Asia-Pacific overview 1
2 Asia, by country Country China Hong Kong India Indonesia Korea Malaysia Singapore Taiwan Thailand The Philippines Weight in MSCI Asia 25% 11% 9% 4% 21% 5% 7% 15% 3% 1% Key sub-sectors Financials (37%), Energy (18%), Telecom (13%) Three largest stocks China Mobile, CCB, ICBC Financials (61%), Utilities (14%), Cons Disc (13%) AIA Group, Sun Hung Kai Prop, Hutchison Whampoa Financials (27%), Technology (16%), Energy (12%) Infosys, Reliance Industries, HDFC Financials (32%), Cons Disc (15%), Cons Staples (13%) Astra International, Bank Central Asia, Telekomunikasi Indo Technology (25%), Cons Disc (18%), Industrials (16%) Samsung Electronics, Hyundai Motor, POSCO Financials (3%), Industrials (15%), Telecom (12%) CIMB Group, Maybank, Sime Darby Financials (47%), Industrials (25%), Telecom (12%) Singapore Telecom, DBS Group, United Overseas Bank Technology (55%), Financials (15%), Materials (14%) TSMC, Hon Hai, Chunghwa Financials (38%), Energy (26%), Materials (13%) PTT, Siam Commercial Bank, PTT Exploration Financials (42%), Industrials (23%), Utilities (12%) SM Investments, PLDT, Ayala Land Trading data Market cap (USDbn) 2,469 2,31 1,6 377 91 261 642 645 33 214 Average daily trading volume* (USDm, 12 months) 17,155 8,85 2,744 427 5,397 525 1,52 3,346 919 153 Performance since 1 January 2 Absolute 58% 11% 141% 271% 135% 128% 22% -32% 162% 5% Relative to MSCI Asia 1.4x.3x 3.5x 6.6x 3.3x 3.1x.5x -.8x 4.x 1.2x Correlations (5-year) with MSCI Asia.91.93.85.84.82.73.91.89.8.66 M1.62.52.53.15 -.3.53.26.61.67.2 Country exports.27.59.47.69.49.49.68.76.74.68 US ISM.42.71.58.67.76.74.7.73.82.67 Key sector stats EPS growth 211 (%) 9.9 22.4 8.9 2-15.1 7.1-5.8-27.6 14.9 4.5 Long-term average PE (x) 12.8 14.9 13.8 12.8 11 15.9 15.9 17.7 19.2 14.7 12-month forward PE (x) 8.2 13 12.4 11.6 8.3 13.8 12.1 12.7 1.2 15.6 Long-term average PB (x) 1.6 1.8 2.8 2.8 1.2 2.1 1.8 2.4 2 1.9 12-month forward PB (x) 1.3 1.1 2 2.6 1.1 1.9 1.3 1.5 1.9 2.5 Long-term average ROE (%) 12.5 12.1 2.3 21.9 1.9 13.2 11.3 13.6 1.4 12.9 12-month forward ROE (%) 15.9 8.6 16.1 22.6 13.4 13.9 1.6 12.1 18.5 16 Investment issues Themes, characteristics High degree of governmentled price arrangements in various industries *The trading data and market cap data for the country stock exchanges Source: MSCI, HSBC estimates as of mid-june 212 Dominated by property and banks, so very interest rate sensitive. One of the most volatile markets in Asia Substantial rerating in last decade. Market volatility is significantly higher than earnings volatility One of Asia s most open democracies. Elections in 214. Strong income growth in rural areas on back of commodities boom Cyclical market populated with sectors such as technology, autos and shipbuilders. Highly export led market A defensive market. Not very liquid. Current account surplus implies little reliance on foreign capital. Domestic investment funds are large owners Stable market with wellcapitalised banks and strong regional real estate players Cross-Strait relations between Taiwan and China a recurring theme Strong income growth in rural areas on back of soft commodities boom Software outsourcing and remittances from overseas workers are two key themes. Strong income growth in rural areas on back of commodities boom Asia-Pacific Equity Research
Asia, by sector Sector Consumer Discretionary Consumer Staples Energy Financials Healthcare Industrials Materials Technology Telecom Utilities Weight in MSCI Asia ex Japan Key sub-sectors Korea and China autos, retailers 1% 6% 7% 31% 1% 1% 7% 18% 7% 4% Food & Beverage Oil refiners, distributors Banks, real estate and insurance Generics, hospitals Transport, shipbuilding Steel, Coal Hardware, software Telecoms, Internet, Media Electric and gas utilities Trading data Average daily trading volume* 1,285 493 776 3,121 136 1,275 1,112 2,368 587 275 (USDm,12 months) Market cap (USDbn) 234,257 135,514 178,21 751,842 21,355 236,283 175,848 446,643 157,1 91,661 Performance since 1 January 2 Absolute 133% 198% 361% 64% 12% 11% 16% % -29% 57% Relative to MSCI Asia 3.3x 4.9x 8.8x 1.6x 2.5x.3x 2.6x.x -.7x 1.4x Three largest stocks Hyundai Motor, ITC, KT&G, CNOOC, China Con.Bank, Sun Pharma, Hutchison Whampoa, POSCO, China Samsung Elec, China Mobile, CLP, HK and Hyundai Mobis, Kia Motors Want Want PetroChina, Reliance ICBC, AIA Group Dr Reddy s, Celltrion Keppel Corp, Hyundai Heavy Steel, LG Chem TSMC, Tencent Singapore Telecom, Chunghwa CH Gas, Power Assets Correlations (5-year) with MSCI Asia.94.85.96.98.78.96.94.86.78.85 M1 Asia.7.52.38.6.56.43.51.73.5.43 Key sector stats (avg 211-12 numbers) Sales growth 15% 21% 16% nm 16% 15% 17% 16% 12% 1% Net income growth 25% 18% 8% nm 25% 6% -1% 21% 9% 2% ROE 2% 19% 17% nm 18% 6% 11% 16% 17% 12% Key sector themes Industry structure Highly competitive. Companies building brands, with varied success Food inflation puts pressure on margins, but industry leaders pass this on over time to consumers Oil a key driver, which is positive for exploration plays but pressures margins for refiners Banking penetration a driver in ASEAN. In CH, capital requirements and bad debt (LGFVs) a recent theme Asia healthcare is focused on generics, but looking to develop so-called biosimilars when US/EU patents on biologic products expire Very varied sector. Low competition in high-end oil rigs. Shipbuilding highly competitive Steel is Hardware consolidating, companies coal is an already struggle with consolidated margins, but market niches within hardware tech growing fast. Examples: Apple ipad makers, AMOLED display Mobile penetration rising in Indonesia. In India, industry is starting to consolidate. In China, new viable global technologies will drive growth With rising energy costs and stable (Chinese) electricity prices, the utilities sector is facing a margin squeeze Asia-Pacific Equity Research *The trading data and market cap data for the MSCI Asia ex Japan sector indexes Source: MSCI, HSBC estimates, as of mid-june 212 3
Asia-Pacific overview Introduction In the last two decades Asia has experienced three large corrections. The first crisis (1997-98) was regional and was caused by regional imbalances in currencies, balance sheets and capital deployment. The other two the end of the tech bubble in 21 and the financial turmoil of 28-9 were driven by global events. The chart below indicates that Asia is a volatile region. In this chapter we aim to look at the drivers of this volatility market structure, correlations, earnings, valuations and fund flows. Market structure Herald van der Linde* Deputy Head of Research, Asia-Pacific, and Head of Equity Strategy, Asia-Pacific The Hongkong and Shanghai Banking Corporation Limited +852 2996 6575 heraldvanderlinde@hsbc.com.hk *Employed by a non-us affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations Market structure and liquidity are important in explaining volatility in Asian markets. Illiquid markets experience more volatility. In markets with low volumes, prices often fall quickly when investors rush for the exit. Asia s largest stocks are two electronic giants (Samsung Electronics and Taiwan Semiconductor), a mobile phone operator (China Mobile) and two banks (China Construction Bank and ICBC). The top-1 stocks account for 2% of the region and financials and technology are the two dominant sectors, accounting for almost half of total Asian market capitalisation. The most concentrated markets are those where the top-1 stocks carry the largest accumulated weights in the market Thailand, Indonesia and the Philippines. China, India and Taiwan are the most diversified markets. Interestingly, if we rank countries by market liquidity, a similar story emerges. Smaller countries (think ASEAN) tend to be much more concentrated around a few large, liquid stocks, while larger markets (Hong Kong, Korea, China) have a better spread of sectors and stocks. MSCI Asia ex Japan index 7 6 5 4 3 2 1 Asia ex Japan 9 91 92 93 94 95 96 97 98 99 1 2 3 4 5 6 7 8 9 1 11 12 Largest stocks in MSCI Asia ex Japan Stock rank Stock name Index weight 1 SAMSUNG ELECTRONICS 5% 2 TSMC 3% 3 CHINA MOBILE 3% 4 CHINA CONSTRUCTION BANK 2% 5 ICBC 1% Top-5 14% 6 AIA GROUP 1% 7 CNOOC 1% 8 HYUNDAI MOTOR 1% 9 TENCENT HOLDINGS 1% 1 PETROCHINA 1% Top-1 6% 4
Country weights of top-5 / top-1 stocks Asia ex Japan (AEJ) market Top-5 Top-1 Daily average stock market turnover (USDbn) Current 5-year average Thailand 45% 73% Indonesia 51% 72% Philippines 42% 68% Singapore 49% 65% HK 36% 56% Malaysia 35% 55% Korea 41% 53% China 35% 52% India 35% 51% Taiwan 34% 45% China 19.5 23.6 HK 7. 9.2 Korea 4.1 5.3 India 2.1 4. Taiwan 2.5 3.7 Singapore.9 1.2 Thailand 1..7 Malaysia.5.5 Indonesia.4.4 Philippines.2.1 Asia ex Japan 38.5 48.4 Note: Ranked by 5-year turnover Source: Bloomberg, HSBC Market structure and liquidity are important in explaining volatility in Asian markets. Illiquid markets experience more volatility. In markets with low volumes, prices often fall quickly when investors rush for the exit. Meanwhile, markets with large, dominant stocks are influenced by the share price performance of those shares (e.g., TSMC in Taiwan, Samsung in Korea). Measured over the last five years, the most volatile markets are Hong Kong, China, India and Indonesia. The least volatile are Malaysia and Singapore. Another way to examine volatility is to segment it into two components earnings (or forecasts) and valuations. This is illustrated in the table below (the variation in valuation is defined as the difference between market volatility and earnings volatility). Earnings and index volatility MSCI indices Earnings volatility Market volatility 1 years 5 years 1 years 5 years Malaysia 18% 26% 16% 17% Australia 12% 1% 17% 2% Japan 81% 98% 22% 24% Philippines 24% 18% 25% 26% Singapore 27% 17% 22% 26% Thailand 46% 32% 25% 29% Taiwan 51% 63% 26% 29% Korea 41% 4% 26% 29% Indonesia 26% 18% 3% 31% India 13% 16% 29% 34% China 16% 18% 32% 38% Hong Kong 29% 35% 25% 41% Asia ex-japan 23% 25% 23% 28% Asia Pacific 76% 62% 2% 23% Note: Ranked by market volatility over 5 years. Earnings volatility is high in Hong Kong, Korea and Taiwan. Volatility in valuations (i.e., changes in the PE for that market) is highest in Hong Kong, China and India. Markets with the lowest valuation volatility are Malaysia, Hong Kong and Singapore (the latter two are both developed markets under MSCI classification). 5
Correlations So far we have briefly examined market structure, liquidity and volatility in earnings and valuations to explain market behaviour. Another factor that drives market volatility is the sensitivity of markets to global and domestic economic factors. To examine this further, we correlated various macro (using ISM and country exports as a proxy for global macro conditions and M1 money supply as a proxy for domestic economic conditions) and fund flow factors with the market. The results show that the countries most exposed to global economic conditions are Singapore, Taiwan and Hong Kong. In Korea this exposure to global factors appears low. However, the market is dominated by the technology sector and Korean companies are part of a large global technology food chain. Hence, the low correlation masks a relatively large domestic sector within the market that is rather insulated from global conditions. Indeed, the technology sector in Korea shows a very high correlation with proxies for global growth, such as the ISM index and exports. On the other hand, Malaysia, India and Thailand are more sensitive to domestic liquidity conditions (M1 supply). Note that, in each of these markets, banks and financials play a dominant role in the index composition. Market correlations (since 21) Factors China Korea Hong Kong Taiwan India Singapore Indonesia Malaysia Thailand The Asia Philippines ex Japan Economic factors ISM.56.71.76.76.71.76.72.72.78.67.77 Exports.35.33.6.74.52.54.56.49.59.59.53 Money supply.51..42.63.52.45.7.66.56.22.48 Fund flows past 1 years.51.73.6.2.62.34.72 past 5 years.56.78.66.21.68.36.73 previous 5 years.36.67.51.26.49.37.72 Indices (past 1 years) Asia ex Japan.84.8.9.84.79.87.66.65.71.56 World.72.7.77.67.7.8.61.5.62.49 Source: MSCI, Thomson Reuters Datastream, Bloomberg, HSBC Earnings Asian earnings are currently growing above trend, primarily driven by above trend growth in India and China, and to a lesser extent Southeast Asia. Asian earnings grew on average 11% annually in the last decade. Somewhat unfortunately for many investors, the smaller and less liquid markets have shown the best earnings growth in this period Indonesia, the Philippines and Thailand. Still, larger markets such as China and India have made it to the top three. 6
Actual vs trend earnings MSCI Asia ex Japan annual EPS growth 5 4 3 2 2% 15% 1% EPS Grow th CAGR AEJ=11% 1 5% Sep-99 Jul- May-1 Mar-2 Jan-3 Nov-3 Sep-4 Jul-5 May-6 Mar-7 Jan-8 Nov-8 Sep-9 Jul-1 May-11 Mar-12 Actual Earnings Trend % China Philippines India Indonesia Thailand Singapore Hong Malaysia Taiwan Korea If we look at how accurate analysts have been in forecasting this growth, it becomes apparent that Asian earnings have continuously been subject to upward revisions in the last decade, with the exception of 29 when the global financial turmoil made analysts cut their numbers. Earnings momentum: AEJ vs MSCI AEJ returns 12-month forward EPS growth* vs MSCI AEJ Index (%) 4 3 2 1-1 -2-3 -4 12 9 6 3-3 -6-9 (%) 3 25 2 15 1 5-5 12 9 6 3-3 -6-9 24 25 26 Momentum 27 28 29 21 211 212 MSCI AxJ Index y-o-y (RHS) 24 25 26 27 EPS grow th 28 29 21 211 212 MSCI Ax J Index y -o-y (RHS) Note: Earnings momentum is defined as the 6 month % change in 12M forward EPS forecast *Percentage change in trailing 12-month and 12-month forward EPS We can now ask the question do analysts in Asia have a good insight into market behaviour or earnings? Analysts earnings upgrades and downgrades as well as their recommendation changes correlate well with the market. Still, this does not answer the question. Indeed, one has to be careful with the causal relationship is the market moving higher because analysts are upgrading earnings and recommendations, or vice versa? Here, evidence if more mixed. Markets were falling in late 27, well before analysts started to cut their numbers (but then again, valuations were also high in 27). However, there is also evidence that analysts earnings forecasts and ratings do matter. In 29, for example, analysts earnings forecasts and stock recommendations were raised before the market rallied from its bottom. 7
Upgrades as % of total earnings revisions* AEJ vs MSCI AEJ returns Recommendation consensus score (%) 8 7 6 5 4 3 2 1 24 25 26 27 28 29 21 211 212 % upgrades MSCI AxJ Index y-o-y (RHS) 12 9 6 3-3 -6-9 3. 2.8 2.6 2.4 2.2 2. 1.8 Analysts feeling more bearish Analysts feeling more bullish 94 95 96 97 98 99 1 2 3 4 5 6 7 8 9 1 11 12 Recommendation consensus score (RCS) Av erage ±2SD *Number of EPS estimates up as a % of total number of revisions in estimates Note: the recommendation consensus score (RCS) assigns a score of 1 to each buy recommendation, 3 for hold and 5 for sell. This is also confirmed by looking at the recommendation consensus score (RCS) analysts were bullish throughout 29 before the market rallied. Indeed, they turned more cautious while the rally continued. Still, one has to be careful with this. In Korea, analysts are more optimistic than elsewhere the number of Buy ratings has been consistently much higher in the last decade than elsewhere in Asia. But it can be argued that at least in Asia, analysts views do (sometimes) matter. Valuations In the last decade, Asia ex-japan has traded on an average 12.3x earnings, with Hong Kong being the most expensive market. Korea typically trades at a 3% discount to the market, presumably a reflection of complex Korean ownership structures, crossholdings within conglomerates and its proximity to volatile North Korea. Return on equity (ROE) in Asia has been relatively stable across the region at 15%, with the sole exception of 28 when they fell to 1%. PB ratios, however, continued to rise in the early 2s to peak in 27. This rerating of Asian equities (e.g. rising PBs while ROEs remained relatively stable) is also visible in PE ratios, which rose quickly over 22-7. Forward PE, by market Asia ex Japan: Earnings and bond yields PE now Avg 21-12 % diff Avg 1993-212 % diff China 8.2 12.5-34% 12.8-36% HK 12.8 15.7-19% 14.9-14% India 11.9 14.1-15% 13.8-14% Indonesia 11.6 1.2 14% 12.8-1% Korea 8.3 9.2-1% 11. -24% Malaysia 13.8 14.1-2% 15.9-13% Philippines 15.8 14. 13% 14.7 8% Singapore 12. 14.5-17% 15.9-25% Taiwan 12.9 14.2-9% 17.7-27% Thailand 9.8 1.5-7% 19.2-49% Japan 1.7 18.3-42% 28.9-63% Australia 1.5 13.9-24% 14.5-28% Asia ex-japan 1. 12.3-19% 14.2-3% Asia Pacific 1.4 15.3-32% 23.6-56% 14 12 1 8 6 4 2 BY EY 1 2 3 4 5 6 7 9 1 11 12 Source: MSCI, Bloomberg, Thomson Reuters Datastream, HSBC 8
Part of this rerating can be explained by lower market risk. Bond yields have at times declined, reflecting lower sovereign and corporate risk. Thus, it can be argued that for a long time Asia offered excellent value. Valuations rose as risk fell and earnings were upgraded. However, in late 26, valuations started to reach excessive levels of optimism. By that time, Asia was trading at PEs of close to 2x almost twice the average. A correction was to come in 28-9. Asia ex Japan: PB vs ROE/COE (12-month forward) Asia ex Japan PE band chart 3. 2.5 2. 1.5 1..5 PBR ROE/COE 1 9 8 7 6 5 4 3 2 1 Price level 2x 15x 1x 5x 2 21 22 23 24 25 26 27 28 29 21 211 212 May-1 May-2 May-3 May-4 May-5 May-6 May-7 May-8 May-9 May-1 May-11 May-12 Source: MSCI, Thomson Reuters Datastream, Bloomberg, HSBC As the chart indicates, Asian equities have traded in a 1-2x PE band, with valuations only below 1x during the financial turmoil in 28-9 and coming close to 2x when Chinese equities rocketed in 27. We have also looked at sector valuations across Asia. Interestingly, the spread in valuations amongst sectors is about equal to the differences in valuations between countries. 12-month forward PE vs 1-year average and standard deviations from average Current PE Rolling 1-yr avg Rolling 1-yr SD # Standard deviation from average Energy 8.15 1.1 2. -.9 Materials 9.5 9.6 2.. Industrials 1.8 12.9 2. -1.1 Consumer Discretionary 9.6 11.4 1.9-1. Consumer Staples 16.8 14.7 2.6.8 Healthcare 18.2 17.7 3.1.2 Financials 9. 12.8 2. -1.9 Technology 11.2 13.3 4.4 -.5 Telecom 12.2 12.2 1.9. Utilities 13.4 12.8 2.3.2 MSCI Asia ex Japan 1.2 12.1 1.7-1.1 However, taking traditionally low valuation sectors (energy, materials), there is a marked difference. Asian sectors trade closer around some average while country valuations can differ widely. This is another indication that country factors matter more than sectors in Asia. Thus, when thinking about asset allocation in Asia, spend more time on country analysis and worry less about sectors. 9
Fund flows Cumulative foreign institutional funds since 2 in AEJ* Cumulative buying since January 2 $ bn 25 2 15 1 5 Asia ex -Japan USDbn India 1.2 Taiwan 72.4 Indonesia 21.3 Thailand 6.4 Philippines 5.4 Korea -1.2 Total 24.4 Source: Bloomberg, HSBC 2 21 22 23 24 25 26 27 28 29 21 211 212 *Korea, Taiwan, India, Indonesia, Thailand and the Philippines Source: Bloomberg, HSBC In the last decade, investors have added USD24bn to their holdings in Asia (ex-japan). However, there is a wide divergence in where this money was allocated. On a 1-year basis, investors have taken money out of Korea, kept their investments in Thailand and the Philippines relatively stable but added significantly in both India and Taiwan. But in doing so, they have met investment limits in certain markets (see table below). Media is a sector where foreign investments are highly restricted in most countries and even forbidden in China and the Philippines. Banking is probably one of the most open sectors in Asia, closely followed by mining and oil & gas. Singapore is open to investments in all sectors aside from media and transport. The most restrictive with foreign investments are Thailand and the Philippines. Particular sectors (outside media) where limitations are also in place are Indian insurance and Malaysian electricity. Foreign equity ownership limits (1 = full foreign ownership allowed) Sectors China Korea India Singapore Indonesia Malaysia Thailand Philippines Mining, oil and gas 75 1 1 1 98 7 49 4 Agriculture and forestry 1 1 5 1 72 85 49 4 Light manufacturing 75 1 82 1 69 1 87 75 Telecommunications 49 49 74 1 57 4 49 4 Electricity 85 85 1 1 95 3 49 66 Banking 63 1 87 1 99 49 49 6 Insurance 5 1 26 1 8 49 49 1 Transportation 49 8 6 47 49 1 49 4 Media 4 63 27 5 65 28 Source: World Bank Investing across the borders October 21 1