SINGAPORE (Dec 27): With the US-China trade war having dragged on for nearly two years now, the global supply chain, particularly in electronics manufacturing, is being reconfigured. This trend will be irreversible, regardless of what US President Donald Trump says, according to veteran fund manager Wong Koi Hoi of APS Asset Management.
Even if manufacturers stay put in China, they will be looking for other locations if they are building new capacity. “They cannot subject their companies to such huge political risks. Trump’s successor may do the same thing,” Wong, founder and group chief investment officer of the firm, tells The Edge Singapore.
“You don’t want your viability to be influenced by political decisions, which can be made just like that. So, especially for manufacturing companies making products in China to export to the US, they have this fear that the levies, tariffs on their products will increase.”
For these manufacturers, the Plan B forced upon them is to go to other Asian countries. Vietnam has emerged as the big winner, although other countries such as Malaysia are enjoying spillover effects too. According to Wong, industrial estates near Kuala Lumpur are seeing new demand from Chinese companies.
Unfortunately, this big shift will be costly for everyone. The production of goods such as shoes and garments can be shifted quite easily to other countries. Not so, however, for electronics. For example, a smartphone has about 100 different components.
If all the suppliers were to move, it would take four or five years for the whole ecosystem to do so. “That’s a humongous task,” says Wong.
In addition, while costs go up, quality will go down, as new production workers have to be hired and trained, and it will take time for them to attain the level of proficiency of workers from the original production locations. As a result, consumers will be forced to pay more as manufacturers, suffering lower margins, pass along costs that they cannot absorb. “It is bad for the entire world,” says Wong.
World trade, already struggling to grow, will now shrink; capital expenditure, already deferred in many cases, will be held back indefinitely. “You have no idea in this de-globalised world whether you are able to sell.
You are not sure what will take place from here. Will it get worse? Consumption has already slowed, but is still quite all right; and, of course, economic growth will stall as well, because of the slowdown in growth, global trade, capex and so on,” he says.
For Wong, the big question is whether there will be a US recession in the coming year or two. Parts of the US manufacturing sector are already in a decline.
Severe de-FANG?
Some market commentators have recommended that investors bet more heavily on the non-manufacturing-related technology sectors, especially those with digital products and services as their core: the so-called FANG stocks of Facebook, Amazon.com, Netflix and Google (now trading as Alphabet). These four companies have been doing exceedingly well in the past decade, have captured market-leading positions and are seen to continue surprising on the upside.
Yet, Wong believes the FANG stocks might suffer from a “severe correction” in the coming decade. Apple, for one, is essentially a one-product company, with its flagship iPhone, introduced in 2007. He is pessimistic about Apple because the company has struggled to generate breakthroughs in the recent models of the iPhone.“It is quite clear Steve Jobs took Apple’s innovative juices to his grave. Have you seen any major innovative new features in the new iPhones? No. Apple had to cut prices on its last two iPhone models to sell,” says Wong.
When it is pointed out that Apple’s current market value of US$1.2 trillion ($1.6 trillion) is five times higher than when Jobs died, Wong wonders how long this run can be sustained. “Has any consumer electronics company in the world that stopped being innovative stayed at the top? None,” he says, referring to old names that used to occupy the top perch such as Japan’s JVC, Matsushita and Sony Corp.
Google and Facebook face different challenges; they will be the target of growing scrutiny from both US and non-US regulators because of the massively widespread way in which they collect and use data. For example, Facebook owns the popular messaging platform WhatsApp. “They might be subject to regulations where they won’t be able to use their monopolistic power to charge their premium rates. Or, they might even be broken up,” says Wong.
Even if the FANG stocks do not face additional hurdles, Wong is also sceptical about how other investors value them.
Sony, for example, has undergone a multi-year restructuring, in which less profitable units such as PCs have been hived off, leaving profitable and growing ones such as its imaging chip-making division. Yet, the company is valued at just US$70 billion ($95 billion), less than 6% of Apple’s market value. “Investors have lost their sense of value,” he says.
While Amazon.com has established dominance in e-commerce, subsequently building a hugely significant cloud computing business, there is stiff competition from other providers. For example, a recent US government contract in cloud computing worth US$10 billion went to Microsoft Corp instead of Amazon. Competition is coming from smaller companies too. With e-commerce generating thin margins, Amazon might find it difficult to defend its trillion-dollar market capitalisation, says Wong.
Decent margin?
In fact, many other e-commerce players might suffer as well in the coming years and Wong would not be surprised if some of these companies go bust. Consumers, he suggests, have come to expect that the prices they pay online must be significantly lower than the physical retailers, thereby putting a squeeze on online margins. “How are they making money? That’s a big question mark. There’s a low barrier to entry, they can’t make a decent margin,” says Wong.
Furthermore, there will be more and more e-commerce companies entering the market, but their motivation is mainly to cash out eventually. “The game they play is the capital markets game. They want to go for a listing and they know they can’t make money, but, if they go IPO, they can,” says Wong.
Many companies positioning themselves as hot shots in the new digital economy — which includes ride-sharing and co-working, alongside e-commerce — will be facing the significant risk of limited capital from previously generous backers that are tightening their belt. “If the supply of capital gets cut off, they will quickly go bankrupt within a year because their cash-burn rate is so high,” says Wong.
Three picks
Wong is not entirely pessimistic of the technology sector but advises investors to look at companies selling “real technology”. They are in, for example, semiconductors, artificial intelligence, Big Data analytics and cybersecurity. “These are industries that will continue to grow; the demand for these kinds of technologies is ginormous,” he says.
He is especially bullish on some of China’s tech companies — those that have been identified as home-grown champions. The US is trying to contain China’s rise, and one way is by curbing the latter’s technological development. “China is now doubling down, even tripling their investment,” says Wong, who has shortlisted three stocks that are relatively safe bets for the coming decade. They have a common characteristic: They are plugged directly into China’s growth and not as exposed to non-China customers, which shields them from volatile US-China relationships. Wong believes they are also “recession-proof”, given the long-term, underlying growth fundamentals.
First, there is Venustech Group, China’s largest networking security firm and founded by Jane Yan in 1996. Yan, who holds a PhD in computing from the University of Pennsylvania, has built up a client roster comprising some of the biggest players among China’s public sector agencies and state-owned enterprises (SOEs). Those in the financial industry include The People’s Bank of China, Bank of China, Industrial and Commercial Bank of China; the three key telecommunications companies, China Mobile, China Telecom Corp and China Unicom (Hong Kong); the largest utilities and energy players, Sinopec, China National Petroleum Corp and State Grid Corp. State broadcaster CCTV and online giant Tencent Holdings are customers too.
The company was hired to provide network security for high-profile projects and events such as the 2008 Beijing Olympics. Less than two years later, Venustech went public on the Shenzhen Stock Exchange in 2010. So far this year, Venustech has gained about two-thirds to close at RMB34.10, which gives the company a valuation of US$4.3 billion and a historical price-to-earnings ratio (PER) of 56 times.
The second pick is China International Travel Service Corp, the country’s leading state-owned travel agency, which organises tours and related services to the domestic market. Along with growing levels of disposable income, the volume of Chinese tourists has surged. CITS Corp has also built up significant businesses in duty-free travel retail and real estate development. So far this year, it has gained around 42% to close at RMB86.05 on Dec 16, giving it a market value of some US$25.1 billion and a historical PER of 36 times. “This company sells to Chinese tourists, so they are safe, regardless of what happens on the Sino-US front,” says Wong.
Wong’s third pick is Hong Kong-listed foundry Semiconductor Manufacturing International Corp, which is China’s largest. However, relative to other market leaders such as Taiwan Semiconductor Manufacturing Co and United Microelectronics Corp, SMIC has some way to go. TSMC has a market value of about US$290 billion, nearly 40 times that of SMIC’s US$7.4 billion. Yet, this is a key reason SMIC will receive support from the likes of China’s SOEs and companies such as Huawei Technologies. “What if, for some reason, [Taiwanese President] Tsai Ing-wen wins the next election and turns hostile? Or, the US twists Taiwan’s arm to stop business with China? Supporting SMIC is like buying insurance,” says Wong.
