2024-01-12 11:23:51 ET
Summary
- BlackRock's iShares Hong Kong ETF had a poor performance in 2023, with Hong Kong's Hang Seng Index declining for four consecutive years.
- In times like this, it is important to hold "quality stocks".
- We examine the top 10 holdings in EWH looking for quality.
- Many of Hong Kong-listed companies offer deep value combined with good dividend yields.
Investment thesis
In our last article "EWH: Hong Kong Is Open For Business , back in December of 2022, we changed our stance from a Hold to a Buy
However, 2023 was certainly not the year to be invested in BlackRock's iShares Hong Kong ETF ( EWH ).
Hong Kong's Hang Seng Index was the worst major performer in the region, having had four straight years of declines after losing nearly 14% in 2023.
As with so many other buy stances we give, we need patience to see it come to fruition.
The most important thing we as investors can do is to ensure that we pick quality stocks and make sure we do not overpay to get a piece of it.
In GMO's Quarterly Letters, Ben Inker their Co-Head of Asset Allocation, argues both in their Q1 and Q4 letters that " quality stocks have both outperformed over the long haul and protected during market drawdowns, making them uniquely suited for this type of environment"
And it is the topic of "quality stocks" that we want to explore here
Can the stocks in EWH be described as quality stocks?
Quality stocks - or not?
We need to start by determining what are the criteria for a company to earn this fine "stamp of approval". Since the argument came from GMO, we will try to use their definition and comment based on our judgment.
These were GMO's criteria:
- Sustainable competitive advantage, which is often referred to as a moat.
- High, and stable profitability over long periods.
- Low leverage.
GMO runs a more complex Value Model that considers other fundamentals and quantitative analyses, but we can use these 3 main points. In addition, we like to look at the share price in relation to the company's net tangible book value.
Let us just focus on the top ten in their portfolio, which consists of 64% of the portfolio.
It is our opinion that AIA Group, HK Exchange, and Techtronic are not of the same quality caliber as the rest of the top ten holdings.
AIA Group's life insurance faces stiff competition in Asia from the likes of China Life, Prudential, Great Eastern, and HSBC Insurance to name a few.
HK Exchange has a moat as far as the monopoly status it enjoys within Hong Kong. However, although being consistently profitable, it is too expensive. With a CAPE of 36 and a yield below what you can get on risk-free investments, we do not understand why anyone would want to own these shares at their present price level.
Galaxy Entertainment is an owner and operator of casinos and hotels in Macao. Not a good business to be in if people are unable to visit them.
Galaxy Entertainment - EPS 10-years history (Data from Galaxy. Graph by author.)
The big drop in earnings for Galaxy can be explained by the tough travel restrictions during the pandemic. This should improve in 2024, as we can expect a normalization in gaming revenues going forward.
From the rest of the companies, there are some deep value propositions that we cover here in SA that we do like.
They are in particular CK Hutchison Holdings ( CKHUY ) and Sun Hung Kai Properties ( SUHJY ). None of the companies are having a particular competitive advantage over their peers. It is a competitive business. However, they do show consistent profitability, and their shares are now priced very favorably in terms of price to value. They also have very healthy balance sheets.
As such, we consider these companies as "quality companies".
Risks and Conclusion
A year ago, we concluded that there were good reasons to be optimistic about a potential revival of the economy in Hong Kong and China after the pandemic .
Things are certainly much better than what it was. However, China is still struggling with many issues that keep the animal spirit away.
What happens in China, matters a lot to what will happen in Hong Kong, too.
Exports from many industries are down. Consumers and businesses are not confident about the future. The only bright side is automobiles, which increased exports by 62% last year.
Everybody knows that the real estate sector is suffering too. This has been a major pillar of growth in the past.
A continued risk to the thesis is the international sentiment of doing business and living in Hong Kong. If this deteriorates further year by year, Hong Kong's relevance could become less important.
At the beginning of 2023, many of the largest banks on Wall Street, including JPMorgan Chase ( JPM ), Citigroup ( C ), Bank of America ( BAC ) and Morgan Stanley ( MS ), expected a strong year for Chinese stocks. Goldman Sachs ( GS ), even called for a 15% upside. They were all wrong on the timing .
Perhaps 2024 will be the year when their earlier thesis unfolds.
But to perfectly time a bottom, or top, of a market is futile. We do think the stock market in Hong Kong is going to roar back. We just don't know when.
For the most part, EWH contains "quality companies". We therefore maintain our Buy stance on it.
For further details see:
EWH: Will Hong Kong Stocks' Poor Performance Last Year Reverse This Year?