Poor corporate governance is seen as one of the most challenging issues for the China equity market and one that Bolton has highlighted as being partly responsible for the relative underperformance of his Fidelity China Special Situations trust in 2011 and 2012.
However, by investing in a company from the UK, it is possible for stockpickers to get access to the attractive growth potential of China as well as the benefits of an established market.
In Chinese company Hutchison China Meditech – which focuses on the research, development, production and sale of traditional Chinese medicines – investors have an opportunity to do just this.
FE Alpha Manager Mark Slater (pictured), who runs the MFM Slater Growth fund, has an 8.54 per cent weighting in the stock, making it his second-largest holding.
He says the Chinese healthcare sector is a key growth area in its own right, but believes that the market is overlooking Hutchison’s true value. “We are very keen on Hutchison,” he said. “We were initially attracted to its healthcare division, which is a fairly straightforward growth business with a record of strong earnings and revenue growth.”
“It is also enjoying clearly identifiable drivers of future growth, such as growing consumer spending power, brand strength, an effective sales network, and the fact that the government is prioritising healthcare spending.”
“We still expect this division to deliver earnings growth in the high teens to 20 per cent on average.”
“This division also has around $75m net cash and significant surplus property in two prime city centre locations, which is in the process of being monetised. The eventual proceeds could be worth $200m to $300m.”
“Therefore, even using a conservative P/E multiple for this division, it more than looks after the entire market cap by itself.”
According to Bloomberg, Hutchison China Meditech has a market cap of £315m.
Slater says that the company’s 88 per cent stake in a research and development (R&D) business adds a whole new dimension to the stock, which has yet to be realised by the majority of analysts.
“This business loses money but has a very impressive inventory of drugs, including four that have now been partnered with western household names, including Nestle, to help finance development. Others will probably be developed in-house.”
“These drugs are in the main novel, and address large markets. This division is a market leader in China and is very well-placed to develop drugs for China, which will be much cheaper than western equivalents. In addition, there is the real prospect of a blockbuster or two.”
Slater says that most analysts ignore this side of the business and purely see it as a bonus. He disagrees, believing it could be the target of a takeover bid in the coming years.
“We believe that this division is probably worth substantially more than the company’s market cap by itself,” said Slater.
“How this value is unlocked or validated will be the big story for the next year or so.”
“This division would be a wonderful acquisition for a large pharma looking for growth and new drugs. Given how hot biotech-type issues are on NASDAQ now, it would probably be a popular float, too.”
“All together, we are encouraged that more investors are taking interest in the company and can see valuation support for the shares to move north of £10,” he added.
At the time of writing, Hutchison China Meditech was trading at just over £6 a share. If it does indeed hit £10, investors would bag gains of almost 70 per cent if they bought today.
The stock has already had a good time of late, gaining 41.28 per cent over the past 12 months, compared with 19.97 per cent from the FTSE AIM index.
Performance of stock and index over 1yr
Source: FE Analytics
As the graph above shows, the stock is very volatile and is certainly not for investors with a short-term time horizon.
Bolton (pictured) includes Hutchison China Meditech as one of only two UK-listed stocks in his China Special Sits trust. The other is Fortune Oil, which he held back in the days when he ran Fidelity Special Sits.
He agrees that the company’s R&D arm should not be discounted.
“I think it’s the best drug development company in China,” he said. “The drugs it has been developing are fascinating, and it’s run by some really impressive people.” “It’s got a deal with AstraZeneca which shows how well respected it is, and also with Nestle.”
Hutchison and Nestle entered into a partnership at the end of last year with the aim of bringing traditional Chinese medicines to the consumer market.
“It’s managed to take traditional medicines and make them more mainstream, which is very impressive,” added Bolton.
As well as MFM Slater Growth and Fidelity China Special Situations, MFM Slater Recovery and MFM Bowland – both run by Slater – hold Hutchison China Meditech in their top-10. No other trusts hold it in their top-10, though the Invesco Asia Trust and JPM Chinese IT include Hutchison Whampoa, which is a major shareholder of China Meditech.
Slater says that he is reassured by the presence of Hutchison Whampoa as a 71 per cent shareholder.
“The governance they provide, not to mention connections, property expertise and financial muscle, is a very unusual feature,” he said.
Hutchison Whampoa is an investment holding company, and one of the largest stocks listed on the Hong Kong stock exchange.
