Invesco Asia Trust has a strong half year

Invesco Asia Trust has announced its interim results for the six months ended 31 October 2016. During the period, the company provided NAV and share price total returns of 33.6% and 37.1% respectively. In both cases outperforming the company’s benchmark index, the MSCI AC Asia ex Japan Index, which the company says returned 32.1%. The superior share price performance reflects a narrowing of the discount during the period (the cum income discount narrowed from 13.1% to 10.7%).

In terms of performance attribution, Ian Hargreaves (the portfolio manager – pictured) says that the Company’s exposure to a selection of Chinese internet companies has contributed significantly to relative outperformance. In particular NetEase, the second largest holding in the portfolio, enjoyed strong share price gains on earnings upgrades stemming from its continued success in launching new mobile games in China. He says that, consequently, they decided to take some profits by trimming the holding, reflecting the large size of the position in the portfolio. However, in his view, the shares remain reasonably valued given NetEase’s track record of strong execution in a fast-growing industry and the pipeline of new games to be launched in 2017. He says that other shareholdings in the Chinese internet sector had mixed results over the period. Baidu’s shares fell after an incident involving healthcare-related ads on the search engine’s results. New search-advertising rules have negatively impacted Baidu’s earnings so far this year, but Ian says that they believe there is unlikely to be any long-term impact on its business prospects. China’s leading internet media company, Tencent, rose strongly over the past six months and made a positive contribution to portfolio performance although Ian says that it detracted from relative performance due to the portfolio being mildly underweight relative to the index. Tencent derives the majority of its earnings from online games so, in combination with NetEase, the Company has a significant exposure to this area. Ian says that they also believe Tencent can continue to diversify as the company successfully sells more services to its large user-base of the Chinese social networking app, WeChat, and capitalises on the advertising opportunities.

Ian says that the company’s exposure to Indian equities was a key contributor to returns. He says that, for example, the Indian agrochemical company, UPL, a long term holding in the portfolio, has continued its strong run of performance. Given the quality and diversity of UPL’s branded generic business, Ian says that they have always felt that the company has been unfairly saddled with a valuation more akin to a commodity chemical business. An examination of UPL’s historical financials indicates a business of steady growth and stable profitability despite fluctuations in weather and commodity prices. He says that the company has managed to iron out these risks by diversifying its product and geographical mix. Also in India, the company’s holding in Adani Ports, the developer and operator of India’s fastest-growing port, added value due to a pick-up in cargo volumes after last year’s slowdown. Ian says that it also responded positively to the management’s commitment to reducing working capital. Ian believes that this business will benefit from sustained economic growth in India.

Amongst holdings in the small and mid-cap space, Ian says that Minth, a Chinese auto-parts manufacturer, added notable value on stronger than expected sales growth both in China and export markets. Importantly, he says that the company also demonstrated margin expansion as its investments in Europe and the US are beginning to bear fruit and it successfully takes market share in higher margin products such as aluminium trims. This led to a re-rating of the shares.

Conversely, having been a strong performer in recent years, Ian says that the holding in Korea Electric Power has lagged the broader market’s rise. The concerns revolve around the recovery in coal prices, a major cost for the company, and the possibility that the government will cut electricity tariffs for some residential users. However, Ian says that they believe that the market is overestimating the impact of tariff cuts which would likely have a marginal effect on profitability and underappreciating the government’s incentive to encourage investment and dividends by ensuring that the company generates acceptable returns. Ian also says that they believe that the large increase in the international coal price will be unsustainable.

Finally, a large detractor was EVA Precision Industrial Holdings, a small cap manufacturer of high-quality moulds and parts for photocopiers used mostly by Japanese office equipment companies. Ian says that the company’s share price suffered as some of its clients have delayed the launches of new products due to weak end-market demand, which led to sluggish sales growth. However, he says that they remain positive on the outlook for the company over the medium term and that they believe that the company will begin to show improved earnings momentum as it brings on its first plant in Vietnam and its new investments in the auto sector begin to bear fruit. Ian says that, at current prices, EVA is offering a free cash flow yield in the high teens making it one of the most undervalued stocks in the portfolio.

In terms of the outlook for Asian economies and markets in 2017, Ian says that economic growth is likely to remain anaemic for a number of reasons. He says that export growth, a key driver of growth at the margin is not expected to improve much as global growth is unlikely to rise significantly and it remains to be seen what mix of policies the President-elect Trump administration pursues. Ian says that, while tax cuts and infrastructure spend would be positive, protectionist policies would clearly be negative for Asian export growth. Domestic consumption is expected to remain robust in China and increase in India once the impact of rupee demonetisation washes through. However, Ian says that it will likely continue to be subdued elsewhere – in particular, the debt overhang in South Korea, Malaysia and Thailand renders it difficult for these countries to stimulate consumption significantly. The outlook for investment spending is mixed across the region in Ian’s view. He says that China’s determination to meet its 6.5% growth target and maintain stability ahead of the important politburo transition in 2017 is likely to lead to continued high infrastructure investment. Elsewhere he says that it seems unlikely that private sector capex will spearhead a revival in investment. In India and the ASEAN economies, government spending is likely to increase but not to levels which would result in a growth boom.

Asian corporate earnings growth has been sluggish in the past three years reflecting a weaker growth environment. However, Ian says that they believe that market expectations of future growth are now much more realistic than before. He says that the fact that the earnings revision ratio has turned up in recent months supports this view and that they are currently expecting high single-digit earnings growth for 2017. In terms of valuations, Ian says that the region trades at 13x 2017 price to earnings and 1.5x price to book, which places Asia in the middle of its range of the last 5 years. Ian says that this is probably fair given the improvement in earnings momentum going into next year but that it realistically requires earnings to surprise further on the upside to see additional sustained progress for markets. However, he says that one of the major attractions of the region at these levels is that it remains at a large discount to developed markets.

Invesco Asia Trust has a strong half year : IAT

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