Derek Hillen, CAIA, Mirae Asset Securities
November 22, 2012
“Thanksgiving, when the Indians said, “Well, this has been fun, but we know you have long voyage back to
England.” – Jay Leno
Contents
Observations………………………. 1
Research…………………………… 5
Americana…………………………. 9
The Last Page…………………..…..11
Observations
This abbreviated issue of EMI is early due to the short workweek in the US.
US markets fell almost 5% after Obama’s “surprise” re-election. Wall Street got it wrong
betting on Romney. Since we have already sifted through the intellectual detritus on that
issue there is no need to “Re-fry cold rice,” as the Chinese say. Yet, it is interesting to note
that the American Association of Individual Investors, publishers of the Bull/Bear Ratio,
report that retail investor pessimism is the highest since August, 2011 when the US rating
cut occurred. The gauge measures investor expectations of stock prices over the next six
months. Much like certain analyst recommendations (no names!), the B/B Ratio is often an
effective contra-indicator. Back in August last year at the last B/B Ratio peak, the S&P was at
1200 and then rose 22% to its recent peak of 1460. Other technical indicators, such as RSI
(Radio Slovakia International) also show the market is oversold.
Emerging Markets Illustrated
Q3 earnings season is over and 62% of companies beat the street, the worst quarter in three
years. The game, as many know, is for corporates to lowball expectations and then easily
“beat” them. Consensus estimates for 2013 earnings is for around a 12% increase over 2012
and many feel Q3 was the trough. However, year to date earnings in the US have grown a
weak 3.9% and if Q4 is just OK, maybe we see 5% corporate earnings growth this year. What
were analysts forecasting 11 months ago at the start of the year? 11.5% growth….
China Profit Margin De-Rating
Profits in China are even harder to predict for various reasons, including the Great Firewall,
the Great Chinese Wall and the Great Stonewall but one thing is certain: they have been
trending down for a while. Despite the economy showing signs of recovery this year,
corporate profits remain flat. According to China information vendor Capital Vue, net profit
for the 2,500 mainland listed companies rose a tiny 0.4% in Q3 vs. Q3 last year. Profits may
not be growing but costs are and the squeeze is hurting. We talked about corporate China
not paying its bills in an earlier issue of EMI with 2/3 of listed companies reporting account
receivables rising across the board.
The heavier wage bill has been another drag as worker salaries are up an impressive 73% in
the manufacturing sector over the last five years. The redback has appreciated 20% against
the greenback over the same time period, adding further woes to exporters. Average net
profit margins for listed companies in China have dropped from 12% in 2007 (those halcyon,
carefree days of yesteryear. Oh, where did they go?) to 8% now. Malinvestment in excess
capacity is to blame for much of the pain being felt. Every player is determined to keep
producing, no matter if there is any profit in it, just to drive the other guy out of business. A
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Emerging Markets Illustrated, November 22, 2012
Emerging Markets Illustrated
cursory glance at the steel sector is a nice example.
With profits ever harder to come by in China, it seems more and more entrepreneurs and
others with wealth are interested in getting what they have out of the country. Last week
we reported on the amazing statistic that came out of a recent Hurun survey which
indicated of those in eastern and southern China with assets 10 mn Rmb and above, 70%
want to emigrate. I mentioned this 70% number to a Mainland Chinese acquaintance of
mine at a social function last night here in Seattle. His stunning comment was, “It should be
higher, I think.” Leaping lizards, Batman.
China’s interest in pursuing higher education in the US continues to grow in both
undergraduate and post-graduate degrees. First time enrollments by Chinese students have
jumped 22% this year. The latest data from the Institute of International Education show
that as recently as six years ago, China and India each sent about 100,000 students to the US
annually. And today? Today, China is sending nearly twice that number annually and India is
flat. (At least India is holding steady. Looking at Japan, the number of Japanese students here
has plummeted 41% in the last five years as that country turns inward and accelerates its
road-to-nowhere destiny).
Many of these Chinese students will stay in the US, start businesses and contribute to the
economy. The Chinese Academy of Sciences reports that since 1978, of all the students
who left China to study in the US only 27% returned to China. This number rose to above
30% during the last two years as a combination of gov’t incentives in Beijing and high
unemployment in the US lured more back home to work. However, if normal trends hold,
over 70% of the new 200,000 Chinese students arriving this year in the US will stay. This is a
serious brain drain of China’s best and brightest.
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Emerging Markets Illustrated, November 22, 2012
Emerging Markets Illustrated
It isn’t a two-way street: the number of Americans studying abroad remains flat. We import
just about everything so I guess it is easier to import the “international experience” to college
campuses as well. Fordham University in New York reports that 40% of their international
freshmen this year come from China. The top three US universities for international students,
(around 9,000 in each) are: USC, University of Illinois and NYU. Given Chinese attitudes
toward their own country, those numbers look likely to grow.
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Emerging Markets Illustrated, November 22, 2012
Emerging Markets Illustrated
Research
“J'adore Vivienne, habillez-moi
Gucci, Fendi, et Prada.
Valentino, Armani too
Merde, I love them Jimmy Choo” – Lady Gaga
Prada: Hell Bent for Leather
Mirae’s head of consumer research, Janey Dillon, has initiated on the China consumer
discretionary sector with a focus on Hong Kong listed retailers (here), which despite
attractive fundamentals and broker hot air, has underperformed the market for the last two
years. Janey is still not impressed with most of them and with inventory days rising to alltime highs and costs outpacing SSSG, the most enthusiasm she can muster for the sector is a
“Neutral” rating. She does really like Prada (1913 HK), however.
Prada's share price relative to HSI
Source: Bloomberg, Mirae Asset Research
I highlighted Prada’s outstanding operating metrics post results in an earlier issue of
Emerging Markets Illustrated but voiced concerns about valuations. Despite weakening
demand for luxury goods in China, Prada’s most important demographic, Janey believes the
best opportunities for Prada still lie ahead. The market obviously agrees and the stock has
moved higher since my lukewarm review end of September.
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Emerging Markets Illustrated, November 22, 2012
Emerging Markets Illustrated
Prada’s share price relative to MSCI Luxury Goods
Source: Bloomberg, Mirae Asset Research
Despite a sector-wide slowdown, Janey believes Prada is relatively immune due to its store
roll out and desirable product positioning. The company has a much smaller store network
than Gucci or Ferragamo, while LV and Burberry, closer in size, have retail networks 86%
and 57% larger. China is absolutely key to Prada’s growth strategy and Janey estimates that
the company has the second largest luxury business in China in the fashion and leather
category and has achieved this with a store network less than half the size of its peers.
Importantly, demand for the product Prada persistently pushes is growing along with
greater sophistication of Chinese luxury consumers. Apparently, larger numbers of them no
longer want to wander around with bad haircuts and plastered in large, loud logos. They are
gravitating toward a more “subtle look.” Will social graces enjoy a similar improvement?
Clothes do make the man….
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Emerging Markets Illustrated, November 22, 2012
Emerging Markets Illustrated
Janey just visited Prada in Milan on Monday and had this update:
 Prada read her report and were very interested in her analysis of store
networks and price points
 Asia and the Gulf continue to be strong while Japan and the US are slowing
 Europe is possibly the strongest region right now (Xie xie, Chinese tourists)
 Demand for classic luxury is strong and the Prada brand continues to
outperform Miu Miu
 Minimizing working capital is an obsession
 In Korea Prada is paying little or no rent in the department stores thanks to
strong product demand
 Prada will increase the dividend payout ratio from 30% to 50% over 2-3
years
With new store rollout and strong sales growth providing operating leverage, Janey
forecasts EBIT margins at Prada will increase by 4.3% over the next three years to 29% and
EPS CAGR over that time period will be 27%. While this will provide room for consensus EPS
upgrades, it also means Prada should trade at least at the sector PE of 23 times. Prada
currently trades on a 12-month forward PE of 21X, in-line with Ferragamo but below the
30X multiple Hermes commands. Given the sustainable growth outlook for the stock and
extremely positive operating metrics, Janey believes Prada should command a PE of 23X.
I’m convinced. More stylish upside ahead.
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Emerging Markets Illustrated, November 22, 2012
Emerging Markets Illustrated
Investing legend Jeremy Grantham (the “G” in GMO) released his 3Q letter yesterday.
Jeremy Grantham was born in Doncaster, UK, also the birthplace of abrasive television
presenter Jeremy Clarkson and Royal toilet installer Thomas Crapper. Not surprisingly,
Grantham has spent most of his life in the US. I always find his thoughts, while sometimes
turgidly expressed, to be an educational read.
In “On the Road to Zero Growth” Grantham takes a very pessimistic view of the future. He is
math and data driven and according to his numerical analysis, here is what we have to look
forward to:
- The old US GDP growth rate of 3% a year is gone forever
- Resource costs have been rising at 7% a year since 2000 and will continue to do so
- The climate is going to hell and we along with it. Learn to swim. Well.
- Other developed economies will experience zero growth by 2050
- Failed and failing states will multiply in number
Overall his Malthusian prognosticating makes for grim reading. To his credit, Grantham does
give a nod to the new energy revolution occurring in the US with a note on fracking, which
he calls, “a rare positive.” However, the gains are already in the system and there is nothing
to look forward to… I guess you can take the boy out of Doncaster but you can’t take
Doncaster out of the boy. As the song says, “It’s grim up north.”
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Emerging Markets Illustrated, November 22, 2012
Emerging Markets Illustrated
Americana
Thanksgiving in the US as a holiday is similar, in some ways, to that of Chinese New Year: it
is a time of family reunion, no matter how difficult. This is why the holiday is often the peak
travel time of the year – don’t make a trip here then if you don’t have to. (To better
understand the phenomenon, check out “Planes, Trains and Automobiles,” a great John
Hughes cult classic 1987 film starring John Candy and Steve Martin about two very different
guys trying to cross the country by any means possible to get home in time for Thanksgiving
dinner. Highly recommended).
Bizarrely, Americans only cook and eat whole turkeys twice a year: Thanksgiving and
Christmas. The birds, like many of those eating them, are huge and Thanksgiving leftovers
last a week or more rendering everyone sick of the experience by then. But wait, in a few
short weeks it’s time to do it again.
As children in school, we were taught the first Thanksgiving happened in Plymouth,
Massachusetts shortly after the Pilgrims first arrived. In order to give thanks for their first
successful harvest the Pilgrims held an outdoor dinner and invited those nice Indians next
door who showed up washed in freshly pressed buckskins, smiling and carrying pumpkin
pies. This ridiculous narrative is actually maintained throughout your whole school career
and becomes virtually unchallenged doctrine. (All depictions of the event in schoolbooks
show happy, smiling faces - beaming so much their cheeks must hurt. I remember, in my
tender youth, being disturbed by this and I used to draw frowns, scars and pirate eye
patches on all the players. Maybe, I was just disturbed, but I grew into a normal adult; each
morning I plug in some Metallica and drive my daughter to nursery school).
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Emerging Markets Illustrated, November 22, 2012
Emerging Markets Illustrated
Not unique to the US, Thanksgiving is celebrated in Canada and even Australia. According to
the thanksgiving.org.au website, the holiday Down Under is all about “Thanking
God…thanking each other.” Religious overtones are heavy and curiously, there doesn’t seem
to by any turkey consumption. The one place in Oz the holiday is really celebrated is on
lonely Norfolk Island, 900 miles offshore of the mainland. Thanksgiving was introduced
there by American whaling ships (along with rats and syphilis). Probably with all the great
weather and outdoor activities, Aussies have better things to do.
It is traditional at an American Thanksgiving to say what you are thankful for.
I am thankful you have read this far.
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Emerging Markets Illustrated, November 22, 2012
Emerging Markets Illustrated
The Last Page
Resolving to surprise her husband, an investment banker’s wife pops by his office. She finds
him in an unorthodox position, with his secretary sitting in his lap.
Without hesitation, he starts dictating, “….and in conclusion, gentlemen, credit crunch or no
credit crunch, I cannot continue to operate this office with just one chair!”
Derek Hillen, CAIA
Mirae Asset Securities
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Emerging Markets Illustrated, November 22, 2012
Emerging Markets Illustrated
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Emerging Markets Illustrated, November 22, 2012