Chinese Bargains Thrown Out With The Tech Bathwater
The market is aflutter with the current CCP crackdown on China tech and the attached sell-off in mega-caps Alibaba and Tencent. The problem is that these former market darlings were egregiously expensive at former highs and while the plunge has helped with their valuation somewhat, it's not clear that they are outright bargains yet.
Luckily, there are a hapless band of Chinese value stocks that were already cheap before, have also fallen significantly despite any direct government intereference and represent outstanding value today.
I have no idea how BABA and TCEHY will fare from here, they appear oversold, but as often, my preference is for stodgy, cheap, cash-flowing companies at some of the cheapest prices in EM value's history. Below I discuss three I am following.
Melco International Development- 200.HK
Melco is a HK$15b holding company based in Hong Kong, whose major asset is its majority 56% stake in NASDAQ-listed Melco Resorts and Entertainment (MLCO)- a resort, casino and gaming company with operations in Macau, Manila and soon to be Cyprus.
The company has been led by the respected Hong Kong-born, Canadian-raised businessman Lawrence Ho, who has controlled it since 2001 and took the chairman/CEO role in 2006, aged 29. Ho is familiar to Australians for his decade long partnership with James Packer through Melco-Crown and is the son of Stanley Ho, also a Macau gaming billionaire.
Melco had already been crushed by the pandemic due to the closure of its resort facilities and abrupt halt in tourism, with revenues down 70% in 2020 from a year before. The stock price followed suit, down 50% in the inital Covid carnage, before staging a strong rally over H2 of last year.
The government's recent crackdowns have seen its market value fall to new lows again with corruption clamp downs seen as a direct hit to Macau's gaming profitability. At current market cap, Melco is priced at an EV/adj '19 EBITDA of an astonishing 3.8x (Net debt at Dec 31- HK$32b. The company did add debt through H1 this year though, as although it hasn't reported yet, its subsidiary MLCO has recorded a $700m (HK$5.4b) addition to net debt at Jun 30.
Melco's Cyprus operations, the City of Dreams Mediterranean, is hoped to open mid 2022 and as Europe's largest premier resort, will add significantly to company revenues, as well as allowing deleveraging after several years of heavy capital commitments. Melco also won a Joint Venture bid in June to develop a complex in mainland China's Guangdong province, as part of the Greater Bay Area initiative. Melco's contribution will primarily be a theme park which will be operational by 2025.
Like many businesses hit by Covid, Melco will suffer the longer travel restrictions remain in place and if vaccines prove less effective than hoped, but if you believe travel will return to normal over the next couple of years and in the Chinese middle-class growth story, there are very few companies with as much upside to the theme, in my view.
Additionally, Lawrence Ho has been taking his base salary in shares of the company since February this year and will continue to do so until June next year. This obviously pales next to his $1.5b net worth, but is better than not.
Melco International has been left for dead, when in reality it is merely sleeping, it has considerable growth coming down its pipeline and significant exposure to exploding Chinese tourism and living standards.
CNOOC (China National Offshore Oil Corp)- 883.HK
CNOOC is China's third largest oil producer, behind Petrochina and Sinopec, and it's largest offshore E&P. The company is the marriage of EM value and energy and priced accordingly at 2/3 of book value and a 7.5% dividend yield. Additionally, the company produced 11% of its market cap in earnings and FCF in H1 2021.
Valuations like this don't come along everyday and there is a catch, of course- CNOOC is a Chinese State Owned Enterprise (SOE). Despite this, the company is well run and showed discipline to bring their all-in-production-cost down to a record low of $25.72/barrel in H1 last year, with the oil shock at its worst.
Further, I would argue that in an SOE arrangement, there is no need to shadow box or pretend that the company is independent, as the tech companies are currently attempting. Tencent's extraordinary announcement this week that it would raise its already substantial donation to the government's "sustainable social values" program to $15.5b for this year understandably panicked many investors.
Whereas, when the CCP wants a cash injection from CNOOC it can and does encourage it to raise its dividend. In this way, you are somewhat aligned with the CCP's interests and given the company has modest debt (30% debt/equity) and a low payout ratio (33%), higher dividends are a fairly optimal use of capital.
The company owns immense reserves, with 5.4 billion Barrels of Oil Equivalent (BOE) and produced 278m BOE in H1, with 222m from crude/liquids and the remainder nat gas (323 bcf). CNOOC was spot on its full year production target at June 30, however as only 1/3 of projected capex for the year had already been spent, H2 FCF may not be as favourable. Obviously, this will depend heavily on the Brent price, which is above currently above the $62.38 realised over H1.
CNOOC was the subject of its own panic earlier this year, when it was delisted from the US exchanges for Chinese military links, by executive order. The market value partially recovered before declining in sympathy again to the absurd point where it is now roughly unchanged from last April when the WTI futures pricing briefly went negative.
Greatview Aseptic- 468.HK
I am familiar with Greatview through the 28% stake that my, now bought-out, investment in Jardine Strategic held in the company. Greatview is the global number three in the aseptic packaging industry- providing cartons, packaging and machinery to liquid beverage producers globally- chiefly made up of dairy and juice.
Tetra Pak is the giant of the industry with 2/3 of global market share, while Greatview currently commands 5%. The company isn't purely Chinese exposed, with 30% of 2020 revenue coming from outside the Middle Kingdom, a German manufacturing facility and a Swiss co-headquarters.
There is also a positive environmental story to tell, with aseptic packaging having a lower environmental impact than most other types of beverage containers. Many maufacturers also prefer aseptic solutions due to their lack of need for refridgeration and longer shelf life.
Greatview is a moderately growing, cash gusher that has maintained its expansion while paying out significant dividends during its public life. Revenues grew from 2.2b RMB in 2016 to 3b RMB in 2020 and the current dividend yield is an appealing 8%.
Additionally the company is debt free, with net cash of HK$445m, although there is a potential minor mismatch with their cash held within the PRC and their minimal debt denominated in USD and Euros. Although this is more than offset by the benefit of significant foreign revenues, in the event of a Yuan devaluation.
Also favourable, the original founders still own 16% of the shares and Jeff Bi remains as the long-term CEO.
I would be remit to mention that there are also some risks to the business. Mainly in the form of recent inflation in Greatview's input materials which caused a June profit warning that H1 would earnings would be down 5-12% YoY. Even if these costs prove more than transitory, I expect the company will be able to largely pass them onto customers, but this takes time and they were clearly caught out by rising raw materials and international freight costs. The company has a genuine fortress balance sheet to manage this period.
From a post-pandemic high of HK$4.63 in January, the company has fallen 29% to HK$3.30 today. Removing modest FX gains from net income and net cash from the market cap, Greatview is selling for a 9.5x PE, which I view as exceptionally modest for a company I have high confidence will grow 5% over the medium term, with a fair chance of surprising to the upside. A well-backed, sustainable 8% dividend alone is enough reason to consider an investment in today's stunted return/rate world.
Conclusion
Despite heavy falls, several of the China-tech giants are still trading on multiples that require significant future growth to justify. They may achieve this, but given the unpredictability of the CCP, I believe that anyone who feels certain about these investments is deluding themselves.
They may do well, but aren't appropriate for Buffett's "reach for a bucket, not a thimble" analogy, due to uncontrollable macro factors- no matter how well you think you know the company. Additional issues, such as the offshore VIE model, where it's doubtful that the security owner actually has a legal ownership claim on the company, also muddy the waters.
Fortunately, there is no reason to let a good crisis go to waste, with many other Chinese companies having sold off in sympathy and representing outstanding value, with government interference already more than priced in.
In the case of Melco, you will struggle to find a company with more torque to growing Chinese incomes and the burgeoning middle and upper classes. With CNOOC and Greatview, you have investments that will give outstanding returns based on well-covered dividends alone, with future growth a highly-likely cherry on top.
I always like to write about companies I own and would rather not cover those where I don't have "skin in the game", but as I've been inactive in my portfolio for several months now, I thought would cover a little of my watchlist. All feedback welcome.
Thanks for reading, Guy
Please don’t take this as financial advice. Do your own due diligence and consult a professional advisor, if unsure about your finances.