Latest Emerging Market Viewpoints
From Matt Linsey and the North of South Capital team
The recent search for yield on the part of investors has seen a remarkable compression in spreads over the past year. Highly leveraged Chinese property companies have been amongst the chief beneficiaries of this euphoria, with a gross issuance of more than $14 billion in debt this year.
Despite having a debt to EBITDA ratio of over ten times, Evergrande has seen the yield on its five year U.S. dollar bonds fall to less than 7.0%. It is almost impossible now to find, with the exception of Venezuela, any emerging market dollar bonds with a yield to maturity of over 10.0%.
Although investors normally do not cite dividends as a reason for investing in emerging market equities, the massive spread compression in emerging debt yields has significantly improved the attractiveness of emerging market equities relative to their fixed income equivalents. As a result, the current dividend yield on our asset class of approximately 2.9% is quite attractive compared to the yield available on “risk free” domestic debt as well as U.S. dollar denominated Emerging Market external debt.
The overall yield on the asset class of 2.9% hides a wide disparity across markets. It also does not properly illustrate the attractiveness of dividends in some markets relative to the yield available on domestic debt instruments. In this regard Taiwan remains our favourite market to own high dividend yield stocks. The overall market dividend yield of 3.5% provides the highest spread to the domestic bond market (ten year Taiwan dollar domestic bonds yields 1.0%). Also, companies in Taiwan are generally cash rich, are often owned by their founding member(s) who rely on the dividend for income and almost always have very explicit dividend pay-out policies approved by the Board of Directors.
Our own portfolio in Taiwan has a prospective dividend yield of 5.0% with all companies having net cash positions ranging from a low of 5.0% to 40.0% of enterprise value.
One example is Sitronix a fabless semiconductor company that designs display driver integrated circuits for the mobile and automotive industries. The company jokingly refers to itself as a leader in “lagging edge” technology as it focuses on markets segments such as feature phones, a sector that competitors have recently ignored. As a result they have become the dominant player in the segment and have managed to more than double its earnings per share over the past year as well as maintaining net profit margins in excess of 10.0%. Sitronix balance sheet is also conservatively managed, with cash representing approximately a quarter of its market capitalisation. Despite its strong track record Sitonix trades on a prospective 2017 price earnings ratio of only 12x and a dividend yield of approximately 6.0%.
We do also like markets where dividend yields are less spectacular. For example, the yield on the Korean market is only around 1.5%, compared to a 10 year bond yield of 2.1%. In this case however, the low yield is not a result of valuations but of low pay-out ratios. For the KOSPI this sits at a miserly 18%, although that is an improvement from the average of 13% during 2010-2014. If Korean companies were to pay out 60% of earnings like their Taiwanese counterparts, this would imply a dividend yield of 5% on the index, which is almost 3% above the 10yr bond yield.
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