10 per cent.”

Against that backdrop, Main says there are still plenty of opportunities for stock pickers in Asia, if you can drown out the noise. He names South Korea as a “happy hunting ground for cheap stocks”. One company he likes is South Korean chemical giant LG Chem that is based in Seoul.

“Asia is such a diverse region. We can always find something that people are excited about and there’s always things people are absolutely in despair about,” he says.

“As long as humans are having some input into the investment process, I think that’s very much likely to continue.”