We believes that there is potential for a notable improvement in shareholder returns in Asia and this is not reflected in current valuation multiples.
Asian equity markets rallied over the last 12 months and are now trading at valuation levels just above their long term averages. Despite this, they are not at overextended levels, in our view, and on a 13.3x 12 month forward P/E and 1.8x trailing P/B1, they compare favourably with other global equity markets (see charts & table).
One reason why Asian markets are trading at lower valuation multiples is due to Asian corporates’ track record of not prioritising shareholder returns. As a result, we believe there is greater potential in Asia for shareholders’ total return to be boosted going forward and help drive a re-rating of shares, particularly in markets such as China, South Korea and Taiwan.
Asian valuations: forward P/E
Asian valuations: P/B
In China, we have seen a notable mind-set change among state-owned enterprises (SOEs) when it comes to dividend payouts. The Chinese government, as their controlling shareholder, has been consistently calling on SOEs that have relatively strong balance sheets and high cash flow generation capabilities to increase dividend payouts. In our opinion, there are many examples of SOEs that are beginning to do just that. Such as, China Mobile, a holding in the Invesco Perpetual Asian Fund, increased its dividend payout ratio to 48% 2017 (46% in 2016) and is now paying an attractive yield of 4.5% , or 9%, if the special dividend announced last year is included. Management guided for a further increase in the payout ratio this year and emphasized their confidence in continued increases in dividend per share over the medium term. Elsewhere, the oil & gas companies are also showing signs of increasing their payout ratios despite the fact that some businesses are under pressure as a result of the low oil price. Companies such as Petrochina, the largest integrated oil company in China, paid a 104% dividend payout in 2017. Similarly, Sinopec recently declared a +100% dividend payout ratio (2017) and in Sinopec’s case the yield is very high (9.7%).
South Korea is another market where the potential for higher shareholder returns is not reflected in current market valuations, in our view. Currently, it is amongst the cheapest markets in the world partly due to its low average dividend payout ratio which is about 20% lower than the average for the Asia ex Japan region. However, we believe that this is beginning to change for the better with positive implications for valuations. Firstly, Samsung Electronics has moved to a capital return policy which dictates that at least 50% of free cash flow will be returned to shareholders in the form of dividends and share buybacks. As Korea’s most successful company, Samsung’s more shareholder-friendly actions are likely to be copied by other business groups particularly since many companies are under pressure from large shareholders (e.g. Korea National Pension Service). A good example of a company which is doing just that is the insurance company, Samsung Fire & Marine. This company announced a larger-than-expected dividend payout ratio of 44% which puts it on a dividend yield of 3.7%. The insurer stated that it would focus on returning capital to shareholders through dividends and it expects its payout ratio to continue to increase going forward. Finally, this month (March 2018) the Hyundai Motor Group positively surprised the market by announcing that it was planning on untangling its cross shareholding structure which critics have long said gave too much power to Hyundai’s controlling Chung family at the expense of shareholders. We believe this will eventually facilitate the operating company to increase its dividend payout. It is worth noting that large companies which have over recent years yielded to pressure to return cash to their investors in the form of dividends, or share buybacks (e.g. Microsoft and Apple), have seen their share price performances benefit.
Turning to Taiwan, Taiwanese companies have historically had decent dividend payout ratios. Despite this, we believe company executives have been excessively conservative in the management of their balance sheets by retaining substantial cash balances and could, in fact, have paid out more in dividends. These ”balance sheet buffers” are not being factored into market valuations, and good examples of this are the Taiwanese technology companies Delta Electronics and Hon Hai Precision. Delta Electronics is a high quality company with stable growth businesses (i.e. industrial automation and electric vehicle components), and for the last twenty years this company has generated consistently positive free cash flow. After adjusting for cash, the company has no debt which, in our view, is rather conservative, especially when one considers the balance sheets of its international peers. For example, the Germany engineering company, Siemens AG, has a net debt/equity ratio of approximately 50.1% (2017 year-end). Siemens may not be a perfect comparison for Delta, but the businesses are not so dissimilar that they warrant a completely contrasting approach to balance sheet management. Equally, the Taiwanese electronics manufacturer, Hon Hai Precision, is also run very conservatively with the equivalent of approximately one year’s earnings sitting in cash on its balance sheet.
What will impel the market to recognise the value inherent in balance sheets? Usually a catalyst is required for the full value of large cash balances to be factored into the share price, such as higher dividends, share buybacks or an acquisition. As a team, however, we do not have to identify a specific catalyst before we invest as we believe that typically as soon as a catalyst is apparent then the share price reacts very quickly. We trust that our investment horizon is long enough to give time for a catalyst to emerge, and in the meanwhile many of these types of companies (including those above) are paying decent dividend yields, albeit they could be higher. We acknowledge the risk that in some cases a catalyst may not appear and the investment does not render a high value for shareholders, but we rather take the risk of buying what we believe are undervalued stocks with limited downside, rather than buy stocks where there is a material risk of a de-rating.
