The growth of the Asian middle class is one of the biggest themes in world investing and its dominance looks set to continue gathering momentum – it is estimated that this demographic will grow from approximately 600 million today to between 2.5 and 3 billion over the next 20 years.
Roddy Snell, manager of the Baillie Gifford Pacific fund, said that this growth is being accelerated through technology and as a result the top three holdings in his portfolio are those that are helping to facilitate – and benefit from – this enormous shift.
Here Snell reveals why he believes the fundamentals for each one look so compelling at the moment.
Tencent
Tencent began as a gaming business and still makes 70 to 80 per cent of its profits from this area. The company has been one of Baillie Gifford Pacific’s best-performing stocks over the past decade and doubled in value last year, but rather than take profits Snell has maintained it as the largest position in his portfolio. He said this is down to the simple reason that, despite its size, “it is still blowing the lights out”.
“The question we always get asked, particularly after last year when the stock doubled, is ‘what’s still left for the business?’” he said.
“A couple of points. The first is that despite its size, the company is still increasing operating profits by about 60 per cent year-on-year.
“While most of that is coming from gaming, the real value of Tencent in the long term is through its WeChat messaging app – that’s China’s equivalent of Whatsapp or Facebook Messenger, but it’s much more advanced.
“WeChat is effectively how users access the internet in China. You can check out ‘moments’, which is like your Facebook wall, you can order a taxi, it is linked to WeChat Pay and WeChat Wallet – which is the bank – you can invest your money in funds, you can do your shopping and so on.
However, Snell said Tencent has yet to monetise WeChat – according to Facebook’s most recent set of quarterly results, it received approximately $100 a user, while WeChat received less than $5.
“Given the enormous and vastly superior usage of Tencent, you’ll be able to get at least what Facebook does per user,” Snell continued.
“But say it only receives half: $50. That’s 800 million users, so that’s about $40bn of revenue, probably about $30bn of net profit. So just by monetising one asset, it could see its net profit triple or quadruple.”
Snell said that while there is this huge amount of untapped potential in Tencent, the issue is when the company will decide to monetise this asset. At the moment its aim is to get to 1 billion users and ensure that the user experience is superior.
“This might take two to five years, we are not sure, but because of our time horizon we are happy to wait,” he added.
Samsung
Snell also likes a couple of the companies that operate under the Samsung name. First of all, he described Samsung Electronics as a “fascinating business” that is often misunderstood by the market, with many analysts failing to look past its handset operations.
“Actually, the key value of Samsung is that it now controls all the components that go into mobile computing,” the manager explained.
“It is Number One in computer memory such as DRAM, it’s got a monopoly position in OLED, and it has invested more than $150bn in capex over the past five years, increasing its competitive moat. You know, no tech company comes close to that type of spending.”
Snell said that such is Samsung’s position in the market, it has significant control over what many people assume to be the dominant player.
“The reason that the iPhone X went up in price is not because Apple wanted to increase it, but because it couldn’t get the components cheaply enough off Samsung,” he added.
“So you’ve got a company dominating the components and the fastest growing parts of hardware technology, trading on about seven times earnings with a third of the market cap in cash. It just looks ridiculously cheap to us.”
However, Snell said his pick of the Samsung companies is Samsung SDI, a totally separate stock that he also owns. The company develops renewable energy and energy storage systems such as batteries for electric vehicles, but the manager said its real value is in OLED.
“It has a stake in Samsung’s OLED business,” said Snell. “They both own something called Samsung Mobile Display. And the great thing about OLED is they have a monopoly position, no one else is investing money. Samsung has put about $40bn in over the past five years. All the equipment is proprietary, so no one else can get it.
“And display is a $100bn market. OLED is far superior and should eventually be cheaper than LCD. I think it might get a 50 per cent share of that in the next five or 10 years. So in our view, Samsung SDI’s stake in Samsung’s OLED business is worth between $15bn and $30bn. The market cap of SDI is less than $15bn. Plus you’ve got all the other very exciting businesses as well.”
Alibaba
Alibaba is the dominant company in the rapidly developing Chinese e-commerce market. It operates under a marketplace model and collects revenues from commissions, marketing services, subscription fees, cloud computing and other value-added services.
“The opportunity in China in e-commerce remains substantial, with traditional bricks and mortar retailers likely to be significantly disrupted,” said Snell and co-manager Ewan Markson Brown in a note to investors last year. “An entrepreneurial management team, strong cash generating capacity and an industry-leading position combine to make this an attractive investment opportunity.”
Two other Baillie Gifford managers, James Anderson and Tom Slater of the Scottish Mortgage Investment Trust, have spoken at length about their optimism surrounding Alibaba.
“If you go to the biggest day of Chinese retail, Singles Day, there are $25bn of sales on Alibaba’s website,” said Slater. “If you got every website in the US on Cyber Monday, they took $6bn.”
However, Anderson said that the scale is not the point – at the moment, Alibaba is using these sales as a stress test for the future: “In about eight years’ time, Alibaba thinks it will be dealing with such volumes every normal day – around 10 to 12 times current average levels,” he explained.
“Alibaba recently celebrated its 18th birthday. Revenue growth was 61 per cent in the quarter to September 2017. As the company points out, China’s per capita GDP has compounded at an annual rate of 14 per cent over the last 18 years. With its help, China now possesses the most advanced mobile internet technology in the world. China’s physical infrastructure is also modern and often superb. Education levels are generally high. Social solidarity is strong. So why would China stop growing?”
However, Ritu Vohora, equities investment director at M&G, issued one word of warning about China’s internet stocks: “The BATs [Baidu, Alibaba and Tencent] in Asia are great companies, but the market is pricing in the same level of growth for the next 30 years. Is that sustainable?”