SINGAPORE (Jan 29): William Low, head of global equities at Nikko Asset Management, and Iain Fulton, its investment director, who manage the Nikko AM Shenton Global Opportunities Fund and Nikko AM Global Dividend Equity Fund, are not too worried about the 25 basis point hike in the federal funds rate by the US Federal Reserve in December and the constant unsettling tweeting by US President Donald Trump. “Everything Trump does makes great headlines, but we’re reluctant to adopt our investment strategy around the latest tweet,” jokes Low. “Putting headlines to one side, we’re in a world where capital has moved pretty freely across borders, allowing businesses to be effectively financed by one global cost of capital.”
Companies with robust fundamentals, growth prospects and economic moats should be able to give good returns over the long term despite volatile geopolitics. Geopolitics becomes a problem only if it dramatically alters
discount rates applied to risk assets, Low says. An example of this is if global hegemony shifts from the US to, say, China, or if the renminbi continually displaces the US dollar as the world’s reserve currency. The US dollar remains the world’s reserve currency.
Central banks are gradually shifting their reserves away from the US dollar. The International Monetary Fund included the RMB in its basket of special drawing rights in 2016, giving it a nominal status as an international reserve currency. On Jan 15 this year, the Bundesbank announced it would be including the RMB as part of its foreign exchange reserves. In 2017, the European Central Bank invested €500 million ($808 million) in the RMB. At least 7% of the Swiss National Bank’s reserves comprise the RMB, Australian dollar, Scandinavian kroner and Singapore dollar.
Neither does Low think inflation, which market watchers believe will rise, following the passing of the US tax bill in December, will dramatically alter discount rates in the portfolio’s discounted cash flow models. He says, “We believe in a relatively low growth world in normal GDP terms. We’re not expecting a dramatic shift where households and corporations go on a debt-fuelled consumption binge.”
The Scottish duo are disciplined proponents and followers of stock picking, mainly from a bottom-up approach focusing on value, growth and competitive advantage. Not even the noise around the US tax cut bill, passed in December, is likely to change their investment philosophy. “The key issue for us is, does this stimulate long-term investments and assets or is this a one-time benefit to earnings? That quickly gets discounted and we apply a low multiple to that stream of earnings. That’s how we’re thinking about it in conceptual terms.” Fulton says.
The US federal corporate tax rate will fall to 21% from the current 35%. The big question is how businesses will spend the increase in profits. After the bill’s final passage, Comcast, Boeing and AT&T announced special bonuses and wage increases stemming from the tax. Apple has said it is repatriating around US$30 billion ($39.6 billion) to be invested in the US.
“There doesn’t seem to be much benefit to the repatriation of capital and to then spend that in the real economy.
Some companies have said they will do a mix of share buybacks [and] capital expenditure,” Fulton observes. “For the tech sector, the key issue is repatriation of overseas capital, and what the companies do with it. The second issue is how much R&D and intellectual property these companies have that can be offset against the tax bill.”
The “static” score of the bill — the amount of projected debt added when economic growth is not factored in — shows that the deficit would grow by about US$1.5 trillion in the decade after the bill is implemented. The US Congress’ Joint Committee on Taxation Congress said the bill would boost growth by 0.8 percentage point over the first 10 years it was passed, or around 0.08 percentage point would be added to the GDP growth rate annually.
Asian tech sector
Concerns that the Asian tech supply chain could be disrupted by the US tax bill are probably overblown. Fulton does not expect that the supply chain, built up over decades, will alter dramatically. “For hardware production, it’s very difficult to replace the scale, capacity and expertise in the region, or to divert mass amounts of capex,” Fultonsays. “These companies are going to invest where they see the best returns, and it’s unlikely they will move those production lines because of tax incentives. It’s so well entrenched and there’s so much expertise in the region that I don’t see that changing.”
On the other hand, stock prices did very well last year, and with valuations somewhat stretched, there could be profit-taking, Low suggests. He thinks some of the Asian tech stocks are on the high side. “Whether you’ve a prescriptive view of the market or you’re building a portfolio from the bottom up sensing opportunity for growth and cash flow, all that to a degree gets reflected in the share price.”
Would a combination of higher valuations across Asia and changes in US tax rates and bond yields trigger a rebalancing of the portfolio? Low says, “If there’ve been changes in our portfolio in recent months, it’s because of new opportunities emerging, and exciting ideas. That changes the balance of the portfolio rather than [our having] a prescriptive view of US GDP or tax rates or bond yields.”
The next growth opportunity
Low sees huge potential from the consumer internet. Companies such as Google’s parent Alphabet, Amazon.com and Alibaba Group Holding have diversified from search engines and e-commerce portals into artificial intelligence (AI), machine learning and e-payments. For instance, Alphabet designs and manufactures tensor processing units, which are faster than and seen as an alternative to graphics processing units.
“[Companies in the consumer internet] have been all-powerful in terms of returns. Many of the companies are garnering large amounts of profit share. I guess something we’ve been pondering is the degree to which politicians or regulators, or both, expropriate some of those earnings and when that might happen,” Low says.
He says his funds are looking at technologies that have been developed from the consumer internet, for instance, from the Internet of Things such as 3D sensing and automation that can be used for machine learning and low-level AI, and adopted for industrial applications.
A new trend is quantum computing. The only way to play that is from the hardware side, Fulton says. “We don’t have exposure there because of valuations.”
Share prices of companies that make graphic processing units, such as Nvidia Corp, have already risen over a two-year period. Low says, “These businesses are in a bit of a sweet spot. Machine learning and AI use chips in huge numbers. But we’re buying share prices with expectations of growth. While we want growth, we want growth that is underestimated by the share price.”
One name that Low likes is Red Hat. “The company provides Linux software solutions to customers who want to evolve their cloud technology to combine public cloud and private cloud with an inherent solution provider,” he says. “Red Hat upgrades that tech and also caters for the amazing degree of software that optimises physical assets. We look for interesting names, strong franchises, revenue growth and we think that’s the next leg of growth that will last for several years.”
Unexcited about banks
“Are we excited about banks? The answer is no,” Low says. As he sees it, most banks are inherently stuck with legacy systems, particularly after mergers and acquisitions from different geographies. In addition, a significant amount of disintermediation has been happening with fintech, cashless payments and blockchain — the ultimate disenfranchisement of a trusted central party. “We’re only beginning to see who the ultimate winners are,” Low says.
The only financial services companies in Nikko AM’s global fund are TransUnion and Silicon Valley Bank. TransUnion provides credit services in the US and other countries. Low believes that Silicon Valley Bank has much higher growth drivers than other banks because it is based in California, which is the tech and innovation hub of the US.
“For the traditional float businesses that are making their money out of spreads… the only banks we own are in the US,” Low says. “We felt the combination of merger synergies and underlying credit growth backdrop [in the US] is more interesting and the US banks are well capitalised.”
Healthcare stocks in Nikko AM’s global portfolio
Healthcare carries a weight of 21% in the Nikko AM Shenton Global Opportunities Fund, followed by Financials, Industrials and IT.
Healthcare is seen as a growth sector globally because of the ageing population in developed markets and East Asia. ICON is a global contract research organisation (CRO) that provides drug development solutions and services to the pharmaceutical, biotechnology and medical device industries for FY2018. It announced guidance of revenue in the range of US$1,870 million to US$1,930 million, representing growth of 7% to 10%. Earnings per share (EPS) is estimated to be in the range of US$5.89 to US$6.09, representing growth of 10% to 13%. Free cash flow is expected to be around US$360 million for the year, and capital expenditure at US$50 million.
Lab Corp of America Holdings is a US-based global life sciences company. It is more of a solutions provider, offering comprehensive clinical laboratory and end-to-end drug development services. For the nine months to Sept 30, 2017, the company announced a 2.8% rise in net earnings and EPS to US$561.4 million and US$5.40, respectively. On Sept 1, 2017, the company completed the acquisition of Chiltern, a speciality CRO, for US$1.2 billion. Chiltern will boost LabCorp’s Covance Drug Development (CDD) segment. Chiltern’s FY2016 revenues were US$500.2 million, with US$49.3 million in operating income. On April 25, 2017, LabCorp announced it was expanding its LaunchPad business process improvement initiative to include its CDD segment consisting of two phases implemented over three years.
Officially, Royal Philips — previously a provider of lighting and cooking gadgets such as blenders, rice cookers and air fryers — has morphed into a healthcare products and services provider. Previously classified by MSCI under capital goods, it was reclassified as a healthcare stock by MSCI on Sept 1, 2017, and by FTSE indices in December 2016. Philips is listed on Amsterdam’s Euronext Exchange and the New York Stock Exchange. Although revenue was more or less flat y-o-y for 3QFY2017 at €4.15 billion ($6.71 billion), net income rose 10.4% to €423 million, and free cash flow rose €4 million, to €72 million, largely on lower interest expense. The company forecasts a rise in revenues to €7 billion by 2020, from €5 billion in 2016, representing a compound annual growth rate of 11%.
Sinopharm Group Co is seen as a proxy to China’s huge healthcare sector. It is the largest pharmaceutical company in China, manufacturing and distributing pharmaceutical products, medical equipment and supplies, and other healthcare products. It also manages a network of retail drug stores in major cities in the country via direct operations and franchises to sell pharmaceutical and healthcare products to the burgeoning middle class. For the six months to June 30, 2017, Sinopharm reported a 10.1% rise in net earnings to RMB2,764.6 million ($570.7 million).
A recent addition to Nikko Asset Management’s Global Opportunities Fund is Hong Kong-listed Li Ning (China) Sports Goods Co. It produces and markets sporting goods under the LI-NING brand largely for China. The company was established by Li Ning, a Chinese gymnast who won 103 gold medals and became famous at the 1984 Los Angeles Olympics. It saw revenues rise 11% y-o-y to RMB3,996 million and net earnings surge 67% to RMB189 million in 1HFY2017.
