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Emerging Market Viewpoints – October

Wednesday, October 31, 2018

Latest Emerging Market Viewpoints
From Matt Linsey and the North of South Capital team

Taiwan remains one of our favourite markets. It enjoys the lowest cost of capital in the emerging market universe and has a large number of companies with net cash on the balance sheet. Many of these stocks pay dividend yields in excess of 5.0% and are often majority controlled by their management.

Since the inception of our fund at the end of November 2004, Taiwan, as measured by the TWSE Index, has provided an annualised return of 9.13% in U.S. dollars. What is interesting is that most (over 60%) of this return has been through the payment of dividends. By contrast, the S&P 500 has provided an annualised return of 9.04% in U.S. dollars over this period, with dividends accounting for a little less than one third of this return.

We would argue that the payment of generous dividends by Taiwanese companies means that the return profile of the market, both historically and in the future, is of better quality than that of a market with a lower dividend pay-out ratio.

Given its low cost of capital (the benchmark 10 year yield is less than 1.0%), Taiwan arguably should trade at a significant valuation premium to most markets. This is particularly true when unlike other markets with low interest rates (Japan and Europe most notably) Taiwan is actually growing steadily (3.4% annualised in the latest quarter), has a very low Government debt to GDP ratio of only 30% and does not have a Central Bank that is trying to supress bond yields.

In Taiwan’s case there are a number of reasons why the market trades as such a significant “discount” to its cost of capital. Chief amongst these are its reliance on the technology sector and its uncertain status as a sovereign nation. China’s “One China policy” is at the core of their relationship with other countries. This is a highly emotional issue for the Chinese authorities. One example is the demand on the part of the Chinese authorities that U.S. airlines only refer to the city name in Taiwan to where they fly, and not to Taiwan as country or entity.

The risk of upsetting China should not be underestimated, with even those most close to the situation inadvertently crossing unseen red lines. Gourmet Master, a listed food service company in Taiwan with operations also in the U.S. and China made this mistake. The Taiwanese President was photographed visiting one of their outlets in Los Angeles having a cup of coffee. An immediate backlash ensued, with a number of Mainland based newspapers and bloggers threating a boycott unless an apology was issued. As a result Gourmet Master lost over $300 million in market value over a three day period.

Taiwan’s dependence on the technology sector has also been in focus given the recent trade dispute between the U.S. and China. This has been further exacerbated by a report by Bloomberg news of the finding of a malicious hardware chip on a motherboard produced by the U.S. based company Supermicro in China. Although not confirmed by the U.S. Government this resulted in a significant de-rating of those companies with production facilities in China.

Despite all this uncertainty we believe that the recent market correction has provided an excellent opportunity to accumulate well run businesses with a long history of compounding value for investors. One extreme example of value is Gigabyte, a manufacturer of motherboards used in personal computers and data centres. Although data centre growth is beginning to slow and the risk of further trade tensions and rising tariffs between the U.S. and China a distinct possibility we believe that this already fully reflected in current valuation. Gigabyte has a net cash position, accounting for 60% of its market capitalisation and trades on a prospective 2018 EV/EBITDA of 2.5x.

Over the past four years Gigabyte has increased its earnings per share by more than 50%, while its enterprise value has fallen by one third in U.S. dollar terms. Yes, demand is predicted to slow for their products, with earnings anticipated to fall by over 25% year on year in 2009. Nonetheless, this highly cash generative company should be able to more than adequately cover its current 10.25% dividend yield from operating cash flow.

Sinbon Electronics, a manufacturer of cables, connectors and modems is prime example of a company that has grown its earnings per share over an extended time period. Over the past ten years it has seen its revenues triple in U.S. dollar terms. At the same time Sinbon’s earnings per share have gone up six fold as the company has consistently expanded its margins. It has also consistently paid out an attractive dividend, with the current yield at approximately 5.0%. This more than justifies a prospective price earnings ratio of 14x 2018 earnings.

IMPORTANT INFORMATION | Issued and approved by Pacific Capital Partners Limited, a limited company registered in England and Wales, authorised and regulated by the Financial Conduct Authority. The information contained herein is not approved for use by the public and is only intended for recipients who would be generally classified as investment professionals. Information or opinions contained in this article do not constitute an offer to sell or a solicitation, or offer to buy, any securities or financial instruments or investment advice or any advice or recommendation in respect of such securities or other financial instruments. Where past performance is shown it refers to the past and should not be seen as an indication of future performance.

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