Joanne Wong, executive vice president and portfolio manager of Templeton Global Equity Group, talks to the Hong Kong Economic Journal about three underdogs — China, Europe and the oil sector.
Q: Investors are living in a flood of liquidity. As a value investor, how do you find getting the stocks you want?
A: Stock markets have benefited from strong central bank support and from the extraordinarily low cost of capital. The result has been a largely indiscriminate multi-year rally, with performance driven more by a stock’s perceived risk profile than by the fundamentals. We do not know how long this trend will last but we do know that, historically, stock prices have converged with fundamentals over time. When investors eventually become more selective and stock prices begin to more closely reflect future cash flows, we should be well positioned for value recognition. While the rising tide of the past six years has lifted most boats in global equity markets, delivering tremendous absolute gains, we expect the true merit of our strategy will be revealed as conditions normalize and stocks resume their historical linkage to business fundamentals.
Q: China is an enigma to investors. It faces growing risk of deflation and also a seemingly endless anti-corruption campaign. How will you approach this market?
A: Over the course of 2014, we found selective value in China, although the macro environment remains challenging given significant economic imbalances and a highly politicized business environment, as well as multi-year increases in local government and SOE debt levels. Our focus in China is on finding companies with balance sheet strength, capital discipline and the ability to sustainably generate strong free cash flow. From a bottom-up standpoint, we have found some potential valuation opportunities in Chinese companies that have emerged recently, notably healthcare, manufacturing, and transport companies.
Q: Do you like the auto sector in Asia?
A: Many of the Asian auto stocks we own stand to benefit from increased demand from emerging markets and from continued US and European recovery. These auto companies are undervalued relative to historical metrics and have seen improving margins while increasing capacity and launching new models. Our select holdings also exhibit characteristics such as cost competitiveness and strong balance sheets. The industry is also set to benefit from a global shift to smaller vehicles.
Q: Do you like new sectors such as technology/internet and alternative energy?
A: The alternative energy space is not your typical “value” sector — the industries are still young, making “normalization” a challenge, particularly in solar. However, there are select areas where we see good opportunities when we look at long-term trends. In solar energy, end-user demand growth has been strong and we are starting to see module manufacturers become profitable. Module overcapacity has closed a little, although new capacity additions are yet to pick up from trough levels. With pricing pressure, cost reductions and demand growth running at 10-15 percent annually, this sector does not lend itself well to normalization. We are finding fewer opportunities in wind energy as cost-cutting and growing service revenue are unlikely to justify the share price heights reached recently.
Q: Across the world, the energy sector seems to be unloved. Do you find some value in this sector?
A: We have a contrarian overweight in energy, despite continued turmoil in oil markets. In the energy sector, numerous stocks have recently traded at their lowest valuation levels on record, multiples that we think unrealistically extrapolate industry oversupply and depressed oil prices in perpetuity. Looking at the sector more broadly, no one knows when and at what price equilibrium will be restored to oil markets or what degree of further attrition awaits global energy stocks. Instead of attempting to time the near-term direction and magnitude of complex global energy markets, we focus on the things we can analyze with a degree of confidence, namely, the long-term fundamental prospects of individual energy companies. The relative price-to-book ratio of the global energy sector is at a nadir reached only once in the last century.
Q: Money seems to be flowing into Europe for bargain hunting. Why?
A: We continue to find prodigious bottom-up value in Europe given the low valuation multiples, geographically diverse revenue streams and significant earnings recovery potential of select European corporates. The region remains attractive in both absolute terms and relative to the US where companies with limited scope to continue meaningfully expanding margins trade at historically elevated valuations. Policy is becoming more vigilant, credit conditions are improving and an earnings recovery from depressed levels could be powerful. European stocks continue to look cheap on most valuation metrics and relative to bonds at a time when nascent quantitative easing operations and improving credit conditions could buoy depressed investor sentiment and corporate profits. Conversely, US stocks have rebounded strongly since lows reached after the Great Recession.
Ben Kwok contributed this article.
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