|By Matein Khalid| 2015 has been a horror story for emerging markets and Asian shares have not escaped the fallout from the 40% plunge in Shanghai/Shenzhen since June. Yet financial markets discount the future while UAE investors invariably extrapolate the recent past. So even while I resurrect the ghosts of 1998 when Suharto’s regime fell amid anti-Chinese riots in Jakarta, South Korea was forced to accept a $57 billion IMF loan, Malaysia imposed capital controls, the Thai baht was in free fall and India/Pakistan fought a hot war in Kargil, I search for value ideas in the unloved, unsettled Asian stock exchanges.
Sentiment and capital flows can devastate markets even when fundamentals are intact. I concede that this is not the case in certain Asian markets. Take Malaysia. My bearishness on the ringgit at 3.40 last spring has been vindicated with a vengeance, now that it has plunged to 4.45. Southeast Asia’s largest crude oil and LNG producer now faces a Moody’s sovereign debt downgrade, a consumer debt crisis, a $12 billion sovereign wealth fund scandal and an open feud between Prime Minister Najib Razzak and the Malay political elite in UNMO. I would not be surprised to see the Malaysian ringgit test its 1998 lows at 4.80 and see no investment case to cover the strategic short on the Malaysia Fund (EWM). The Wall Street herds are negative on Malaysia and, in this case, I follow the hoofbeat of the herds.
Japan is a different story. At 17000, the Nikkei Dow traded at 13 times forward earnings and 1.3 times forward book value, with half the companies in Section One of the Tokyo Stock Exchange trading below book value. Wall Street’s risk spasm created safe haven flows in the yen and the shock waves from the China bust was a disaster for Japan’s commodities/trading firms, as the profit warnings from Kobe Steel and Mitsui demonstrate. There is justified skepticism about the third arrow of Abenomics (structural reform) but evidence of reflation is undeniable, from rising corporate profit margins, wage growth, land price rises and even rises in shareholder equity and dividend payouts. The only real arrow of Abenomics that matters is the Bank of Japan’s monetary policy, the most aggressive quant easing program relative to GDP on the planet. I remember October 2015 when the Nikkei Dow was at 15000 and Kuroda-san responded to deflation risk with a “shock and awe” QE that led to a plunge in the yen from 105 to 120 and a 40% rally in the Nikkei Dow that I chronicled in this column. Japan has the strongest earnings momentum in the developed world. At 16500-17000, the yen hedged Wisdom Tree Japan fund is a no brainer as well as reflation beneficiaries such as property developer Mitsui Fudosan or megabanks Mitsubishi UFJ and Sumitomo Mitsui.
My certainty that monetary easing was imminent in India was also vindicated when the Reserve Bank of India (RBI) cut its repo rate by 50 basis points. This makes the Indian rupee and G-Sec (government debt) market a safe haven at a time when Russian, Brazil, Chinese, Malaysian and Indonesian debt was leprosy. With consumer inflation at 3.7%, 20% retail loan growth, post Lehman lows in valuations, the highest profitability (ROE, ROA) metrics in international banking and a steeper rupee money market yield curve, I am bullish on private sector Indian banks such as HDFC, ICICI and Axis. I hear my friend Chris Wood, the strategist at CLSA, identified India and Japan as Asia’s winner markets at his firm’s annual conclave in Hong Kong. I agree.
I am still negative on ASEAN due to political uncertainty in Thailand, the commodities price catastrophe in Malaysia and Indonesia and high valuations in the Philippines. Southeast Asian currencies will be hugely vulnerable to a Federal Reserve monetary tightening cycle that begins in December. Even Singapore will slip into recession as world trade shrinks.
Pakistan is an Asian frontier market (to be upgraded by MSCI to emerging markets) that has compelling value at 8 times forward earnings. Sure, the sovereign credit rating is a mere B, way below investment grade but Islamabad still managed to borrow $3 billion in Eurobonds/sukuk, thanks to financial lifelines from Washington, Riyadh and Beijing. Pakistani shares retuned 25% per year for US dollar investors for five successive years. Proves the old Street cliché. The big money is made when things move from Godawful to just plain awful.
Market View – Value ideas in the biotech bloodbath
It is impossible to exaggerate the scale of the carnage in biotech, with the S&P 500 Biotech index down 20% since July and megacaps Biogen and Amgen down a shocking 30-35% from their peaks. The median bear market in biotech since 1992 has lasted three months and lost 27% in value. While Hilary Clinton’s tweet on drug “price gouging” and the Congressional subpoena against Valent gutted investor confidence in the sector, 3Q earnings outlook, clinical trials, cash NPV of drug pipelines and merger/deal potential all remain intact, even though Mr. Market could well go ballistic again on China, the Fed, VW, crude oil or the next nervous breakdown in the algorithmic trading netherworld of global risk assets. Yet the sector bloodbath has also created value in some of the world’s most exciting biotech/Big Pharma shares.
Amgen (symbol AMGN) has been the most valuable biotech in the world since it went public in 1980 with its blockbuster blood cancer drug Epogen and its research driven pipeline that can well deliver 15% EPS growth in the next three years with 48% operating margins. Amgen shares have fallen from their $174 high in end July to $136 as I write. This means Amgen trades at 14 times forward earnings and a 2.3% dividend yield with a payout that will rise in 2016. Wall Street has unjustly hit Amgen and the shares can well trade up to $154 a share as headline risk abates. Amgen three month 140 puts will, I expect, expire worthless, making them a premium generation candidate.
Gilead Sciences (symbol GILD) more than doubled to $123 after I recommended its shares at $50 as a strategic holding in the world’s $20 billion hepatitis C therapeutic market. Neither Mrs. Clinton’s tirades or the House Democrat caucus on a drug price witch hunt can deny the phenomenal success of Gilead’s Sovaldi, though its $1000 a pill cost is a political hot potato. While Gilead has fallen 20% from its summer highs, it trades at a mere 8.5 times forward earnings. Wall Street has discounted the Armageddon scenario for drug pricing, a scenario I do not think is credible even if Mrs. Clinton wins the White House.
Sovaldi was the most successful product launch in the history of biotech. Gilead’s next growth engine includes autoimmune, cancer and HIV drug pipelines. Gilead’s $15 billion share buyback, cash hoard $25 billion revenue run rate, rising div payout ratios make it light years distant from the model of a speculative, one trick pony biotech with a stratospheric valuation. The valuation case for Gilead is irresistible as EPS could well grow 15% next year. Gilead is a quintessential growth stock now trading at deep value prices. This puppy is a no brainer, even if I doubt if Harvoni will ever match Sovaldi’s epic $10 billion in sales.
My fascination for Switzerland’s Roche Holdings goes far beyond any considerations of finance or money making on its shares. Roche’s immune oncology drugs are a revolutionary break through in humankind’s ancient battle with cancer. Roche has 11 FDA Phase III clinical trials in its drug pipeline that address lung, pancreatic, breast, blood and kidney cancer.
The human immune system has finally been leveraged as a weapon in the struggle against malignant cancer cells, a paradigm shift in human evolutionary biology. At 250 Swiss francs, I consider Roche Holdings undervalued relative to its role as one of the human race’s biotechnology crown jewels.
Celgene (symbol CELG) at 108 trades at 18 times forward earnings, even though shares lost 25% in the biotech sell off. While I concede Celgene trades at a valuation premium to Amgen, Gilead and Roche, it has one of the industry’s highest revenue growth profiles. Revlimid, Celgene’s blood cancer flagship drug, can well lead to 25-28% revenue growth next year. Celgene has used acquisitions, royalty agreements and research partnership to broaden its immuno oncology pipelines. Management expects to triple EPS in the next four years. This makes it a momentum growth stock on Wall Street.
Biotech shares are among the most volatile niches of the stock market and are best left to the cognoscenti who can grasp the cash flow value of drug pipelines, track FDA/regulator risk and follow clinical trial data. Now the 2016 race for the White House is another political risk. This is classic Lord Rothschild “blood on the street” turf.
Stock Pick – What next for Standard Chartered Bank and HSBC?
I had originally recommended shorting Standard Chartered Bank at 1500 pence, written successive column this summer outlining the bearish case for the stock and projected a target of 650 pence in London. This target has now been achieved. Britain’s oldest “imperial” bank lost 50% of its value in the past year, thanks to a spike in non-performing loans, exposure to China, Asian trade finance, commodities and a failed investment banking strategy.
Incoming CEO Bill Winters, once J.P. Morgan’s investment banking chief, must raise as much as $6 billion in capital ahead of the Bank of England’s stress test results in December. While management has slashed the dividend and exited equity capital markets, I believe a capital raise is inevitable and the bank’s valuation metrics are only optically “cheap”. The third quarter earnings will be a bloodbath, given Stan Chart’s exposure to Asia’s troubled equities, currencies and exporters. Non-performing loans in India, South Korea, Malaysia and China are certain to rise in the next six months. Stan Chart trades at 0.56 times forward book value, below its post Lehman bottom at 0.75X in December 2008. In 2010, only five years ago, Britain’s pure play emerging markets bank traded at 2 times book value. Since Stan Chart is dirt cheap, a capital raise will be dilutive to shareholders. The bank’s shares will also be vulnerable to a spike in debt defaults and rescheduling across the emerging markets. Provisions for bad loans are certain to rise in 2016. Paradoxically, any bull run in the shares until the Bank of England stress test in December will make a rights issue even more likely. A 600-800 pence trading range would not surprise me in the next twelve months.
HSBC Holdings is grossly undervalued at HK$58 in Hong Kong or 485 pence in London even though CEO Stuart Gulliver’s eagerness to shed his banks in Brazil, Turkey and a dozen other emerging markets makes it the world’s ex local bank! Gulliver plans to slash the payroll by another 50,000 jobs. Unlike Stan Chart, HSBC’s 11.6% Basle Tier One capital adequacy ratio means there is no threat to the dividend, which is now a stellar 6.8%. HSBC trades at a forward valuation multiple of 9 times earnings, reasonable for a bank that can well offer 9 – 10% return on equity. HSBC is also a “safe haven” bank during times of stress in Asian, Arab and African emerging market banking due to its role as Britain’s “too big to fail” bank. HSBC is exposure to China and Southeast Asia’s financial turmoil, the bank’s vast Group Treasury bond portfolio makes it positively geared to a Fed lift off and steepening in the US Treasury bond yield curve.
HSBC shares have priced in a draconian loan loss scenario that I do not believe is credible. After all, loan growth in Hong Kong is only 6% and residential mortgage LTV is a mere 27%, thanks to Hong Kong Monetary Authority (HKMA) regulatory restraints. The bank is no longer as exposed to the Hong Kong property’s speculative mania as it was in 1997, the twilight of the Crown Colony era. HSBC has also exited banking to smaller corporates in Indonesia, Pakistan, India and even the GCC. Stuart Gulliver has made it clear that HSBC will exit subscale or unprofitable markets. HSBC’s price/tangible book value (PTBV) of 0.85, higher then Citigroup’s 0.7X PTBV but lower than J.P. Morgan’s 1.2X PTBV. Of course, neither J.P. Morgan nor Citigroup offer investors remotely a dividend yield as attractive as HSBC.
There is no other “systemic” global bank on earth that matches the dividend yield of HSBC. Management will also aggressively slash risk weighted assets in its Global Banking and Markets Division, and US retail banking, a strategy that will boost capital ratios and further strengthen dividend growth. Stuart Gulliver has injected capital discipline and a shareholder value focus to HSBC that simply did not exist under Sir John Bond. In times of crisis, the Home for Scottish Bank Clerks (HSBC) is a proven winner!
