(May 27): Investors should probably brace for a protracted impasse on trade talks between the US and China. After the latest round of tariff hikes by both countries, China appears to have hardened its stance, with state media ramping up nationalistic rhetoric. The US blacklisting of Huawei Technologies raised tensions further and has widespread repercussions for many companies that are part of the complicated global supply chain.
In fact, should the tariff war turn into a bona fide tech war, it is very likely to spell the end of this bull market.
A tit-for-tat will stop the export and sharing of technological innovations and materials that will, in turn, have a negative impact on the future growth of technology. This is critical, as many tech businesses are valued on the basis of exponential growth from network effects and continuous innovation. A tech war must surely mean a major collapse in prices for tech stocks, which translates into huge losses for not only traditional funds but also private-equity funds.
We are holding on to the stocks in our portfolio for now. It is hard to tell whether US President Donald Trump is serious about checkmating China’s future technological challenge or merely grandstanding.
Stocks in my Global Portfolio traded broadly lower in line with declines in global markets. Last week’s losses pared total portfolio returns to 3.3% since inception. Over the same period, the benchmark MSCI World Net Return Index is up 3.4%.
Shares in Alibaba Group Holding and Apple were some of the worst affected as the scope of the trade war widened into the technology sector. Alphabet too found itself entangled in the ban on Huawei. Meanwhile, shares in Sunpower Group too came under heavy selling pressure amid weakened sentiment. Shares in Ausnutria Dairy, on the other hand, have held up better.
Alibaba
Shares in Alibaba declined sharply in the past few days as sentiment deteriorated on the back of heightened tensions between the US and China. But we believe its underlying fundamentals and future prospects remain intact.
Alibaba owns the world’s largest retail platform by gross merchandise volume (GMV), totalling RMB5,727 billion ($1.1 trillion) for FY2019 ended March 31. That dwarfs Amazon.com’s GMV of some US$277 billion ($382.7 billion) in FY2018.
The company reported a good set of earnings in the latest 4QFY2019, weathering both the trade conflict and global economic slowdown. Total revenue for FY2019 was up 51% y-o-y to RMB376.8 billion and 39% y-o-y if we exclude newly consolidated ventures, unrivalled by any company above the US$450 billion market cap threshold.
Sales for core commerce, which accounted for 86% of total revenue, grew 51.1%, with a healthy Ebitda (earnings before interest, taxes, depreciation and amortisation) margin of 42.1%. In the near term, Alibaba intends to capture user and merchant acquisitions in lower-tier cities and strengthen the online-to-offline (O2O) model by promoting stronger alignment between vendors and customers.
On the other hand, the rest of its businesses, including cloud computing (which expanded 84.5%), digital media and entertainment, as well as a host of other investments remain in the red. This dragged overall Ebitda margin from 38.8% to 28.4%.
Investments such as Alibaba Pictures and food delivery platform Ele.me are cash-burning ventures that are still in their infancy stages. They form part of Alibaba’s strategy to fortify its leading presence across multiple sectors of the economy.
These expansions are supported by the company’s strong cash generation. Free cash flow rose 4.5% y-o-y to RMB104.5 billion, despite the 60% increase in capital expenditure.
Net profit totalled RMB87.6 billion, up from RMB64 billion in FY2018. The company has provided revenue guidance for RMB500 billion in FY2020, implying an impressive 32% y-o-y growth despite its size.
Alibaba is well positioned to gain a greater share of the growth in consumer spending, monetisation through enhancing value and cross-selling opportunities and leveraging its deeply entrenched ecosystem as China makes a transition from an export-driven to consumption-based economy.
Apple
Apple is widely seen as one of the US companies most exposed to deteriorating relations with China. Revenue fell 5.1% y-o-y in 2QFY2019, which the company blamed on weak iPhone sales in the world’s second largest economy. China contributed to roughly one-fifth of total sales in FYSep2018 but only 16% in 1HFY2019.
The company indicated improvement in more recent sales trend, aided by the lowering of iPhone and accessories prices in China. That was before this latest round of altercation, however, which could trigger anti-US sentiment.
Its shares are likely to remain volatile in the near term, dictated by the unpredictability of how the trade war progresses. We are keeping a close eye on the evolving situation and are prepared to sell the stock if tensions escalate further.
Over the longer term, Apple will benefit from upselling to its 1.4 billion users on all devices worldwide. Services — seen as the future growth driver — continued to grow strongly, up 25% y-o-y to US$11.5 billion, in the latest quarter. This encompasses sales from the App Store, cloud storage, Apple Care, Apple Pay as well as rising subscription fees. The company has unveiled several subscription services that will be its key focus areas, including for gaming, news, video streaming and music.
Alphabet
Alphabet, parent company of Google, remains the dominant player in the search engine space, accounting for some 90% of worldwide searches from desktops. The bulk of revenue is derived from advertising, where it controls about one-third market share in global digital advertising revenue.
The company disappointed in its latest 1QFY2019 results, with revenue falling slightly short of market expectations. This was attributed to intensifying competition from Facebook and relative upstart Amazon. Still, ad revenue was up 15.3% y-o-y to US$30.7 billion for the quarter. By comparison, ad revenue for Facebook grew 26.4% in 1QFY2019, but from a much smaller base (about 17.7% global digital advertising market share).
Positively, other revenue, including cloud services, hardware and app sales, increased at a higher 25.1% clip to US$5.4 billion in 1QFY2019. Total turnover was 16.7% higher for the quarter at US$36.3 billion.
Alphabet has unique market positioning and global dominance across various businesses, many of which it has yet to fully monetise. For instance, it has eight products exceeding one billion in monthly active users, including YouTube, Gmail, Google Maps, Chrome, Android and Google Play Store. It is also well ahead of the competition in self-driving and autonomous vehicles.
The company is sitting on more than US$105 billion net cash and generated some US$7.3 billion in free cash flow in 1QFY2019.
Sunpower Group
Elsewhere, shares in Sunpower succumbed to broader market selling pressure — even though the company reported upbeat results for 1QFY2019. Smaller-cap stocks do tend to suffer more in an investor risk-off environment.
The company’s green investment segment continued to register good growth, on the back of strong ramp-up in utilisation. GI revenue almost doubled from RMB125 million to RMB287 million and Ebitda grew from RMB35 million to RMB87 million.
There are currently seven projects in operation, earning double-digit internal rates of return. Two more projects are under construction, targeted for completion later this year. In addition to organic growth, Sunpower aims to secure new customers, following the mandatory closure of small “dirty” boilers and relocation into industrial parks.
Sunpower has so far invested and committed RMB1.3 billion in equity to build up its GI portfolio, and is on track to raise this amount to RMB2.5 billion by 2021.
Meanwhile, its manufacturing and services arm is operating at full capacity and will focus on higher-quality orders to improve yield. Its orderbook stands at roughly RMB2.5 billion. Underlying net profit for both business segments was up 30.7% y-o-y in 1QFY2019.
Ausnutria Dairy
Shares in Ausnutria held up comparatively well in the market selloff and is the best-performing stock in my portfolio. The company’s integrated business model — from raw milk collection and processing to end-market sales — continues to benefit from growth in Chinese consumer spending.
To recap, Ausnutria operates 10 milk powder processing factories (in China, the Netherlands, Australia and New Zealand) and markets them under its own brands, mostly in China, where imported milk formula enjoys better reception than locally sourced milk formula over safety concerns and taste.
Ausnutria is the largest importer of infant formula goat milk, representing 62.5% of total import volume in China. Known to have less allergenic protein, more digestible fat and less lactose than cow milk, goat milk infant formula market is enjoying strong double-digit growth, albeit from a small base.
Total revenue grew 29% y-o-y to RMB1.5 billion in the latest 1QFY2019, of which 82% is contributed by sales of its own-brand milk products. The shift away from original equipment manufacturer business is translating into better overall profitability, as margins for own-brand products are double that for OEM sales.
The company is also focusing on higher price point products. For instance, ultra-premium infant formula product now represents 62% of sales, up from 38% in 2017, while mid-range formula products have declined from 32% to 5% of sales. Net profit (adjusted for one-off items) was up sharply, from RMB104 million in 1QFY2018 to RMB195 million in 1QFY2019.
Tong Kooi Ong is chairman of The Edge Media Group, which owns The Edge Singapore
Disclaimer: This is a personal port- folio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/ sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.
This story appears in The Edge Singapore (Issue 883, week of May 27) which is on sale now. Subscribe here
